The year may have gotten off to a bit of a slow start compared with a record-breaking 2018, but investment bankers and other advisors interviewed by Mergers & Acquisitions say they are very busy, and their forecasts for M&A in 2019 remain bullish.
They point to a lot of cash that must be deployed by strategic buyers and private equity firms alike; a healthy U.S. economy; and low interest rates. Competition for high-quality targets has never been more intense, especially for technology providers, they report, which means sellers are commanding high prices. It all adds up to a seller’s market.
A certain mood of urgency prevails, as dealmakers seek to close deals quickly, while conditions remain favorable. The advisors interviewed for this story say they don’t see signs of an impending recession; however they are closely monitoring bellwethers, including corporate earnings, wage pressure, global supply chains and slowdowns abroad. They are recommending that clients be prepared for an economic slowdown in the next two years.
Specialization is the name of the game, and investment bankers advise clients to seek targets with business-model stability, limited cyclical exposure and a recurring revenue business model. Technology, business services, healthcare, consumer and manufacturing are among the most promising sectors.
Here are Q&As with 8 prominent bankers and advisors.
Paul Aversano, Alvarez & Marsal
Cole Bader, Stifel
Karen Davies, Huntington National Bank
J.R. Doolos, KeyBanc Capital Markets
Andrew Jessen, William Blair
Derek Lewis, Harris Williams
Peter Lombard, Piper Jaffray & Co.
Christopher Stradling, Lincoln International
Middle-market M&A will continue to be robust, predicts Paul Aversano, Alvarez & Marsal
What is your outlook for middle-market M&A in 2019?
While still robust relative to historical levels, first quarter deal flow was generally down in terms of both volume and value, especially in sponsor-backed transactions. The majority of our clients attribute this to high valuation levels and intense competition for deals.
In general, I am bullish when it comes to M&A in 2019. The U.S. economy is fairly healthy; there is a tremendous amount of capital/dry-powder needing to be deployed; and interest rates are still at historically low levels and look like they will stay that way through the remainder of the year. Economically, I think we are at or close to the peak in the cycle, but I think in either a good or bad economy, middle-market M&A will continue to be robust.
Do you expect an economic downturn?
A downturn will happen at some point – just a question of when. Barring any unforeseen shock to the global economy, I would anticipate the U.S. economy to continue at current levels with consensus being 2.5-3 percent GDP growth. We are advising our clients to maintain pricing discipline on their deals as well as be very thorough and address up front their value creations plans for the business post-transaction.
How is the lending environment affecting deals?
The lending market appears to continue to be healthy – almost too healthy – as both commercial lenders and alternative financing sources continue to compete for deal financing.
What opportunities and challenges do buyers face?
The biggest opportunities for buyers tend to be in certain industry sectors where we are seeing a lot of activity, such as healthcare and technology. Challenges include: valuation, competition for deals, pressure to deploy capital, pressure to exit investments, technological disruption and digital transformation – just to name a few!
What opportunities and challenges do sellers face?
Not many challenges. I do believe it is a seller’s market, as the M&A process in the U.S. is extremely efficient. Biggest challenge I see is managing the competitive process, given the amount of capital out there chasing deals, as well as overly-aggressive buyers looking to transact. I believe it is a prime time to be a seller, given the amount of dry powder in the market, the pressure to deploy capital, and historically record-high valuation levels.
Which sectors and which types of deals are most promising?
Buy and build strategies seem to be coming back into favor; technological disruption and digital transformation driving both consolidation and divestitures; industries such as healthcare and technology.
Sellers need to have pristine capital structures, advises Cole Bader, Stifel Financial
What is your outlook for middle-market M&A in 2019?
Overall deal activity in the first quarter was certainly choppier than in 2018. Geopolitical worries over a possible trade war in Asia and the lack of resolution to Brexit in Europe tempered sentiment internationally. In North America, however, activity remained strong, as the stock market rallied back from its December lows. We expect middle market M&A to be particularly strong in 2019, especially in North America. Dealmaking should benefit from continued strength in the U.S. economy, historically attractive interest rates, and sponsors flush with capital. If we’re able to navigate the global uncertainty around Brexit and Asian supply chains, this is shaping up as another very strong year.
Do you expect an economic downturn?
