Transaction Volume Declines but Valuations Rise Further
M+A activity in the Manufacturing and Distribution (M+D) sector slowed materially in 2013 (as did the broader M+A market), down almost 27 percent from 2012, registering the lowest level of activity since 2009. Deal activity picked up modestly during Q4 and the M+D deal pipeline is increasing as we proceed through Q1 2014. The ratio of closed transactions between strategic and financial buyers remained unchanged at approximately 2-to-1 during 2013, although financial buyer purchases spiked to 41 percent of all U.S. M+D deals completed during Q4.
Despite the 2013 volume decline, valuation multiples expanded further during the year. For transactions of $250 million and less, the average M+D EBITDA multiple reached 6.1x, up in each of the last five years by an aggregate total of 0.6x. The direct correlation between deal size and average EBITDA multiple remained in place, with larger deals commanding higher multiples on average – the average EBITDA multiple for M+D transactions in the $100-$250 million range is currently 7.0x.
Demand for Targets Currently Exceeds Supply
Capital is available in abundance for M+A, particularly in the M+D sector, which represents approximately 18 percent of all deal activity in the U.S. Public and private companies have been accumulating cash, PE firms have $466 billion in raised but un-invested equity, and lenders are eager to fund deals. Demand for acquisition targets currently exceeds supply so valuations are on the rise – it is a “seller’s market.” Private business owners have been somewhat hesitant to engage in sale discussions primarily due to concerns over the economy. Consequently, M+A volume declined in 2013.
Economic Indicators Hint at a Sustainable Up Trend
The stifling impact of economic concerns on M+A activity seems to be softening, due in part to recent improvements in key indicators. GDP rose materially in Q3 and Q4 of 2013, industrial production was up a healthy 6.8 percent during the year, and manufacturers and distributors have been investing more in capital projects and inventory. Economists are cautiously suggesting that our economy finally has some positive momentum. This news is helping to fill the deal pipeline.
U.S. transaction activity in the Manufacturing and Distribution (M+D) sector slowed in 2013, as was the case for the broad M+A market. Sector sale transactions were down by almost 27 percent vis-à-vis 2012, registering the lowest level of activity since 2009. Indeed, the year started off very slow, following a huge push to close transactions in Q4 of 2012 in avoidance of the capital gains tax hike that came with the new year. In fact, Q4 2012 deal volume in the M+D sector jumped 50 percent over the Q1-Q3 2012 quarterly average. A similar dynamic occurred at the end of 2010 when the Bush tax cuts were first set to expire.
M+D sector activity during 2013 really didn’t pick up steam until Q4, and then only modestly, again mirroring trends in the broader M+A market. Interestingly, the ratio of strategic-to-financial buyers held to the historical norm of about 2-to-1 during the year, suggesting that both groups of buyers remain interested in the sector.
Public securities investors continue to favor the M+D sector over the broader market, as indicated by our M+D Index and its fairly consistent outperformance of the S+P 500 Index during the 2009-2013 period. Overall, the M+D basket of stocks bettered the S+P index by more than 16 percent during the reported date range (2009-2013).
Private company valuations have also risen during this period. Average EBITDA multiples for transactions of $250 million or less have expanded in each of the last five years, increasing by 0.6x overall to reach 6.1x during 2013 (see Figure III). In addition, transaction size and average EBITDA multiple paid continue to be directly correlated, with larger companies achieving higher EBITDA multiples. It should be noted that all multiples highlighted in this report are averages. The actual multiple paid for a specific target can vary from the average significantly, based on the specific attributes of the seller and buyer involved.
For those of you who are thinking about doing something this year, either on the buy- or the sell-side, the M+A marketplace should be active.
After five-plus years of cost-cutting, streamlining and paring down to core competencies and operations, U.S. corporations have become lean, optimized and have been accumulating cash. Federal Reserve Bank data suggests that excess cash on public company balance sheets is currently about $300 billion. Add in the cash held by private companies, which arguably have more excess cash on an aggregate basis than public companies, and we are talking about significant buying power.
Combining buying power with the increasing intentions of CEOs to grow in part through transactions (as suggested in numerous recent CEO surveys), it is easy to see why we believe this to be a “sellers’ market.” And this market is being fueled further by $466 billion in private equity capital that has been raised but un-invested as of yet (according to PitchBook) as well as a supportive lending community which is currently providing debt capital to LBO transactions at an average of 3.4x EBITDA (according to a recent report by GF Data Resources for transactions of $250 million or less).
