Steering Eager Buyers To Willing Sellers In the Middle Market

The deal flow in the m&a middle market is moving at an unprecedented pace because the market is synthesizing a huge buyer appetite and a large supply of companies for sale. Companies willing to sell are linking up with armies of financial and strategic buyers scouting heavily for good deals. Five professionals who concentrate on the mid-market explain how they are matching these twin trends. Dealmaking Olio Mergers and acquisitions in the middle market are at an absolute zenith because buyers and sellers are coming together in unprecedented numbers. Whether marketing their companies for traditional personal reasons or in response to swift-moving strategic and financial trends, sellers invariably run into buyers who want or need their company. High prices, industry consolidations, and more aggressive searching by both strategic and financial acquirers are all stirring the pot. Competitive Tiering The middle market is uniquely split. Larger sellers or targets that enjoy some obvious marketplace advantage are most likely to draw the biggest number of interested bidders and the most intense competition sometimes through auctions. Smaller or commodity-sized companies, that sell for less than $50 million, tend to be offered in private, negotiated transactions. The Tug of Cash Mid-market sellers are very wary of accepting stock from a publicly owned acquirer. Many still regard stock as paper that is to be discounted when the final price is calculated, especially when the shares are selling at whopping multiples. While equity can be useful in consolidation plays and when selling owners are staying with the business, cash often is preferred for its liquidity and absence of downside risk. Non-Stop Buying Demand Acquirers plying the middle market know what they want and dig hard to get it. The dedicated buying population ranges from large companies looking for a special niche or technology to smaller firms executing consolidations to financial buyers needing to put their mega-billions to work. Whether approached to sell or reaching the sell decision on its own, a target company can find an interested taker somewhere in the buying spectrum. Pricing Beyond the Numbers Pricing of mid-market companies, as with most target companies, still is more art than science. Qualitative factors strongly impact the ultimate price. Size, market position, and earnings consistency would tend to buoy the bid price, but that may be just for starters. Dealmaking Olio M&A: Where are most middle-market deals originating these days? Is it from the traditional manner in which middle-market companies put themselves up for sale, from searching by strategic and financial buyers, from some combination of those, or from other factors? Warren: In the Midwest, all of those factors are resulting in a lot of middle-market activity. Companies are putting themselves up for sale for the classic shareholder and strategic reasons. Most sellers have five years of good earnings increases behind them and some of them are at a point where they don’t want to chance riding out the next down cycle in the m&a market. So, they are offering themselves for sale. Other sellers are squeezed by competitive pressures. This has been going on for more than five years because of such factors as globalization and the way big customers continue to whittle down the suppliers they want. There is a threshold in many industries of size and resources that are necessary to be successful and those companies that can’t cope are finding partners by acquisition, strategic alliance, or sale. On the buy side, strategic buyers are aggressively pursuing acquisition projects. Some of them are public companies on an earnings growth treadmill. Some are in consolidating industries and they need to broaden their product lines or reposition their service offerings. And some have special needs for technology or know-how that young, fast-growing, dynamic companies bring to them. We also are seeing cross-border middle-market activity both European companies looking in the United States and American companies doing deals in Europe and elsewhere, although Asian companies are on the sidelines now. Finally, the financial buyers are beating the bushes as never before. They have all been out raising unprecedented amounts of equity capital in the last several years and they are trying to put that to work. They become strategic buyers when they have a suitable platform company in their portfolio. They can then make some very savvy moves, and sometimes they wind up as market leader in some obscure niches, which can range from deli salads to gun safes. Wherever they operate they have a game plan with intended exit, for the five-to-seven-year time frame they are going to stay with the company. Deutsch: Clearly, the current tenor of the merger market is driven by many fundamental factors, such as globalization, the need for continued growth in earnings, and the tone of competition in certain industries. But I think the key determinant of today’s high level of merger activity is much more of a technical determinant than a fundamental determinant. Today’s peak level of m&a activity has more to do with such things as the buyer/seller balance and the overall level of public equity market underwriting and trading activity. There is an old adage in the stock brokerage business that securities aren’t bought, they are sold. I think companies are sold as well. Many of today’s sales are motivated by the tenor