Assuming no geopolitical shocks in the U.S. or beyond, we expect to see positive, but more muted, economic growth in 2019. Employment, consumer confidence and business sentiment are at or near record highs. We are, though, mindful of potential headwinds to watch, including wage pressure, uncertain global supply chains and more pronounced slowdowns abroad. A potential corporate earnings slowdown would also be problematic. As equity markets have strengthened and debt markets continue to offer attractive lending terms and rates, we are advising clients that now is an opportune time to raise capital, which bodes well for M&A.
How is the lending environment affecting deals?
Banks and non-bank lenders are being very aggressive, both in terms of leverage and terms that makes it particularly attractive for sponsors to execute middle-market transactions using that leverage. The competition from sponsors, combined with strategic buyers with healthy balance sheets, is creating favorable valuations for sellers.
What opportunities and challenges do buyers face?
There’s a plethora of good assets out there, for both stand-alone platforms and add-on opportunities. Entrepreneurs have been creating great companies over the last 20 years and they are still bearing fruit. In terms of challenges, there’s increased competition for purchasing assets from both strategic buyers and PE firms. That frothiness is creating relatively high valuations.
What opportunities and challenges do sellers face?
It’s still a seller’s market with intense competition for deals and significant transaction capital available. This combination is driving up multiples/valuations. That being said, buyers continue to be rigorous and disciplined in their diligence processes. If they find anything troublesome, they are quick to reduce their offered price. Sellers need to focus on having pristine capital structures, clean operations, and transparency on future revenues and profitability.
Which sectors and which types of deals are most promising?
Technology continues to be one of the largest sectors within M&A. The cycle of the last 20-plus years of venture capital and PE capital, paired with innovative entrepreneurs, has created a huge number of very attractive and innovative companies.
In a number of spaces, particularly in software and the Internet, we believe there will be a long runway of great transactions and outcomes for sellers for a while.
Private equity is interested in Baby Boomer-owned businesses, says Karen Davies, Huntington National Bank
What is your outlook for middle-market M&A in 2019?
With more than $1 trillion of private equity dry powder and strong balance sheets of the corporates due in part to tax reform in 2018, investors are clamoring for high-quality assets, and there is an urgency to deploy capital in the form of acquisitions. Our general view is that 2019 will remain a very active year for M&A, comparable to 2018. The back half of the year shows positive indicators for continued M&A volume across all sectors. Mid-markets and corporates continue to demonstrate revenue and Ebitda growth, albeit at a slower growth clip than 2018. The general underpinnings of the economy are favorable: positive GDP expansion, low interest rates and significant availability to liquidity in the capital markets and ready access to credit.
Do you expect an economic downturn?
We are suggesting to our clients and borrowers to be generally prepared for an economic slowdown in the coming two years. While there is no certainty to this, we are advising clients now to manage all forms of risk in preparation: interest rate risk, commodity input fluctuation risk and exogenous market shock risks inclusive of trade. We are also discussing with our middle-market Midwest-based privately held businesses that there is urgency to consider transition and succession planning and time the market for potential sale accordingly. There is a significant amount of wealth transfer that will be occurring with Baby Boomer-owned privately held businesses in the coming years. Private equity has significant interest in these businesses. Mid-market businesses considering a sale should consider it now as there is ready and waiting PE dry powder to support acquisitions. Sales that occur now will still allow room for organic growth pre-cycle. If sellers do not act now, they will likely need to ride out the cycle and gamble on future valuations post cycle.
How is the lending environment affecting deals?
Access to capital markets and credit remains robust. Interest rates are low, and high-quality assets are in demand for lending investors. The lending market is very competitive for high-quality assets, which translates to borrower-friendly structures at this point in the cycle.
What opportunities and challenges do buyers face?
Uncertainty with trade deal in China, tariffs, commodity fluctuations or an increase in interest rates could provide hesitation in investing in some sub sectors. Investing in cyclicals, such as automotive or building products, will be undertaken with caution.
What opportunities and challenges do sellers face?
Mid-market sellers have opportunity to transition wealth or take chips off the table now in a robust M&A market that could provide what may be peak valuations prior to a cycle. Pre-sale due diligence, such as quality of earnings and market study evaluation is imperative to understanding buyers’ interests and investment thesis, and maximize valuation to provide the cleanest and most timely execution. If sellers plan to remain on board and roll over equity, evaluate and pick your partners wisely.