The sellers’ market has in fact been the norm for quite a while now, at least since 2012, and has partly been responsible for the rising multiples highlighted in Figures III and IV. We expect the sellers’ market to continue at least through 2014 based on current and expected deals in the pipeline and assuming a stable, if not a forward-leaning, economy (see the Economic Indicators section of this report for more insight).
The pressure to create value continues to grow in C-suites across the country, accentuated by these growing cash balances and the ever-present shareholder demand for share price appreciation. And acquisitions, assuming a thoughtful and thorough post-transaction integration plan, are again in favor because of the impact they can make. As many of our readers know, buying versus building can provide for operational synergies, additional capacity, access to new products and markets, new customers, the broadening/fortification of existing relationships, and game-changing technologies and other IP (e.g., processing expertise). In addition, there is a scarcity of talent across our industrial base and, consequently, we are seeing more transactions being driven at least in part by the need for good people. Productive, well-positioned assets are most quickly secured through acquisition and, combined with the other aforementioned potential benefits, create a compelling argument for more M+A activity in the coming quarters.
So, why the slowdown in deal activity in 2013?
There are several answers to this question, the easiest of which is that the tax-driven spike in activity in Q4 of 2012, up 50 percent versus the Q1-Q3 2012 average, caused a rush of sellers to sell by year-end. This rush resulted in a substantial and premature draining of the 2013 deal pipeline.
A second answer to the question has to do with the cautious mindset of many business owners in recent periods. There was and remains, to a lesser extent, a sense of uncertainty about the economic and regulatory environment which has caused owners to delay sale efforts. We often hear owners say “we are doing well but we are less certain about the players around us and our industry’s future performance in general.” Relatedly, they question whether or not a buyer would pay fair market value given a stagnant economy.
Unknown to many owners, though, is that valuations have been trending upward and that experienced private company investors (namely PE firms), have been taking advantage. Ryan Guthrie, a BDO partner and head of the firm’s due diligence practice in the western U.S., recently said that “many of our private equity clients were net-sellers in 2013, selling more businesses than they bought during the year in order to take advantage of the sellers’ market.” He added, “Interestingly, we have seen non-PE backed businesses move forward with a sale process once their owners have been brought up to speed about the favorable M+A market dynamics. Consequently, requests for us to do sell-side diligence have been more and more frequent from both PE and strategic sellers.” This observation is one of the main reasons we are currently seeing deal pipelines filling.
Key economic indicators suggest that the U.S. economy is gaining some momentum and should support a healthy M+A environment through 2014.
The U.S. Bureau of Economic Analysis reported that Q4 2013 real GDP rose by 3.2 percent on an annualized basis. When adding Q3 2013 growth into the mix, the annualized growth rate during the second half of 2013 totaled 3.7 percent. This is a welcome result after the lower readings in the first half of 2013, as well as the prior 3-plus years.
According to the Federal Reserve, industrial production rose 0.3 percent in December, its fifth consecutive monthly increase. For Q4 2013 as a whole, industrial production advanced at an annual rate of 6.8 percent, the largest quarterly increase in over three years, and the gains were widespread from an industry perspective.
Inventories – Manufactured Durable Goods
According to the U.S. Census Bureau, inventories of manufactured durable goods increased by 0.8 percent in December and it was up in eight of the last nine months, including November and October. In total, inventories of manufactured durable goods rose 3.8 percent in 2013. The rise in inventories shows that business leaders are preparing for accelerating growth in sales.
The U.S. Census Bureau also reports that wholesale trade sales were up in the most recent month reported (November) by 1.0 percent over the previous month and up 5.5 percent for the trailing 12-month period. Similarly, wholesale trade inventories were up in the most recent month by 0.5 percent and up 3.3 percent during the trailing 12-month period.
Deal volume was down but valuations continued to rise for M+D companies during 2013. The deal pipeline is filling as we proceed through Q1 2014. Strategic and financial buyer capital is abundant and lenders are being supportive of leveraged M+A. Consequently the landscape is best characterized as a “sellers’ market.” Would-be sellers have been reluctant to go to market, hampered by a concern for economic uncertainties. However, the U.S. economy seems to be gaining some momentum as evidenced by favorable GDP growth, industrial production levels, and manufacturer and wholesaler investments in inventories, among other indicators. All factors considered, we expect a healthy and growing M+A marketplace in the M+D sector during 2014.
This article originally appeared in BDO USA, LLP’s “Manufacturing and Distribution” newsletter (2014). Copyright © 2014 BDO USA, LLP. All rights reserved.
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