Capital markets have been highly supportive of the M&A world in recent years, creating easier access to debt capital. M&A transaction volume was light in 2013 due to a banner year in 2012. The combination of a limited supply of deals in 2013, strong competition for those deals and ample sources of debt capital have driven up transaction valuations.
In 2014, we expect deal volume to increase, valuations to remain high and acquisitions to fuel corporate growth as the economy sputters along.
Increased Deal Volume
Tax law changes pulled forward into 2012 many deals that would otherwise have been taken to market in 2013. The number of U.S. M&A transactions increased from 8,589 in 2011 to 8,734 in 2012.1 Deal volume in 2013 was light, particularly in the first half of the year, when the number of M&A transactions declined to 5,598, down 23 % over the prior year period.2
We saw deal volume pick up in late 2013. That trend has continued in January 2014, and we expect it to continue this year.
Another Year of High Valuations
Median enterprise value multiples were 10.4x EBITDA as of third quarter 2013, compared with the 10 year median of 9.8x.1 Availability of debt capital along with competition for a limited number of deals has resulted in multiples we haven’t seen since 2007.
A strong supply of debt financing in 2013 allowed private equity sponsors to bid aggressively for deals. Additionally, this abundant supply of credit has led to highly competitive loan pricing and cheaper debt financing than a few years ago. Pricing of asset-based facilities is significantly lower than cash-flow loan facilities, making ABL facilities highly attractive for companies with strong asset support.
Competition for deals has been and will continue to be significant due to the overhang of private equity dollars that need to be invested and significant cash held by corporate America. Private equity firms have more $320 billion to invest, and time is running out for 708 firms that have investment periods expiring by the end of 2015.3,4 U.S. non-financial corporations, which had an estimated $1.5 trillion of cash as of year-end 2013, will add to the competition for M&A transactions in 2014 as well.5
Growth Through Acquisitions
Current forecasts call for real GDP growth of 2.8% to 3.2% in 2014.6 While better than the 2.7% growth in 2013, this still suggests that organic growth will be difficult. We expect management teams and investors will pursue alternative growth drivers such as acquisitions.
Recently we have seen a number of deals that would make good add-on acquisitions for our portfolio companies. Owners of smaller companies are selling, given today’s generous valuations. Additionally, large corporations are continuing to divest non-core businesses. Some of these non-core businesses may be low-growth assets, while others may have capital needs that don’t work for the corporate parent.
Between 2006 and 2008, U.S. private equity buyers represented only 13 % of divestiture buyers, but in 2013 they represented 26%.2 We expect private equity firms and their portfolio companies to be active investors in corporate divestitures in 2014, and that many U.S. companies will look to grow through acquisitions to broaden capabilities and increase geographic reach.
Continued Demand for Asset-Based Loans
Increased deal volume, heavy competition on the buy-side front, and expected high valuations will continue to fuel demand for debt financing.
Additional factors that will support demand for asset-based loans are increases in U.S. manufacturing and increased capital spending. Since 2010, U.S. manufacturers have added 665,000 jobs.7 Major corporations such as GE and Ford have re-shored manufacturing, and we expect this trend to continue. Capital expenditures at U.S. non-financial corporations have grown 45% since 2006, from $598 billion to $868 billion. All of this leads to an increase in assets in the U.S. and continued demand for asset-based financing.
Overall, we expect to see an increase in the number of M&A transactions in 2014 relative to 2013. Strong competition for deals will continue to drive generous valuations. Transaction volume will be supported by acquisitions as an antidote to sluggish growth, and positive trends relating to manufacturing and capital spending will all contribute to continued strong demand for debt financing, and asset based loans in particular.
John A. Hatherly is managing partner with Wynnchurch Capital. Hatherly founded Wynnchurch Capital in 1999. Prior to that, he enjoyed a 12-year career as a senior executive at GE Capital’s Merchant Banking Group. Before GE Capital, Hatherly spent three years in banking with the First National Bank of Chicago and BankOne.
1. Houlihan Lokey. Market Overview. September 2013.↩
2. Teplitsky M, Bourne D. Healthy-Company Carve-outs May Provide Antidote to Soft Restructuring Market. Journal of Corporate Renewal 2013 Nov/Dec;10-13.↩
3. Carey D. Bloomberg. Available at: http://www.bloomberg.com/news/2013-02-12/buyout-boom-shakeout-seen-leaving-one-in-four-to-starve.html (Last accessed 2-6-14).↩
4. PitchBook 1H 2013 VC Fundraising and Capital Overhang Report, p. 4.↩
5. Smith R. Why are U.S. Corporations Still Hoarding $1.5 Trillion in Cash? Available at: http://www.dailyfinance.com/on/corporations-cash-hoard-trillion-profits/ (Last accessed 2-5-14). ↩
6. Madigan K. Vital Signs: Fed’s GDP Forecast Finally Hits the Bull’s Eye. Available at: http://blogs.wsj.com/economics/2014/01/30/vital-signs-feds-gdp-forecast-finally-hits-the-bulls-eye/ (Last accessed 2-5-14). ↩
7. Moad J. Manufacturing Trends to Watch in 2014. Available at: http://www.gilcommunity.com/blog/manufacturing-trends-watch-2014/ (Last accessed 2-5-14).↩