Which sectors and which types of deals are most promising?
Healthcare, tech and business services are the most active with attractive valuations for sellers. Fragmented industries across all sectors provide attractive opportunities for buy and build investors.
The biggest challenge for sellers is standing out, says J.R. Doolos, KeyBanc Capital Markets
What is your outlook for middle-market M&A in 2019?
Compared with 2018, 2019 started slowly, but activity has picked up significantly in March and April. We expect momentum to continue through year’s end. In 2018, new tax code and tariff legislation were hot topics. In 2019, the market is watching for legislative changes that may have long-term impacts, but the focus has been more granular – on company- and industry-specific fundamentals. Although 2019 started slowly, we expect mid-year transaction momentum to continue into the fourth quarter but believe the year will end relatively flat year-over-year. Given the backlog of sell-side mandates throughout the industry, we expect the number of deals to increase quarter over quarter in the second and third quarters, which will lead to a spike of deal closings during the back half of the year.
Do you expect an economic downturn?
We do not anticipate a downturn within the next 12 months. With the Fed planning to stabilize rates for the remainder of the year, we expect the leverage markets to remain healthy and corporate earnings to continue to grow while jobs are added to the economy and disposable income increases – all of which support growth in the equity market and M&A activity.
How is the lending environment affecting deals?
Leverage levels remain strong but below the peak levels of 2017. Traditional lenders are focused on potential cyclical impacts and risks unique to each business they review. They have a keen focus on a company’s variable cost structure and performance during the last recession. Direct lenders continue to find creative ways to reach higher leverage levels. Yet most PEbuyers are not opting to take maximum leverage. They are taking a conservative approach to allow for credit availability to fund capital investments or future acquisitions.
What opportunities and challenges do buyers face?
The biggest challenge for buyers is competition for high-quality assets. Financial and strategic buyers are mainly looking for the same characteristics in targets – an opportunity for growth, diversification and sustainability. With record levels of private equity dry powder and cash on company balance sheets, investors are looking for M&A as a main vehicle for growth. In a competitive process, this can push buyers to valuations that put the targeted return on that asset at risk.
What opportunities and challenges do sellers face?
The biggest challenge for sellers is standing out in a crowded M&A market. Most companies have experienced meaningful growth during the past decade, and there continues to be a plethora of companies available in the market. Buyers are quick to make decisions about what is worth spending their time to pursue at a value that makes sense. It is critical for companies to be prepared for a sale process and convey the unique merits of their business to potential buyers early in the process.
Which sectors and which types of deals are most promising?
The sectors that offer the most opportunities are those with inherent business-model stability and limited cyclical exposure. The most coveted assets are necessary business services, regardless of economic conditions, and manufacturing, that have a visible, recurring customer base centered on nondiscretionary spending.
Pitch activity is high, reports Andrew Jessen, William Blair
What is your outlook for middle-market M&A in 2019?
Our pitch activity continues to be very active in line with 2018 volumes, which is a good predictor for 2019 M&A deal volume. Private equity and corporate buyers remain very aggressive.
The private equity fundraising environment has been great, with many firms raising new and larger funds. This large inflow of capital will fuel continued investment activity. The middle market has also seen increased buy-out activity by larger private funds who traditionally focused on multi-billion dollar transactions but are now also acquiring high growth middle-market platforms. Furthermore, there has been an activity uptick in family office and direct LP investing. This broad base of investor appetite, combined with a strong economy and company performance, has created an attractive environment for sellers.
Do you expect an economic downturn?
We do not see any signs of an economic slowdown or downturn in 2019. However, the sensitivity of both investors and lenders to a possible cycle has increased. We are advising clients to focus their growth investments on customer and market segments that are more recession-resilient and less discretionary. We are also advising clients to prioritize infrastructure and resource investments in areas like technology that increase productivity and create more variable and flexible costs. This way, companies can minimize both the revenue and profit impact of a potential downturn, which makes them stronger, and more valuable businesses.
How is the lending environment affecting deals?
The middle-market lending environment remains healthy, due to significant committed capital within the direct lending community. However, the market has begun to bifurcate, with challenging and/or cyclical credits seeing increased scrutiny as lenders exhibit caution regarding the current (late) stage of economic cycle. This dynamic is particularly true with respect to junior debt, as lenders increasingly shy away from such positions in favor of first dollar (senior or unitranche) structures. On the flip side, lender appetite for attractive, non-cyclical credits remains robust, which continues to drive attractive leverage and terms, and commensurate M&A valuation multiples.