of this active merger market, by the tenor of the public equity market, and by the tenor of the currently easy credit markets. There is also an awful lot of buy-side solicitation going on much more than ever before. There are more active letter campaigns than I can remember by intermediaries and buyers who are actively beating the bushes. There are many more than in the past, and they are much more sophisticated than they have ever been. And there is greatly increased sophistication in buy-side data base management. Jordan Co., for example, maintains a vast data base of prospective targets so it can call on them directly. Berger: We have certainly seen very proactive activity on the side of buyers. They have gotten so much more aggressive, and it’s more than just mailings and phone calls. They are actively working the trade associations, actively calling on companies, and physically going out and seeing people. In the past, it was often a more passive approach a phone call or a letter and that was it. That makes a big difference, especially in the hinterlands of southern Georgia or lower Alabama. I think that everyone is involved in the m&a business. I am working on a deal right now that was brought to me from a hedge fund and another one that an advertising agency originated. I have even had a reasonably good-sized deal that my tailor brought to me. So, everybody is in the business these days! Goldenberg: We have seen a great deal of impact from the consolidators and the roll-up IPOs. Numerous roll-up IPOs have been done. Most of the companies that have been acquired in these roll-up IPOs have been middle-market and, frequently, lower middle-market companies in widely dispersed industries where there aren’t really a large number of players. Some of the deals have been successful, some of them have been less than successful. In addition, we are constantly being contacted by people who are trying to do private deals and they have a very specific platform company in mind. Getting the right platform is terribly difficult and you have to do a lot of hard work, literally around the country, to get the right company. There are other things that are at play in the marketplace. Sellers have become more interested in certain industries because the pricing of the deals for their particular type of business has moved up. One of our affiliates, which is somewhat of a specialist in machining businesses that supply the aerospace industry, has told me that on the smaller deals the multiples have moved up from the range of 4.5 to 5.0 to a range of 6.0 to 6.5. On some of the larger middle-market companies it is even higher than that. That is being driven by the demand for these businesses, many of which are now working triple shifts and even quadruple shifts and are running literally seven days a week, 24 hours a day to supply the needs of Boeing and other big companies in the aerospace industry. From my perch, the number of deals that are happening because the seller has put the company on the market for traditional reasons seems to be declining. I would say it is a smaller percentage of the deals that happen now. We are getting an increased number of assignments in which we are more actively doing searches for certain kinds of companies than we have done in a long time. Companies come to us because they don’t have the staff to run a continuing search program. Beier: My perspective might be a little bit different. My role in life is to advise financial buyers and strategic buyers in investment decisions and structuring the transactions that might be originated. It is very clear that financial buyers are extremely well-heeled and that there is a flight to employ capital, which is a huge, huge effort. My definition of the middle market tends to be bigger than what other people think so I am going to talk more in the context of $150 million to $1 billion in transaction size for the purposes of my comments. In that area, the financial-buyer plays are huge with respect to developing and searching for platforms and, once a platform is identified, aggressively pursuing build-up strategies. There are several firms that have been extremely successful in executing that strategy. I don’t know that I see much of a play by strategic buyers in terms of middle-market- sized companies, other than the trend in the high-tech business. There are some huge market-cap companies aggressively pursuing extremely small acquisitions. They are pursuing a specific technology or targeted personnel. Deutsch: To echo a point that Arthur made about the engagement of buy-side agents, we have observed a lot of work by a number of organizations such as Value Finders, ECDI, and relatively new on the scene smaller firms such as Markowitz & McNaughton and Trudeau & Trudeau. We have noticed these buy-side firms much more than in the past. The strictly buy-side agents are probably as busy as they have ever been. Beier: Clearly, sale prices are high, which seems to be a huge trigger. That creates activity. It puts the sale thought in the mind of a 50-year-old business builder who happens to be the chairman of a company that went public three years ago. He says, “Wait a minute. I can sell, take my $200 million, and reinvent myself into anything I want to do.” I have been involved in numerous situations in which that is a common theme. It is driven by the high market multiples, which also seems to drive non-public situations. Deutsch: I don’t think today’s level of value is, necessarily, the prime motivation; however, it