Unlocking Prospects in the Middle Market

An unusual cheering section is hailing the megamergers that are consolidating the top tier of investment banks into a handful of global juggernauts. It’s composed of regional investment banks, accounting firms, specialist boutiques, and other dealmaking advisers that traditionally have concentrated on the mergers and acquisitions middle market. Expansion of the bulge bracket operatives, they say, generates an exceptional opportunity for the smaller shops to bag a lot more highly lucrative m&a work, and they are gearing their talent-rich organizations to snap it up. Middle-market players not only expect to do more deals. They expect to do larger and higher-profile transactions, represent bigger buying and selling clients, and play a greater role in cross-border and private equity acquisitions and sales. In response to the potential for bigger paydays, they are bulking up professional staffs, widening operations to national scale, stepping up marketing efforts, and opening new offices. The betting is that at minimum the bulge bracket behemoths will cede the smaller advisers a large swath of nine-figure deals that they no longer can afford to handle. A consensus is that the advisory gap will open around the $300 million level but could go even higher – perhaps as great as $500 or more. The thinking is that with their new cost structures, the big firms will have to turn down anything that doesn’t generate at least $4 million to $5 million in fees. On the demand side, the middle-market advisers also stand to benefit from a seldom-publicized but longstanding edge in the relationship between Wall Street and much of Corporate America. Many companies of substantial – but less than giant – size long have complained of getting short shrift from the big investment banks and are expected to gravitate to the smaller shops that covet their business. “We will put an absolute full-court press on a $300 million deal,” says Mark Mealy, head of mergers and acquisitions at Charlotte, N.C.-based First Union Securities Inc. “That’s an event that would be of passing interest to the kinds of global firms that are being formed now. These boats are going out to fish in larger waters and are leaving the smaller waters for us, which we enjoy.” B. Andrew Schmucker, who heads the Philadelphia-based strategic advisory group at Legg Mason Wood Walker Inc., says that aside from the economics, the big banks face time pressures. In a mid-market transaction, he comments, “the details become more important, and it takes a different approach to process that kind of transaction.” “That’s what we are focused on – spending a lot of time on our own due diligence and working through the details,” he adds. Going upstream is not, however, a slam dunk. Michael Murphy, managing director at U.S. Bancorp Piper Jaffray warns that going upstream presents strategic and managerial challenges that must be handled with care. His firm, says Murphy, focuses on growth companies in both m&a and underwriting, and “the higher-growth companies tend to be smaller companies.” Moreover, he, in concert with most of his peers, believes that the middle market is an “underserved” area. “We see more opportunities to get bigger, but we have to be careful not to stray from our strategies that have been working well for us in the middle market,” he comments. “We are not pushing up-market but we are being pulled up-market because that is where our clients want to be.” Among the forces expected to shift an increased number of deals and dealmaking dollars to the middle-market advisers are: * Anticipated decisions by bulge bracket firms to concentrate on mega-transactions for the largest corporate buyers and sellers, often on an international scale; * Referrals of substantial deals that used to be the bread and butter of the bigger banks to reputable smaller advisers to keep the clients happy; * Alliances between the bigger and smaller firms aimed at directing overflow business to the middle-market players; * More joint advisory assignments among middle-market firms, including those belonging to networks such as the International Association of Merger & Acquisition Professionals (IMAP) and M&A International, to handle larger and more complex transactions; * A larger book of business from good-sized corporations that long have chafed about their treatment by Wall Street; * A heftier share of dealmaking on both the buy and sell sides for private equity firms, whose deals in recent years have tended to be in the mid-market range; * More intermediary work for privately held companies that are either buying other businesses or selling themselves; * The ability to recruit highly qualified dealmaking professionals who will be either forced out of the bulge bracket firms, or who will leave voluntarily in the belief that they will find greener pastures in the middle market. In many respects, the fallout of deals from the bulge bracket is less a windfall than an acceleration of trends