What opportunities and challenges do buyers face?
Middle-market investing is more competitive than ever. The increased amount of funds to invest, domestic and international strategic buyer engagement, larger PE funds “playing down” and an influx of alternative investors has made it more difficult to win a sale process.
What opportunities and challenges do sellers face?
Sale processes are moving much faster, so the amount of pre-process preparation has meaningfully increased. This includes diligence preparation, data analysis, and third-party reports, such as quality-of-earnings and industry studies. These activities take time and require more upfront expenses prior to a sale. Also, buyers have become wary of sales processes and are more selective. This makes it challenging to get time and attention of buyers. These activities have increased the amount of time and attention management teams spend on a sale process versus running their businesses.
Which sectors and which types of deals are most promising?
We are seeing strong, sustained activity across our core market segments in technology, healthcare, consumer, services and industrials.
Buyers require more data from sellers, says Derek Lewis, Harris Williams
What is your outlook for middle-market M&A in 2019?
We have seen robust levels of activity to date in 2019, similar to what we experienced in 2018, and continue to see our backlog grow. Despite M&A volume market wide trending slightly down over the last few quarters and the volatility in the public markets in January, high-quality companies are still attracting a lot of attention from strategic and private equity investors. There is a significant amount of dry powder among private equity groups and cash on corporate balance sheets to be invested, and the pressure to deploy capital should keep valuations near all-time highs.
Do you expect an economic downturn?
We’ve been in a very long upcycle and people keep looking for the turn, but there aren’t signs of it happening yet. The data shows that debt isn’t over extended, unemployment is very low, and companies are performing well. The outlook for M&A activity remains positive, due to slowing opportunities for pure organic growth, as well as high demand among strategics and private equity to put capital to work. Quality businesses, especially those who have a history of performing well during recession, will continue to be very attractive assets. If there is a downturn, we are anticipating it to be a shallow recession and the M&A markets should remain largely insulated because of the amount of available capital.
How is the lending environment affecting deals?
The lending markets are very strong, which is setting a floor for valuations. Robust leverage levels in M&A deals, supported primarily by non-bank lenders in the middle market, should continue to keep valuations high. These alternative lenders are hyper-focused on serving the private equity community and sponsor-backed deals. The current state of the leverage markets is equaling the playing field between private equity and strategics. For strategics, the bond market is strong, and debt continues to be cheap.
What opportunities and challenges do buyers face?
We have seen an interesting dynamic in the buyer landscape recently, primarily due to the imbalance in supply of high-quality deals coming to market and the high demand among strategics and private equity groups. S&P aggregate cash positions (excluding financial companies) have hovered near $1.5 trillion over the last few years, and PE dry powder is hovering over $1 trillion, creating immense competition in the market. With this in mind, investors should be aggressively pursuing assets of interest and, at Harris Williams, we are keeping an open dialog with investors across the board.
What opportunities and challenges do sellers face?
Sellers have a unique opportunity in today’s market, given where we are in the cycle and the pressure for investors to deploy capital. The competition in the market and the available capital are keeping valuations at near all-time highs. While buyers are willing to pay premium valuations, they are requiring increasing levels of data from the sellers in order to support those valuations. Therefore, companies which have tracked and organized data with a sale in mind are in a much better spot than those that have not.
Which sectors and which types of deals are most promising?
At Harris Williams, all 10 of our Industry Groups have been very active. Businesses, regardless of industry, who have a history of performing well across economic cycles are very attractive assets in today’s market.
Sellers should do a lot of heavy lifting up front, advises Peter Lombard, Piper Jaffray & Co.
What is your outlook for middle-market M&A in 2019?
Sellers are eager to take advantage of an M&A market that’s having a long run. Buyers are building recession scenarios into their models, and bankers are managing deal quality closely, avoiding weaker assets. 2018 was a great year for M&A activity, and I expect 2019 to remain strong.
Do you expect an economic downturn?
With each passing great year in M&A, probabilistically, the economic winds have to shift at some point, motivating sellers to explore their options now, rather than wait. We are working with clients to think about the impact of a recession on their projection models. We work to accelerate and de-risk the sale process and front-end load as much buyer due diligence as practical, with seller Quality of Earnings and often market studies. Deal quality at this stage in the cycle becomes ever more critical, as buyers analyze how targets might perform in a downturn.