does affect timing. Our clients still bring themselves to market for the same reasons they always have, but perhaps they do it a bit sooner and perhaps their preparation phase will be truncated, so they don’t want to miss the “window.” Berger: A lot of industries go through clear cycling from emerging to growth to becoming mature industries. The difference for middle-market companies is that the cost, the speed, and the risk of staying in business has changed significantly over the last 20 years. To stay in business and to continue to grow the business is a lot more costly and the pace of change is a lot faster. I think that has changed the way a lot of middle-market business owners look at the question of staying in another five or 10 years or cashing out. Goldenberg: The players on the buy side that we are seeing come in various shapes and forms and they include the displaced executive. This is the guy who left his company and either is latched up with some financial group that is doing a specific search to find a company for him or who is independently trying to find something to acquire that fits his background and experience. It is not necessarily a recent phenomenon, but I have been seeing a lot more of it during the last year. Warren: The financial buyer segment has become more operations-oriented because the more prominent firms back operating executives with specific hands-on experience. They have been CEOs or COOs in their careers. They have probably done a combination of operations and marketing work and have all of the experience pieces that are necessary to successfully run the business they are trying to acquire. This know-how gives their financial backers many of the benefits that strategic acquirers enjoy. There are buyout firms that focus strictly on a particular area. An example is Ampersand Venture Management in specialty materials. When it finds the right platform company, it is off and running. Competitive Tiering M&A: What is the intensity of competition in the middle market? Are most deals being done through some type of competitive mechanism or are most being done through direct buyer/seller negotiations? Deutsch: By all accounts, competition for transactions is keen. However, this competition is most reflected in valuations of larger middle-market companies and is noticed a bit less in transactions in the $50 million to $100 million range. It is hardly reflected at all in transactions below $50 million. In fact, we believe that many of those transactions are quite cheap, given the overall level of public equity market and merger market activity and the bidding-up of larger transactions. Beier: I have seen less direct-sale transactions and a greater percentage of transactions being done through auctions. Deutsch: Auctions are back. It has been in vogue for the last number of years to refer to one’s auctions as “limited auctions.” But the fact is that they’re still auctions. Berger: In the middle market, sellers underestimate the time, the intrusion, and the depth of complexity involved in actually selling their companies especially through an auction. Some of those companies are actually better served through a negotiated sale. We have been advising a number of our clients, in specific situations, that as long as they have a “high-end” price, a negotiated sale is often a much better way for them to go. Goldenberg: We had a lengthy discussion on various auctions and the forms that they take at our IMAP meeting in April. A number of our affiliates presented examples of auction processes that they had done. The consensus was that for companies with revenues of more than $50 million, a very high percentage of them will be sold through some type of auction process, although not necessarily the same type for all. In many cases, the results of doing it that way have been quite startling. In the smaller middle-market deals, getting competition is still an important factor. But unless it is a very unusual situation involved, the deal is not being done nearly as much by the auction process as by the standard kind of negotiated deal. Basically, when you have a company with more than $50 million in revenue, you are usually dealing with a more sophisticated management that knows the process to some degree. When you are dealing with a company under that level of revenues, you are dealing with somebody who has little or no knowledge of the process and, therefore, is much more dependent on the adviser to develop the best technique for moving the business. Deutsch: If the question is, “What have we observed in terms of auctions versus negotiated transactions?” then the answer is that auctions are more prevalent. But if the question is, “What is the best course of action for our client?” the answer is, definitively, not always auction. The winning strategy may be a properly negotiated transaction, given the right circumstances. Seller’s Options M&A: We have kind of delineated this by size of company. But are there any other qualities and characteristics that might figure in the decision to negotiate or auction? Warren: Most of the financial buyers, no matter what they are looking for in terms of industry, still want the classic generic financial and risk characteristics that they always have. When we get a company that has those characteristics, we will profile it to a carefully selected subset of proven financial buyers as well as any strategic buyers. That will usually result in exposing that seller to a greater number of buyers. On the