underway for several years. Increased m&a business started flowing to mid-market shops well before the recent burst of banking mergers that linked J.P. Morgan & Co. and Chase Manhattan Corp., UBS AG and PaineWebber Group Inc., and Credit Suisse First Boston Inc. and Donaldson Lufkin & Jenrette Inc. One key reason is that the middle market has been consistently redefined to include ever-larger deal sizes and relentlessly boost the outer limits on prices. During the mid 1980s, the middle market was measured by transactions in the $25 million to $75 million range but by the close of the decade the cap was closer to $100 million. As dealmaking climbed in the 1990s and transactions grew larger across the board, the mid-market ceiling rose accordingly – to $150 million, then $200 million, and later $250 million. Now, the smaller shops talk of $300 million at the outer edge, but suggest that it may not stop there. David Braun of Washington, D.C.-based Virtual Strategies says that the bar was only in the $100 million to $150 million range as recently as five years ago. But he suggests that it was driven upward when more companies got into m&a and fished for larger and larger deals as they grew and honed their experience. He points out that $300 million deals are typically in the province of companies with market capitalizations of $1 billion, which puts them somewhere in the mid-sized range. “We moved with the bubble,” he says. “We have moved up as the tide has been rising.” “There is no question that the business has been migrating upstream,” says Stephen M. Blum, m&a director at KPMG Peat Marwick. “We regularly get eight-figure and nine-figure assignments now. A decade ago, it would have been in the tens of millions.” Part of that trend reflects the fact that the Wall Street banks already have been turning down or referring less than giant-sized transactions because they couldn’t make enough money on them. “They can’t afford to do deals for a $1 million or $2 million fee,” says Michael Hammond, head of PricewaterhouseCoopers Securities LLC, the investment banking arm of the big accounting firm, which has been referred deals by Salomon Smith Barney Inc. “The threshold fee has to be $4 million to $5 million.” The big banks often refer deals to mid-market intermediaries they can trust, he adds, because “you can’t say no too often to a lot of clients.” Michael Goldman, SVP of TM Capital Corp., which also gets a lot of referrals on mid-market deals, says that it typically is good business for firms of his size because the clients are often prestigious companies. “They are already pre-qualified as to quality,” he says. While rarely going public with their beefs, many buying and selling companies long have griped within m&a circles about the treatment they have received from Wall Street firms when their fees fall short of the highest brackets. The most annoyed clients are either mid-sized or fall just below the giant class and are least likely to regularly execute megadeals. They frequently complain about the fees they pay and are said to be even more annoyed at the low experience levels of the bankers put to work on their deals. “They may get the attention of the largest firm,” notes one intermediary, “but they don’t necessarily get the A team. They get the B team.” On top of that, the bulge bracket mergers have narrowed the choices at the top for Corporate America. By contrast, mid-market dealmakers say they are ready to put their top guns to work. “With the big houses, they can’t turn on the lights working with transactions of $50 million to $75 million to $100 million,” notes Stephen Goldsmith, head of Minneapolis-based Goldsmith, Agio, Helms & Co. “Quite honestly, on these deals you see teams of people who are two years out of business school. The companies are increasingly more sophisticated, and they are now coming to firms like us. They get nothing but senior-level attention, and we are staffed accordingly.” “We promise senior-level involvement,” says Michael E. Gibbons, senior managing director of Brown Gibbons Lang & Co. To that end, the Cleveland-based firm has been adding senior professionals and expects to take on more. One area in which it has paid off, Gibbons says, is “that we have managed to get the acceptance of larger companies to do divestitures.” S. Jack Campbell, president of MASI Ltd., based in Deerfield, Ill., points out that senior-level professionals are necessary to deal with and get access to people of comparable stature at client corporations, which are increasing in size. “As a natural consequence of what is taking place, we have been in the process of adding to our professional staff at the senior level and at the middle level,” he says. “We are investing in additional staff. This has been an active process at our firm for some time.” A lot of future hires are expected to be ex-Wall Streeters. Even if they are not pink-slipped, they may lose senior status or dislike the new environments, say mid-market operatives who are