M&A in 2008: Strategic Buyers Emerge as Deal Activity Picks Up

By Steven G. Booth and Trisha K. Hansen
From Milwaukee Business Journal Online
June 27, 2008

To the casual observer consuming a steady diet of financial news over the past several months, the mergers and acquisitions (M&A) environment appears to have slowed to a sluggish, if not completely dormant pace for 2008. Seemingly daily headlines have encouraged the perception that the bottom has dropped out for those buying and selling companies.

To an extent, that picture is relatively accurate: M&A dollar volume through May 2008 is off 39 percent from the same period last year. However, it is important to note that 2007 was the highest year on record for M&A dollar volume. When the 2008 data is compared to the same period in 2006 - which was the previous record holder - M&A dollar volume is down only 17 percent from 2006, suggesting that perhaps the doom and gloom headlines aren't representing the whole picture.

M&A activity has remained healthy in certain segments and seems to be showing signs of a rebound for the second half of 2008. Although the much publicized credit markets crisis has taken its toll on billion dollar plus deals, middle market deals - those valued under $1 billion - are doing relatively well.

"Deal flow in the lower end of the middle market is holding up a lot better than the press - which tends to focus on large corporations - has led many to believe," says John Emory Jr., President & CEO, Emory & Co. "Very little of the lower middle market deal information ever makes it into the public domain, so it is often overlooked."

As of May 31, 2008, the number of U.S. deals valued over $1 billion has declined by 51 percent year compared to the same time period in 2007. Yet the number of U.S. middle market deals has dipped only 11 percent in that same time frame.

"Problems stemming from the credit crunch and related balance sheet issues at the big money center banks have obscured the underlying resilience of the middle market deal environment," says John Beagle, co-founder and Managing Director of Grace Matthews, Inc. "Even with more restrictive credit and debt covenants, middle-market valuations have held up and deals are closing."

"The middle market has remained strong," adds John Peterson, Managing Director, Cleary Gull Inc. "Many entrepreneurs are nearing retirement and want to monetize their investment, corporations are divesting non-core business units, sellers are especially motivated by potential tax changes, and private equity funds are reaching the end of their investment horizons."

Certain sectors have also continued to experience healthy levels of M&A activity through the downturn, particularly global, export-driven sectors that have minimal exposure to the housing and financial markets. Computers & Electronics, as well as selected areas of Professional Services, Healthcare and Consumer Products, have fared well in this market, generating interest from both strategic and financial sponsor buyers.

Additionally, strategic buyers have become more active in this current environment, displacing financial sponsors as the main source of M&A activity. While the number of financial sponsor deals are down 47 percent YTD compared to the same time period in 2007, those deals stemming from strategic activity are down only eight percent. Both numbers illustrate a drop in activity, but the strategic decrease is far less dramatic. Moreover, in terms of YTD deal volume composition, strategic buyers have made up over 87 percent of the transaction volume as compared to 79 percent for the same period in 2007.

The rise in the strategic activity is a result of several factors. As lenders aggressively scaled back capital commitments during the second half of 2007 and into 2008, financial sponsors found it increasingly difficult, if not impossible, to find financing for traditional leveraged buyout (LBO) structures and were no longer able to out-bid strategic buyers or even participate in auction processes.

With fewer buyers offering lofty, debt-financed bids, valuation multiples have steadily decreased over the past several months and will continue to do so if general economic activity remains sluggish and the financing markets remain challenged. As a result, valuations of targets are now more reasonable and accessible to strategic buyers.

"We have been approached in record numbers by domestic and foreign strategic buyers seeking add-on acquisitions," says Joe Sweeney, Managing Director, Corporate Financial Advisors, LLC. "These firms recognize that their organic growth prospects are currently constrained, and the M&A markets now offer an attractive avenue for growth in a more difficult economic environment."

Leading up to this environment, many corporations earned record profits while prudently managing their balance sheet. As a result, these companies headed into 2008 with large cash balances and significant financing flexibility. At the same time, global pressures to achieve greater scale with greater efficiencies and compete in an increasingly hyper-competitive marketplace continued to mount.

 

Thus, the effects of the credit crunch, combined with the relative decrease in valuations, strength of corporate balance sheets and pressure for companies to compete, have created ripe conditions for strategic M&A activity.

 

These various M&A trends demonstrate that the market, while it may be down, is most certainly not out. High quality transactions, particularly those with a strategic angle, are still able to find financing at attractive levels and rates, and are getting done.

 

But the landscape has changed. The seemingly daily occurrence of billion dollar plus LBOs in 2007 has been replaced in 2008 by high profile, negotiated, strategic acquisitions such as Mars / Wrigley and Hewlett-Packard / EDS and market-moving, hostile activity such as InBev / Anheuser Busch and Electronic Arts / Take-Two.

 

"Deals are tougher to get across the finish line as buyers are more comprehensive in their due diligence," Marconnet explains. "That being said, Mertz has maintained a full stable of active clients, closings and a consistent funnel of prospects so far in 2008."

 

Indeed, change is sometimes good. Well thought-out strategic transactions may be a key catalyst that will drive efficiencies and growth in the general economy, which in turn should help stabilize credit markets, as well as the M&A market as a whole.

 

Steven G. Booth is the Director of Investment Banking at Robert W. Baird & Co., overseeing the firm's global corporate finance and M&A activities. Steve also co-manages Baird's Equity Capital Markets Group and is a member of the firm's Board of Directors and Executive Committee.

 

Trisha K. Hansen is a Director in Baird's Consumer and Industrial investment banking practice, assisting in public and private equity financings, M&A and other advisory services for private equity-backed, public and privately owned companies.