other hand, if the seller’s business is industry-intensive and it would be of greatest interest to readily identifiable operating companies, the process is much more of a rifle-shot approach. That means doing careful homework on the best prospects so that you can present a very tailored reason-why approach, make it as personal as you can, and create strong interest in a small number of buyer candidates. Berger: I find it easier to answer the question from the standpoint of what company is not a good auction candidate. For example, we have found that very people-intensive businesses are usually ones on which we don’t want to spend a lot of time shopping the street. Another example would be companies with only one or two major customers with serious competitive concerns, like many that are servicing the auto industry. We have found that their need for strict confidentiality and reduced exposure precludes a large-scale auction process, so a direct negotiation works better in those situations. Deutsch: Generally speaking, larger middle-market companies are more able to withstand the rigors of the auction process. They are more accustomed to “open-book” accounting. They have much more diverse customer bases and vendor bases and are, generally, less susceptible to the risks of disclosure. Smaller middle-market companies, on the other hand, aren’t used to public scrutiny. They are, in many cases, family businesses. They are generally averse to sharing information with anyone, whether or not they might benefit by doing so. To a great degree, our advice is based on the personal attitudes of these corporate owners and whether or not they have the power to conduct an auction. If they have the power the swagger to tell potential acquirers to stand in line and “bid” they will likely benefit from the process. If they don’t have the power, if they don’t have that kind of marquee name, if they are not large enough to interest as many potential buyers as they might otherwise, the most promising acquirers may turn up their noses at the prospect of owning that company. Beier: I have seen a number of situations with firms primarily in a business that is hotly contested by financial buyers. I would call it almost a semi-auction, getting down to a short list and then whittling it down to maybe even a shorter list. At that point, protracted, but not too protracted, negotiation begins to occur. I don’t know whether I would call that a run-off sale, an auction, or a combination thereof. Deutsch: Some might refer to that as a “limited auction.” Seizing the Moment M&A: Is most of the sell-side deal flow stemming from the traditional reasons for selling, such as people getting older and wanting to retire, or are there special reasons connected with the m&a market, consolidation, or other industry trends? Deutsch: Again, our clients seem to pursue transactions primarily for the same traditional reasons, but the timing of these sales is a function of today’s level of pricing and today’s ease in consummating a transaction. Beier: The fact that industries undergo consolidation is not a new phenomenon. But the fact that we have a number of them going on at the same time could be viewed as a relatively new phenomenon. That may be a function of the markets. Clearly, the consolidation business, or the roll-up business, is driven by that fundamental need for professional managers for businesses in an industry that is starting to mature. But secondly, there is a hot IPO market. So, what does the owner of a firm in a consolidating industry start thinking about? Where can you get your biggest returns? Selling into the IPO market is a way to do that. How do you do it? You have to have mass. How do you get mass? You do a roll-up. But I really don’t see that as anything new or anything innovative. I just see that as reacting to the market. Deutsch: It is tough to ignore that the S&P 500 is trading at 26 times latest 12 months’ earnings. It is tough to ignore long-term treasuries at 5.8% or lower. Financing is as cheap as it’s been in 25 to 30 years. Berger: Over the last 10 years, sellers have become much more astute regarding estate planning and portfolio management. They’re quick to understand the latest estate planning techniques designed to reduce taxes or delay payment, and many are enticed by the present capital gains rate. Further, the ability to structure a deal by selling for stock or structure other tax-advantaged methods really has been brought down to the middle-market by professionals as well as business owners. Sellers often can realize more in after-tax gains than they could just five or 10 years ago. Beier: Are you saying that the middle-market companies themselves have gotten smarter? Or that the advisers who are advising have become more numerous and therefore accessible to the middle market? Berger: I think both have gained a greater awareness of estate and personal financial planning. Ten years ago, some understood it and many truly didn’t. Now many magazines frequently run articles on estate-planning techniques designed to pass on assets and reduce taxes. I think the middle market’s sophistication has changed significantly over the last 10 years. Liquidity Choices M&A: Let’s look at the m&a market versus the IPO market. Back in the early 90s when we hit the m&a air pocket, a lot of companies went public because they could get a better multiple than by selling. Does this tension still exist in company decisions? And is there such a thing today as a hard-to-sell company? Warren: One