Last fall, the Citizens Bank Commercial Markets Team conducted its annual M&A outlook survey for 2017, which predicted a busy year for mergers and acquisitions activity based on responses from around 600 middle market business leaders.
The survey illuminated several conditions that the Citizens team identified as “fuel” in the M&A engine for the year ahead: notably, that baby boomer-aged business owners wanted to cash in on their business and retire, and the perception of an impending financial crisis, among other things. At the time, respondents said their predictions for 2017 did not depend on the results of the 2016 U.S. presidential election.
When the survey team reached out to 208 of the original respondents in February 2017, several months after the election, however, it found that these middle market business executives were even more optimistic and confident in the economy than they were pre-election. Bob Rubino, executive vice president and head of Corporate Finance and Capital Markets at Citizens Commercial Banking, says this general economic optimism also extends to the M&A market outlook.
“There didn’t seem to be a market-respondent change before the election. There seemed to be indifference towards who won and their attitudes towards the market,” Rubino says. “But we’re getting the sense that this could be changing post-election with the outcome. That’s why we took on the new survey.”
Optimism and confidence boosted post-election
The post-election survey was designed to identify any changes in views or expectations following the election of Donald Trump to the White House. And overall, general optimism in the economy jumped 18 percentage points from the previous survey, with 52% of respondents saying they believed the economy would improve, compared to just 34% prior to the election (pre-election, 49% had believed the economy would stay the same).
Prior to the election, 48% of survey respondents felt there would be a financial crisis within the next three years. That number has shifted down to 41%, indicating some renewed confidence in the economy, though the figure is still higher than the 38% in 2016 who indicated a financial crisis was imminent.
“The other thing in our survey that’s important to look at is what people’s perceptions are of when the music might come to an end or when do we see some economic downdraft,” Rubino says. “We’ve been in an eight-year recovery/expansion and cycles typically don’t generally last that long. In this survey, there’s a little bit of respondents thinking, ‘well, wait a minute. We might be able to expand this run.’”
What might be driving this economic optimism?
Rubino says this could be attributed to discussion from the Trump administration around putting together a big infrastructure bill and possibly easing business regulations.
“I think what we’re witnessing here, it will be played out over the next couple of quarters, is that confidence drives action on either the buyer or seller side. Lack of confidence has a dampening effect on people’s willingness and ability to want to get engaged,” Rubino says. “I think confidence as one of the critical drivers of M&A can be, as we see from the survey, driven by expectations of fiscal and monetary policy.”
According to the survey, 71% of respondents now believe there are going to be lower healthcare costs, as well as relaxed regulations leading to decreased costs of doing business, both of which would have a positive effect.
Potential tax policy relief – which has been discussed by both the Trump administration as well as prominent G.O.P leaders like Speaker of the House Paul Ryan – also played into the general confidence.
“70 percent of those who responded after election think there is going to be lower corporate taxes, and many also believe there will be lower personal taxes,” Rubino says.
All that said, the optimism wasn’t shared by all surveyed business leaders and the results were heavily stratified according to industry. For instance, optimism increased among those in the manufacturing and infrastructure-related fields by 27 percentage points (from 29% to 56%), and by 20 points among those in the business and professional services industries (from 38% to 58% percent). But for those in more consumer-facing industries, including retail, hospitality, and food and beverage, optimism stayed relatively flat (dropping form 35% to 34%).
What does the optimism mean for M&A?
The survey team at Citizens believes the general economic optimism extends to perceptions of the mergers and acquisitions space in 2017 as well.
The prior survey found that both buyers and sellers showed plenty of appetite for M&A activity in 2017 (though both sides seemed to agree it was a buyer’s market), and that appetite only seems to have increased post-election.
Pre-election, 53% of potential sellers were already involved in a deal of some kind or were opening to considering a sale, while 73% of buyers were currently involved in or open to such a deal. After the election, nearly four in 10 respondents expect the market to be even busier in 2017, with only 26% saying there would be less M&A over the course of the year. Meanwhile, 60% said there was no change in the likelihood of their company to participate in some kind of M&A transaction and 22% were more likely.
“What I think is happening is the average seller is an entrepreneur with a closely held, potentially family operation, and since they’re not in the M&A environment every day, they may be thinking, ‘hey, I’m kind of at the whim of buyers,’” Rubino says. “The truth really is, if you run a fair and balanced and disciplined process, then you’re going to get really good value for your firm. There are a lot of buyers out there looking to buy your quality assets.”
In the pre-election survey, Rubino and the Citizens survey team noted an emerging factor for sellers: owner fatigue. As the baby boomer generation continues to age, they are looking towards a sale of their businesses in order to provide liquidity and enter retirement. Rubino said he doesn’t anticipate a presidential election and five months passing to change that sentiment among middle market business owners who are of the baby boomer generation.
“I think the overriding influence in middle market M&A is the link between ownership age and desire to retire. 70% of business owners link their desire to retire with the sale of their business. As the baby boomers continue to march on, that demographic trend will continue,” Rubino says.
Sellers can also benefit from the current expectations for valuations. According to Rubino, expectations for valuations have remained stable, with 54% of respondents saying valuations would stay the same, compared to 56% pre-election, and 23% believing they would increase, down just one point from pre-election responses.
“We had this view that in the original survey people felt pretty good that valuations were toppy. We saw around 60% thought that valuations may even go down. We’ve had a significant run-up in public valuations,” Rubino says. “What we did think happened was hey, people thought valuations were high before the election, the markets have run, public comps are up. Those are good proxies for private company valuations, they’re up and so we think we’re really toppy. That puts a lot of people, when you look at those looking to sell, and from our survey work, 80% of people going to sell, they either want to provide liquidity to their owners or they want to take advantage of today’s market pricing.”
In other words, middle-market sellers want to take advantage of this toppy valuation period before it ends, and according to Rubino, the overall economic confidence tends to embolden the buyer as well.
“We heard from a lot of potential buyers that when valuations are toppy, there’s a little reluctance and there’s a little bit of concern that you’re going to be paying way too much,” Rubino says. “But when your confidence level in the future goes up, then you see your way to saying, ‘hey, wait a minute. I’ve got a longer run here with this acquisition and I can justify paying that toppy type of valuation.’ We think that’s very positive for the M&A environment.”
How might 2017 play out?
Rubino compared the outlook to the activity during the Q4/12 when people weren’t sure what tax policies would look like in 2013 after the last election. Rubino indicated that we could be in for more of the same. So while deals may not be being closed left and right just yet, Rubino says the “fuel in the system” hasn’t gone anywhere.
“In such moments of change, you may have near-term volatility and people pausing in the near term until they actually understand the direction that the new administration is going to take policy through,” Rubino says. “Our view is that in talking with a lot of clients, to the degree that they are anticipating acts regulatory or healthcare changes, they may be waiting until there’s more certainty. We are 100% confident that once that uncertainty is lifted those people too will jump into the activity.”
What evidence do Rubino and his team have that this general economic optimism could lead to boosted M&A activity?
“Another reason we think there’s fuel in the system is that 90% of those selling say they’re dealing with financial advisor or want to deal with a financial advisor,” Rubino says, which he believes indicates sellers are serious about selling their property. And Rubino predicts that when these middle market companies do engage in M&A activity in 2017, there will be plenty of opportunities for those on the financing side of the equation to take advantage of as well.
“There is a lot of liquidity, whether it’s in private equity or on strategic balance sheets,” Rubino says. “There’s a lot of liquidity (still) from the debt market to finance acquisitions. There’s still not, in our mind, enough properties to satiate the appetite that these buyers have.”