anxious to sign them up. In fact, the exodus already has started, with resumes beginning to pile up on the desks of small-shop m&a heads and calls from job seekers punctuating the day’s telephone traffic. “Our phone has been ringing off the hook with calls from professionals at the Wall Street firms,” reports James Simms, co-head of m&a at Boston-based Adams Harkness & Hill. “The competition is reduced, and for many reasons people are leaving those organizations,” comments M. Benjamin Howe, head of global m&a at SG Cowen Securities. “We have new people at the senior level and more are on the way,” says Gibbons. “Many are from the big banks.” Recruiting won’t be problem-free, the middle-market m&a managers admit. They are concerned about getting people with the right temperament to work with executives of smaller public companies and entrepreneurs. And there is a question of devising competitive pay packages for people used to big salaries and bonuses. The prospective employers say that regardless of an applicant’s professional skills, they intend to carefully screen him or her to ensure they are getting people with the people skills they want. The mid-market managers concede that they may not be able to match Wall Street dollar for a dollar in pure compensation but that they still can offer lucrative packages as well as a less pressurized job environment and senior status. “We can offer competitive salaries, and they have an immediate opportunity to make partner,” Goldsmith says. Besides bulking up on the people side, the smaller shops have been spreading their wings geographically by opening new offices in an effort to gain national presence. Many of the former Wall Streeters they hope to hire are expected to man these new outposts. In recent months, U.S. Bancorp Piper Jaffray has set up shop in Los Angeles and Adams Harkness & Hill in San Francisco while Goldsmith Agio Helms has moved into New York and Los Angeles. Simms says that Adams Harkness’ new San Francisco office is headed up by a “senior guy” who worked at one of the top-tier investment banks but was “eager to return to a smaller firm where there was more fun.” Some of the middle-market players are emphasizing differentiation or looking for niche opportunities to capture an increased book of available business. Arthur Andersen’s m&a practice, unlike many of its middle-market competitors, is built around industry groupings such as technology and energy, says Terry Brown, the head of corporate finance at the giant accounting firm. “That is the key to getting people and to getting business,” he states. We don’t think we will be engaged by clients unless we have specific industry knowledge. We won’t be able to get the $250 million to $500 million deals unless we know the space.” Brown adds that the corporate finance group, which numbers around 750 people across the globe, also has an edge in its ability to use other areas of Andersen’s expertis, such as taxes, auditing, and consulting, as well as the firm’s experience in international business to handle cross-border deals. Simms says that Adams Harkness, as a “research-driven firm,” has carved out specialties in technology and health care, especially biotechnology. The plan is to continue to emphasize those areas as the m&a practice moves into larger and more complex transactions. “We follow the research analysts,” he says. “They run the early warning systems on where the opportunities are. That is our way of differentiating.” While the general trend is to go up-market, some firms are moving more gingerly than others. At more than a few firms, there is some reluctance to exit the market for deals with a cap of $150 million because that sector is considered underserved and may mean substantial business as the larger middle-market shops go upstream. T. Patrick Hurley Jr., the m&a director at Summit Capital, which was known as Howard Lawson & Co. until its recent acquisition by Summit Bancorp, thinks that the lower end of the middle market still is the place to be. “The $50 million to $100 million area is still very inefficient and very lucrative,” he says. “We’re not shooting to go above $100 million.” The $50 million deal, he points out, still can generate a million-dollar fee, and that’s “fine for us.” The acquisition has given Summit Capital increased resources and manpower plus access to many Summit banking clients in a region ranging from southern New England through the Middle Atlantic states. But the challenge is to increase the business. “We’re going to be pushed to grow,” Hurley says. ” They want results, and we have to put the numbers on the board.” Linda Mertz, head of Milwaukee-based Mertz Associates Inc., says that her firm has concentrated on providing the “seasoned professional” who understands the nuances of smaller deals. “Our objective is to be a boutique firm, so we can work on the kinds of deals we enjoy doing rather than building a big firm,” she says. r Joan Harrison contributed to the preparation of this article.