challenging assignment is to try to get a fair price for a very profitable Subchapter-S corporation that has low net worth because the money has been taken out. A number of entrepreneurs think first of the tax aspects of their behavior instead of thinking what their long-range plan should be. If they intend to go into the market to sell the business within three years, they should manage the business to help generate a successful sale. In another category, a friend who is a computer consultant is starting to see some large corporations rating their business units from the standpoint of whether the Year 2000 problem is too costly to fix and whether they would be better off putting them up for sale. While every transaction boils down to a matter of price, those will be challenging assignments. Deutsch: There is an axiom in trading that active markets trade up and inactive markets trade down. With this level of active merger activity, everyone has raised their sights in terms of size and quality of a target for a number of reasons. People need to deploy capital and they feel that if they have a good deal flow, they can choose better targets over less desirable targets. What does this mean in terms of what may or may not be marketable? Small middle-market companies that are “down-and-outers” and companies that are in the midst of turnaround might have been interesting to acquirers in the early 90s but are less interesting to most acquirers today. The same holds true for companies that are too small, that aren’t necessarily leaders in their fields, that lack depth of management, and that aren’t in today’s sexy industries. On the other hand, if you are any kind of service or distribution enterprise, someone wants to own you and roll you up. In certain other industries, textile and apparel for example, you need a lot more luck. What is always difficult to sell is a client with too-rich expectations. One of the great ironies of this market is that as much as there are great levels of activity and great increases in multiples of every kind and every definition, so have the expectations of our clients increased. In some cases, sellers are outsmarting themselves. M&A: How does this figure in the decision of selling versus going public? Deutsch: Companies need a certain scale to consider going public. In today’s market, to do a properly institutional IPO, they need a minimum of $30 to $50 million pre-offering equity valuation. Smaller middle-market companies, unless they benefit from extraordinary valuations, need not apply. M&A: Wouldn’t those be the same companies that have those unrealistically high expectations in sale prices? Deutsch: One of the problems with this marketplace, from an adviser’s point of view, is that there are many more advisers than ever before. This population includes those that are willing to take virtually any company public. They are telling our smaller middle-market clients anything to get them as clients. Berger: It does depend on the purposes of a sale. If you are looking to cash out, if you want to leave, an IPO is not the right answer. If you are looking to sell because you can’t keep up with the speed and the cost of doing the business and the changing landscape, then an IPO may be a viable alternative to a sale. But you really have to understand what the seller’s motivation is before any alternative is chosen. Warren: If there are strategic reasons for selling, then being acquired may be the thing that you need to do. M&A: There has been a big reduction in the capital gains tax. Has there been any real impact on deal flow? Beier: I haven’t seen a huge impact from the capital gains tax cut. Goldenberg: It certainly has been a motivator in some deals recently where there has been more interest on the sell side because the tax burden was lowered. This is particularly the case if it was a C corporation rather than an S corporation. Deutsch: We haven’t seen the change in the capital gains tax rate affect the number of transactions so much as it might be affecting the structure of transactions. At the margin, today, there might be a slight bias in favor of stock sales for private sellers who, in an asset sale, might complete the sale and then make a distribution to shareholders that might be treated as ordinary income. Today, there is, obviously, a difference in tax treatment between capital gains and ordinary income. The Tug of Cash M&A: Do you get the impression that a lot of sellers to publicly held companies just don’t trust the stock market at this current level and would rather take cash and move on? Berger: You absolutely have to discount paper that is trading at upwards of 25 to 30 times earnings as opposed to cash. I think that is a decision that everyone makes based on the fundamentals of the stock. But nearly everyone discounts taking paper from a public company in some way, shape, or form. Beier: The only time I haven’t seen that has been in the case of somebody who is reasonably sophisticated and gets a very liquid stock, which is an unusual combination. I have been involved in situations involving Heartland-type companies that were in the $200 million to $600 million range in terms of value. They were approached by New York financial buyers and were trying to evaluate the quality of the deals but they felt intimidated by those buyers, and that prompted either a sale to a strategic buyer or a lengthened period of time until the transaction closed. It was not that they didn’t trust the New York financial buyers, but they were