Time to Get the M&A Party Started?

Is it time to get the M&A party started? Judging solely by the title of its recent article, the Wall Street Journal’s answer appears to be “no” (see It Still Isn’t Party Time for Buyouts, February 18, 2013). Yet the fact that the article was written at all indicates that there are enough favorable indicators out there to ask the question. With several large transactions having recently been announced, everyone wants to know if happy times are (finally) here again.

In the years since 2007’s peak deal volume, there have been many times in my firm’s transaction practice that the floodgates appeared to be opening. But in between those particular months when multiple transactions inexplicably converged, things would settle back down to the “new normal.” Do the recent headlines reflect a similarly random clustering of data points, or something more? Even if the recent spate of activity continues, how long will it take for the trend to percolate from the mega-deals down to the lower-middle market?

Any optimism ought to be tempered by 2012’s experience, when most M&A professionals, myself included, wrongly thought that impending year-end tax rate changes would motivate sellers and drive deal activity. In hindsight, there were several reasons that this did not happen in the lower-middle market:

  • Potential sellers felt that their valuations were still suppressed, and believed, rightly or wrongly, that if they delayed an exit they could raise their valuations enough to overcome an increase in tax rates
  • Potential sellers were leery of a liquidation event in such uncertain times. The thought process goes something like this: “I know what my business has been generating, even during these past few years of weak economic conditions. If I sell it, where do I invest the money in this economy? I feel more comfortable with the risk/return of my own business!”
  • Other potential sellers did want to exit, but simply underestimated the complexity and duration of the process and could not get a deal done in time
  • Still others were selling what nobody wanted – i.e., poor quality deals
  • Owners/investors chose to monetize a portion of their holdings prior to the tax rate changes through dividend recapitalizations or other transactions rather than outright sale

Empowered by hindsight, we develop narratives to explain previously unforeseen events, which only increases our false sense of confidence in yet another round of predictions. At a recent program hosted by the Philadelphia chapter of the Association for Corporate Growth, the consensus that emerged from a panel of M&A professionals was that 2013 would be a big year for transaction activity, although perhaps skewed toward the latter half of the year. Of course, for every positive factor supporting this optimism (lots of money on the sidelines, low cost of capital, improving economic conditions, higher valuations, etc.) there was a negative variable to temper the enthusiasm (continued slow economic growth, poor supply of quality deals, increasing competition from the IPO market, etc.).

My own predictions are as irrelevant to the ultimate course of economic history as anybody’s. But just to play along, my guess is that 2013 will not see an appreciable increase in lower-middle market deal activity. As the WSJ article notes, the favorable elements are not new; many of them have existed for two or three years. Even the additional tax-related variables in 2012 did not generate the activity we expected. So it is hard to be too optimistic about 2013 when that particular positive factor is gone, there are no noteworthy new ones, and there is arguably an uptick in certain negatives such as competition from IPOs. Meanwhile, the overall economy slogs on in the darkening shadows of Federal, state and municipal budget deficits and Congressional logjams. Maybe the passage of time is itself enough to generate some increase in M&A activity, as more sellers get tired of waiting for the perfect time to exit, more corporate buyers turn to acquisitions to drive growth, and private equity money comes under increasing pressure to be put to work. We shall see.

But regardless of what 2013 holds, I am bullish on the longer term, and quite certain we will see a boom in lower-middle market M&A activity sometime between now and the end of 2015. Demographics alone will help drive future deals in this segment of the market, as baby boomers need to exit their businesses to fund retirement. It may not be time to get the M&A party started just yet, and it may be impossible to predict exactly when it is time. But who doesn’t love a surprise party?