According to a survey conducted by Citizens Commercial Banking of 600 C-level executives at U.S.-based middle market businesses, 2017 could be a busy year for M&A transactions. In 2016, corporate leaders — propelled by a sluggish economy, perceived peak valuations and slow growth — felt it was the right time to sell their business or make acquisitions.
For 2017, survey respondents seem to retain that sense of urgency to make a deal. Bob Rubino, EVP, head of Corporate Finance and Capital Markets at Citizens Commercial Banking, provides insight into the continued appetite for M&A activity in 2017 and discusses how the national election results might shape that outlook.
Election Results Disrupt Initial Assessments
Although the annual survey was conducted just prior to the 2016 U.S. elections, both buyer and seller respondents believe little would change in the post-election business environment, regardless of the outcome. Given recent murmurings from Washington D.C. regarding the policy goals of President-elect Donald Trump, however, markets have responded more positively than anticipated.
“When you look at, on a post-election basis, the run up in the market to where people’s expectations are, it looks like there will be a turbo-charge effect to that overall environment,” Rubino says. “Public equity markets have rallied since the election, with higher valuations for private enterprises. We think that’s going to be some added fuel.”
Rubino mentions discussion in Washington about passing a bill to repatriate taxes from overseas, which could further drive the market.
“That’s important because that has to be put to work for shareholders, and no doubt some of that is going to be put to work in making acquisitions,” Rubino says.
Even though fewer executives at buying firms were confident in their company’s ability to manage the costs of increasing regulation — the survey showed extreme confidence dropped from 55% in 2016 to 51% in 2017 — Rubino says it remains to be seen whether this trend will continue under the new administration, which has hinted at loosening regulations.
Based on market reactions to the election and potential economic policy changes from the incoming administration, Rubino says, “Those involved in infrastructure are going to have some wind in their sails. That also means transportation logistics.” Rubino includes the energy and energy transmission sectors as potential beneficiaries alongside aerospace and defense.
“We think technology will continue to consolidate, as middle market tech firms are looking for scale to compete against their larger global competitors,” Rubino says. “We think healthcare will continue to be very active, but it remains to be seen what happens to the Affordable Care Act. It’s too early to understand the ramifications of any changes there, although one would speculate that changes in Affordable Care Act will affect those firms that have benefitted from it.”
It’s a Buyers’ Market, and Sellers Are All In
Among buyers, 53% of survey respondents believe 2017 is shaping up to be a buyers’ market, and 52% of sellers agree.
Both sides saw increases in those currently involved or willing to engage in an M&A deal in the year ahead. For sellers, that figure rose from 34% in 2016 to 54% in 2017. On the buy side, 73% of mid-market executives say their firms are either currently involved in or are open to considering the acquisition of another business. This figure is up 13 points from the 2016 survey, with most of the increase being driven by those who are open to considering a deal (jumping from 38% to 52%), while those currently involved in a deal dipped slightly from 22% to 21%.
Around a quarter of sellers were extremely confident that their business would be acquired in 2017, and 23% of buyers were extremely confident their organization would make an acquisition within 12 months.
These figures appear to overshadow concerns among executives at buying firms that M&A might not benefit their organization — less than one-fifth were extremely confident a deal would benefit their firm — due to inherited liabilities, merging different company cultures and overpaying for the target firm. As the survey team put it, “Growing reservations aren’t scaring buyers away.”
Why They’re Buying
According to the survey, many executives view acquisitions as the primary way to stimulate revenue growth since internal growth has been hard to come by. For the upper-middle market, 60% saw buying as a way to increase revenues, while 70% of the lower-middle market reported the same.
“The smaller companies really have a need to find some scale to compete against larger companies, especially in the tech sector,” Rubino says. “What you’re seeing in the survey [is that] scale is important to be able to spread out regulatory cost over a larger revenue base, to compete geographically or along product lines more holistically.”
The survey also notes that M&A allows lower-middle market firms to add adjacent products and services to improve operational efficiencies and meet market expectations. For the upper-middle market, M&A is a way to eliminate a competitor, with 32% of buyers reporting as such (compared to 25% in 2016).
Financial Crisis Coming?
Sellers want to take advantage of current high valuations — concern that sellers will be undervalued dropped from 50% in 2016 to 40% in 2017 — which they believe are starting to stagnate and may taper off in the near future. Added to that urgency is the fact that 58% (up from 41% last year) of sellers anticipate a significant financial crisis within three years. Under these conditions, 63% of selling respondents are now prepared to sell.
Among the top reasons for selling, owner fatigue is an emerging M&A driver, with 25% of upper-middle market sellers and 36% of lower-middle market sellers believing a sale would alleviate that fatigue.
“Many businesses are owned by or run by baby boomers. They have really tied their retirement to the sale of the business,” Rubino says. “The economy’s decent. Valuations are high. The capital markets are very liquid. The equity capital markets, debt capital markets, bank markets are all very supportive right now. This momentum of wanting to sell before the next downturn is big. A lot of business owners in 2006-07 who didn’t sell had a long recovery time.”
Rubino recalls discussing various ways a business owner in his mid-60s could add to his firm, given that businesses of similar shape and size were typically looking for acquisitions to stimulate growth.
“When he was confronted with purchase price multiples of some of those acquisitions, he turned around and said, ‘If that’s where the market is, I’m not a buyer. I’m a seller,’” Rubino says.
What Can We Really Expect in 2017?
The survey revealed that transformative deals are still preferred by well over half of both buyers and sellers, but bolt-on acquisitions are becoming more popular, especially among the lower-middle market. Rubino says this ties in to concerns that a buyer may have about the liability and risk involved in an acquisition.
“I think you’re seeing a movement towards bolt-ons. A majority of buyers would still like to do a large deal … but a bolt-on allows you to grow revenue, find some synergy and it’s not as burdensome on your culture. If you overpay, it’s a little less draconian of an effect if it doesn’t go well,” Rubino says.
That said, the number of executives at buying firms concerned over distractions or lack of knowledge during the M&A process rose compared to the previous year, meaning third parties will likely play a larger role in transactions than they did in 2016 (90% of respondents said they would seek to engage third-party services in 2017). Overall, buyers reported valuation and financing as the top third-party services needed, while sellers sought valuation and big negotiation services.
Rubino says the perceived confidence in making a deal in 2017 is, in part, due to the availability of financing. Late in the fourth quarter of last year, Rubino says, many businesses didn’t close a deal because they weren’t able to get it financed. Looking forward, Rubino says the market is “extraordinarily liquid” and there are “many more pockets of liquidity today than there were even 10 years ago.”
“When does that (ABL) product really play well? It usually plays well in some time of financial distress, and 58% of the respondents see a financial crisis in the next three years,” Rubino says.
Survey results showed many predictions regarding the effects of capital gains rates, valuations and regulations will depend largely on the actions of the incoming administration. With major events like Brexit, the recent Italian referendum and tense elections taking place across Europe, however, Rubino believes the U.S. will increase its share in the global M&A market during the year ahead.
“Typically in a year, the U.S. makes up 30% to 40% of global M&A market,” Rubino says. “We think because the U.S. is growing faster than the rest of the world with a higher growth market, because it’s a safe haven with stable laws and a stable currency, we believe there’s going to be a larger percentage of M&A conducted in the U.S. than is the historical norm.”