Heartland-type guys who were not accustomed to dealing in the financial marketplace, notwithstanding the fact that they had well-known and capable advisers on their side. Fundamentally, they were seasoned entrepreneurs who started their businesses many years ago. The businesses were very profitable and very well run. Selling them to those sophisticated New York financial buyers was a hurdle. Deutsch: I think most sellers are intelligent enough to distinguish between overall market multiples and individual company values. For example, they know where the Dow trades or the S&P 500 trades and they distinguish between those multiples and the prospects for equity gains by their acquirers. We have had instances where clients have been offered equity in overvalued roll-ups. And, at exactly the same time, we have had clients that have been offered equity in transactions where we have advised them to accept that equity because we believed it was very undervalued. In some cases, clients very much buy into the notion of the “consolidation play” that they might be selling into, especially if they are likely to become an important participant in the consolidated entity and they have the ability to determine that new entity’s destiny. Berger: Equity may be good for a company that heretofore had no liquidity. I think a lot of the car dealership roll-ups happened because of just that. There was not a real liquid market 10 years ago for selling car dealerships. Deutsch: Car dealerships have been the second or third most active acquisition industry this past year. Berger: And the deals have been done for mostly all stock. Non-Stop Buying Demand M&A: What are the principal sources of demand on the buy side big companies, small companies, consolidators, financial buyers, or all of them? Warren: This market is about as active as it gets. All of them are present in the marketplace in certain situations. Deutsch: Well, this is not strategic versus financial buyer, although one subcategory of strategic buyer has included the most active acquirers of any category. They have been the industry consolidators such as IKON Office Solutions, Republic Industries, U.S. Office Products, Service Experts, and American HomePatient. All of them are acquiring companies at the rate of 20 to 30 to 40 a year. But to get back to traditional divisions of strategic versus financial buyers, what has clearly emerged is a new and bigger sort of hybrid buyer hybrid financial buyers who are really strategic buyers in disguise, or financial buyers in disguise, whichever way you view them. But they tend to be financial buyers who are very active after establishing platforms. Beier: We know where the activity is coming from. Financial buyers have never been more active. We all know that their dealmaking is bigger than it has ever been. I can’t tell you how often we have a partner at one of our client companies who decides he wants to go on his own and starts his own fund. He has been a very successful dealmaker and it takes him about five minutes to come up with another billion-dollar fund. What does that mean in terms of middle-market company competition? It adds to the competition. Deutsch: Speaking of the population of financial buyers, the 500th largest financial buyer today has $55 million under management. Said in a different way, that means there are 500 private equity investor organizations with at least $55 million under management. And the vast majority of those are targeting the middle market. Berger: Ten years ago financial buyers could buy a middle-market company at a very reasonable price, just dress it up a little, take it to the next level, and get a good return. A lot more financial buyers now have to work very smart and very hard to get the type of returns they need in today’s pricey market. Does that turn a financial buyer into a strategic buyer? In the case of a roll-up situation or consolidation where you are buying groups of companies and there is a financial benefit play on operations, purchasing, or other synergies, I would think that is the case. Are they a financial buyer or a strategic buyer? I think the distinction has changed. Beier: That’s absolutely right. I think the financial buyers the names that are recognizable fancy themselves as moving in the direction of being more than just a financial player in the way they create companies. Whether they are doing it by grand strategy, or because it is more fun, or because that is the only way you can create value in these marketplaces doesn’t matter much. Take your pick. I think it is a combination of all three. My experience, though, is that the key drivers are one and two it is a grand strategy and they find that more fun. They prefer to move in that kind of direction, and that happens to be where the market is moving. They are playing to create value in the marketplace. Deutsch: You see evidence of this in the market, by the way. Take a look at purchase price multiples in the buyout industry. In the late ’80s, financial buyers bid just about as much for the same target as strategic buyers, and, in some cases, they bid more. In the early and mid-’90s, strategic buyers clearly outbid financial buyers by about 20% to 25%. Now, in today’s marketplace, financial buyers have bid themselves back up into a position where their indications of interest are only 10% to 15% lower than those of the average strategic buyer. M&A: Yes, but a lot of the companies that they are going after are peculiarly structured to be acquired by financial buyers