Economic Trends in 2019: It's a Seller's Market

David H. Crean, managing director for Objective Capital Partners, and Adam Torres at Money Matters Top Tips highlight for entrepreneurs and business owners what is happening in the current market for buyers and sellers in M&A transactions.

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Outlook for Middle-Market M&A in 2019 

Our firm has seen robust levels of activity to date in 2019, similar to what we experienced in 2018, and continue to see our sales pipeline grow. Despite M&A volume, market wide trending slightly down in the first few months of 2019, 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.

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 craving for high-quality assets, and there is an urgency to deploy capital in the form of acquisitions. 2019 should remain a very active year for M&A, comparable to 2018. 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.

The private equity fundraising environment has been robust, 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. This broad base of investor appetite, combined with a strong economy and company performance, has created an attractive environment for sellers.

Yes, it is a seller's market.

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. Buyers are building recession scenarios into their models. I-banking firms, like Objective Capital Partners, are managing deal quality closely, avoiding weaker or less desirable, low quality assets. For strategics, the bond market is strong, and debt continues to be cheap. That said, and in general, I am bullish when it comes to M&A in 2019.

Lending Environment

The middle-market lending environment remains healthy, due to significant committed capital within the direct lending community. The strong lending markets seems to be setting a floor for valuations. Both commercial lenders and alternative financing sources continue to compete for deal financing. 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. Lenders have a keen focus on a company’s variable cost structure and performance. The current state of the leverage markets is equaling the playing field between private equity and strategics.

Opportunities and Challenges Facing Buyers

It is a super competitive M&A market. To win 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 convincing package that convincingly can get to a closing efficiently and quickly. The biggest opportunities for buyers tend to be in certain industry sectors where we are seeing a lot of activity, such as healthcare, life sciences and technology. Challenges include: valuation, competition for deals, pressure to deploy capital, pressure to exit investments, technological disruption and digital transformation.

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 many 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. 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. 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.

Opportunities and Challenges for Sellers

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.

The 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. 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. Companies that are growing in a capital-efficient manner will command higher multiples than those that aren’t. 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. Sellers need to focus on having pristine capital structures, clean operations, and transparency on future revenues and profitability.

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.

Sellers need to stand 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 that and conveys the unique merits of their business to potential buyers early in the process.

Sectors to Watch

Healthcare, life sciences, technology, 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. Buy and build strategies seem to be coming back into favor. The sectors that offer the most opportunities are those with inherent business-model stability and limited cyclical exposure.

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 similar like PE owners and focus on optimizing core businesses while shedding others.

Happy transacting!

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?Disclosure

Objective Capital Partners is a leading investment banking advisory firm whose Principals have collectively engaged in more than 500 successful transactions serving the transaction needs of growth stage and mid-size companies. The executive team has a unique combination of investment banking, private equity, and business ownership experience that enables Objective Capital Partners to provide large enterprise caliber investment banking services to companies with annual revenues up to $500MM. Services include sale transactions, equity and debt capital raises and comprehensive advisory services. The firm’s industry expertise includes healthcare, life sciences, business services, technology, and consumer products. Additional information on Objective Capital Partners is available at www.objectivecp.com.

This article is provided for informational purposes only and does not constitute an offer, invitation or recommendation to buy, sell, subscribe for or issue any securities. Securities and investment banking services are offered through BA Securities, LLC Member FINRA, SIPC. David H. Crean is a Registered Representative for BA Securities. Objective Capital Partners and BA Securities are separate and unaffiliated entities. While the information provided herein is believed to be accurate and reliable, Objective Capital Partners and BA Securities, LLC makes no representations or warranties, expressed or implied, as to the accuracy or completeness of such information. All information contained herein is preliminary, limited and subject to completion, correction or amendment. It should not be construed as investment, legal, or tax advice and may not be reproduced or distributed to any person.