On the surface, the news seems good. The first half of 2015 delivered around 1,100 completed middle-market transactions and generated about $140 billion, according to preliminary data from Thomson Reuters. (See related graphic.) That’s roughly equivalent to the level of dealmaking conducted in the same period in the previous year. Considering that 2014 was the best year for M&A since 2007, the fact that 2015 is holding steady is a reason to cheer. And yet, there’s an undercurrent of doubt, with many dealmakers wondering: How much longer will the good times roll? Has the wave of M&A already peaked?
Building on momentum from the previous year, dealmakers experienced heightened activity during the first months of 2015. “Traditionally, June and July are our busiest months for new deal flow,” says Jay Jester (pictured, below) of Audax Private Equity, a lower middle-market firm based in Boston. “But in 2015, deal flow appears to have started even earlier. Q1 was very busy - only slightly behind the previous peak years of 2007 and 2008. And June marked the completion of our biggest Q2 ever. In addition, Q2 2015 was our second-best quarter ever, at 4 percent below our Q3 2012 record.” Audax announced several new platform deals in the first half of the year, including purchases of advertising company AllOverMedia in March, TPC Wire & Cable Corp. in May and medical-instrument maker Katena Products in June. Watch our video interview with Jester below or click here.
What, Me Worry?
The early flurry of activity sounds encouraging, but it’s also possible that 2015 will turn out to have been front-loaded. While PE firms saw a lot of leads, the fact remains that fewer deals made it all the way to completion in May than in April. And, after three months of increases on Mergers & Acquisitions’ Mid-Market M&A Conditions Index (MACI), early-stage deal flow dipped in May. In June, the MACI rose again.
Deal value and volume of completed deals also grew in June, but they fell short of the previous year’s June.
It may be that we’re at a pivot point.
“There are two schools of thought,” Jester muses. “One is: It’s been a long time since we had a downturn. It’s got to end. We’re doomed. And the other is: It’s been a very gradual recovery. We probably have a lot of room left to run. The answer is probably in the middle.”
Jester is optimistic that M&A in the lower middle market will continue to provide opportunities even if the environment changes. “There are a lot of things you can do with a small company, even if the economy slows a little.” As for 2015, Jester predicts will be a “record year” for the middle market.
Some say the current market conditions are likely to hold, but they don’t necessarily benefit all dealmakers. Widely available leverage from a range of lenders, including new breeds of alternative loan providers, such as business development companies (BDCs), has pushed multiples up to an average near 10 times Ebitda, approaching the historic highs of 2007.
The availability of leverage is new to the lower middle market, and the impact has been to intensify competition and raise prices, says Derek Spence of Striker Partners, a family-based investment firm in Wayne, Pennsylvania, that makes majority equity investments in small companies. Watch our video interview with Spence, here.
“The environment is challenging for everybody, because the multiples are so high,” agrees Steven Marcus, founder of Rainbow Capital LLC, an independent sponsor of private equity transactions located in Upper Saddle River, New Jersey. “I think this is going to continue for quite some time, which means it’s a great opportunity for sellers, but it’s not a good opportunity for buyers,” Marcus says. To see our video interview with Marcus, click here.
Peter Alternative (pictured, left) of Mirus Capital Advisors concurs. “It’s a phenomenal time to sell your business,” says Alternative, who also serves as president of ACG Boston. Alternative invests in technology, a sector he argues can withstand an economic slowdown. Watch our interview with Alternative, here.
Tech & Health Care Hang Tough
Software companies have lots of recurring revenues, and there’s nothing better for a private equity investor than recurring revenues,” Alternative says. “A lot of times, entrepreneurs running software companies are happy with the current state of affairs, and bringing in private equity with more of a growth orientation can be a real win-win.” Alternative lists several sub-sectors among the ongoing opportunities for tech M&A, including health care; marketing and advertising; mobile; data subscription services; security; and the so-called Internet of Things, which enables machines to communicate and provide services.
Capitalizing on the trends, many tech deals closed in the first half of the year, including one of the biggest middle-market deals. Gemalto NV, a developer of software and chips that make transactions more secure, bought data-protection company SafeNet Inc. for $890 million in cash in a deal that closed in January.
Another sector teeming with transactions is health care. The industry is expected to continue to benefit from consolidation opportunities triggered by the Affordable Care Act, a key provision of which was upheld by the U.S. Supreme Court in June. One of the biggest deals to close in the sector was the hostile takeover of Gentiva Health Services Inc. by Kindred Healthcare Inc. (NYSE: KND). The purchase, which closed in February, is one of many transactions we’re seeing among home-based health care services.
Fueled by a continued wave of biotechs, the health care sector has been a significant driver of initial public offerings, accounting for more than one in three IPOs for four quarters in a row, reports Renaissance Capital. IPO activity more than doubled during the second quarter compared with the slow first quarter, which hit a two-year low. The IPO market provided liquidity for private equity and venture capital alike, which together backed 77 percent of all offerings.
The Jewel in GE Capital’s Crown
The most closely watched deal of the year has been General Electric’s (NYSE: GE) sale of GE Capital, the lender responsible for half the loans made in the middle market. Dealmakers were especially interested in the fate of the Sponsor Finance group, which lends to PE-backed portfolio companies and is home to lending powerhouse GE Antares.
In a deal announced June 9, Canada’s largest pension fund, Canada Pension Plan Investment Board, agreed to pay $12 billion for the unit, beating a long list of big-name bidders that included reportedly: Apollo Global Management (NYSE: APO), Ares Management (NYSE: ARES), the Blackstone Group (NYSE: BX), Guggenheim Securities, Kolhberg Kravis Roberts & Co. (NYSE: KKR), Mitsubishi UFJ Financial Group Inc. (NYSE: MTU) and SunTrust Banks Inc. (NYSE: STI). Under the new owner, the group, now known as Antares Capital, plans to expand beyond senior debt into mezzanine and junior debt, CEO David Brackett tells Mergers & Acquisitions.
The intense competition for GE Capital’s Sponsor Finance group serves as a validation of the middle market as a whole, but it also may have come at the height of the M&A cycle. On Mergers & Acquisitions’ monthly polls, we’re starting to see signs that transaction pros believe growth will decelerate in the months ahead. While dealmakers polled in May forecasted roughly the same level of growth over the next three months as the next 12 months, those polled in June predicted significantly slower growth in the 12-month outlook. As the year unfolds, we’ll be watching the survey results and deal data very carefully.