as opposed to strategic buyers, and that is where they are winning. Berger: In addition to Ray’s point about fun and grand strategy, I think these build-ups are also being done out of necessity. Prices have gotten frothy and the availability of capital for strategic buyers with a proclivity for m&a is tremendous. To continue to get good returns on the funds that they have entrusted to them, I think that financial buyers have to create more value. That takes more work and more operational focus. Goldenberg: We tend to define financial buyers very generically, although, in fact, they are not generic. The largest group out there is made up of the people who raise various kinds of funds. But there is another set of financial buyers out there, many of whom have been doing this for a long time, and they are not dependent on funds raised from the outside from pension funds and what have you. They literally have started with their own money and built up their capital over time. Typically, when they buy a company, they have much longer horizons. They are almost buy-and-hold investors, unless they have some motivating reason to sell. These guys look at things very differently than the other financial buyers. That differentiates the buy side very significantly because these people typically are following some sort of synergistic acquisition. They are not out there trying to buy just anything. The company they buy might not be 100% strategic, but they believe it fits in some way with the other companies in their portfolios. Pricing Beyond the Numbers M&A: On the subject of pricing, I want to go beyond the average multiples or some other benchmarks. There seems to be considerable variations on pricing, based on the quality of the company and a whole bunch of different characteristics. Do you agree that these variations exist and what are some of these recognizable variations that loop into the setting of purchase prices? Goldenberg: One of the clear factors is the overall quality of a company’s track record. A company with an outstanding track record and earnings curve that looks like a public company’s earnings curve is clearly going to be looked at very, very hard and priced very aggressively because the bidders know that there is going to be competition out there. A second factor is that pricing can be a little bit misleading. If you are being compensated by, let’s say, a public company stock, you are going to want to discount that versus an all-cash deal in which you will be willing to take less for the company. Of course, there are all sorts of variations in between such as seller paper, earn-outs, and non-compete agreements, which really have to be discounted if they are paid over time. Deutsch: To some degree the expansion in market multiples is a bit overblown in the sense that there is a direct relationship between pricing and cost of capital. Go back to the example of the Dow. Even though the Dow might be trading today at 26 times earnings whereas one year ago it was 21 times earnings, by other measures, the Dow may be cheaper. For example, some people choose to compare the dividend yield of the Dow with the yield on triple-A corporate bonds. You would have given up 570 basis points of yield to buy equities a year ago to earn that dividend yield versus the yield on triple-A corporate bonds. Today, you give up only 470 basis points. So, by this measure, stock is a better bargain today. It hurts you less to own equities today than it did a year ago, even though the Dow trades at a greater multiple than it did a year ago. Likewise, in the private merger market, we have expanded multiples, but in the context of much cheaper cost of capital. Warren: In a transaction that will generate real synergy between buyer and seller, what looks like a high-price offer may be justified but only if it is backed up with beady-eyed operating projections based on realistic transition planning that will enable the buyer to extract value. One of our manufacturing clients is acquiring related products that can be moved into its highly automated plant, with a wonderful effect on the bottom line. This relocation into shared facilities is a key value driver in its acquisition program. When a transaction is announced at today’s prices, you know the buyer has committed itself to making important changes and assuming risk. If the stock market does not believe it can do so, the buyer’s stock price gets hammered. The real question in negotiations is how the buyer and the seller will share the expected increases in value. If you at least have a pool of value there to negotiate, you have the basis for a transaction where both parties can win. Beier: We also have to take into account the deadlines of the two sides for completing a deal and who the buyer is. I am going to make a distinction between a strategic buyer and a financial buyer in that sense. Generally, a financial buyer today will pay more for a target when it can take control of it but also avoid goodwill. It will do that because it believes that one exit strategy will be to sell to the IPO market. Why? Because its reported earnings at that point in time would be higher. So, there is a lot of effort going into being able to achieve those kinds of transaction structures. The point is that certain transaction structures can impact pricing by either accounting or tax concerns. Financial buyers think hard about whether they can avoid goodwill or gain certain tax objectives. If they find that they are unable to do so, they will pay less.