How is the lending environment affecting deals?
Volumes for middle market loan issuance were down on a year-over-year and quarter-over-quarter basis in 1Q19, due to a lack of high-quality deals and light pipelines. Lenders still have a great deal of dry powder and are still willing to be aggressive on good credits. However, lenders are beginning to take a more cautious underwriting approach and are less likely to stretch on highly cyclical businesses given where we stand in the current cycle. In 1Q19 middle market M&A financings were down from both 4Q18 and 1Q18 by about 30% and about 35%, respectively.
What opportunities and challenges do buyers face?
It is a really competitive M&A market. To prevail in competitive auctions, buyers need to be disciplined and focus on where they have conviction around an investment thesis, and then be smart and efficient around risk allocation to present the seller with a package that convincingly can get to a closing efficiently and quickly.
What opportunities and challenges do sellers face?
Companies that are growing in a capital-efficient manner will command higher multiples than those that aren’t. This is obvious but critical, as the cycle matures, and buyers focus on the strength and resilience of the business. Sellers are well advised to do a lot of heavy lifting upfront to prepare for exit. The tradeoff sellers make is that the impact of negative surprises – or minor deviations from advertised performance – can be profound. The flip side of that reality is that tracking at or above performance enables optimal outcomes. Sellers need to think hard about what performance they want to be graded on during the process.
Which sectors and which types of deals are most promising?
Technological disruption across verticals continues to be a key theme, which points to the technology sector being a persistent focus for both strategic and financial buyers.Corporate divestitures also continue to be attractive targets for PE and other strategic buyers, as companies increasingly manage like PE owners and focus on optimizing core businesses and shed others.
Buyers should specialize, recommends Christopher Stradling, Lincoln International
What is your outlook for middle-market M&A in 2019?
We’re anticipating strong growth for 2019. We have M&A bankers with deep expertise in a variety of industries and what’s great about that – beyond being able to serve clients – is that if there is a cyclicality impact to one, others are likely not feeling that pressure. The mid market is powering the global economy – our middle market index continues to prove out that the private markets are providing more stability and sustained performance than the public markets.
Do you expect an economic downturn?
I don’t see a major correction happening in 2019. Companies overall continue to perform well. Low unemployment, rising wages and low inflation are all driving strong consumer confidence and spending. That said, it seems reasonable that sometime in 2020, we will see a modest economic correction.
How is the lending environment affecting deals?
The market is still pretty aggressive. Debt multiples are still 1 or 2 turns ahead of historic norms. Interest rates are still low. And there remains an over-abundance of debt capital available, so the supply/demand curves continue to favor potential borrowers.
What opportunities and challenges do buyers face?
On the deal side, competition for A-quality assets has never been greater. This is driving not only higher prices, but abbreviated sale and due diligence processes as well. In many cases, the winning buyers try to jump ahead of a sale process and perform third-party due diligence in advance of any formal bid. This is both a challenge and an opportunity. Winning investors need more than ever to specialize in certain sectors such that they can quickly and confidently select and pursue the best assets. On the operational side, companies that will thrive in the future economy will be very adept at harnessing the power of rapid technology while staying on the cutting edge of evolving consumer preferences.
What opportunities and challenges do sellers face?
White hot market - M&A sellers today benefit from very strong M&A market that is likely to last through and beyond 2019. Slow growth – while the economy is performing well it is still only growing at low single digit rates. This means that only a small portion of companies will be able to consistently grow at double digit rates. Those that can, will certainly gather significant interest from acquirers. Valuation asymmetry between buyer and sellers – with valuations creeping ever higher, sellers often develop unrealistic valuation expectations for themselves. At the same time, buyers get uneasy at such high valuations and then fixate on downside risk. The combination of these two dynamics is, in some cases, creating artificial value gaps between buyers and sellers.
Which sectors and which types of deals are most promising?
Specialize, specialize, specialize. With heavy competition, successful investors will have to form and continue to enhance specific areas of expertise.
The days of generalist investors using only financial engineering to drive 25%+ IRRs are long gone. Rather, those that thrive in the current market will have powerful insights in choosing the right investments and will provide significant operating value to their investments post-closing.