Middle-Market M&A Activity Shows Signs of Improvement

Review of the First Half of 2010

Many observers are commenting that M&A activity is slowing and that the trends are indicating a weak second half. However, as it pertains to middle-market companies, the statistics are somewhat misleading. It is true that announced global M&A activity remained stable during H1 2010 at $976 billion (H1 2009 was at $977 billion), and that announced U.S. H1 2010 M&A activity, at $339 billion, was down 5% from H1 2009 (at $358 billion)—according to Thomson Reuters. However, M&A volumes for H1 2010 for deals of less than $500 million were up 39% over H1 2009. Another interesting change is that M&A activity backed by global private-equity funds for Q2 2010 totaled $40 billion, which is an increase of 33% over Q1 2010 and an increase of 125% from Q1 2009, with year-to-date activity up 102% from H1 2009. These are all clear signs that domestic middle-market activity is accelerating!

Since our WSJ Headline Economic Gauge turned positive in the beginning of Q2 2010, it continues to show marginally positive results with 50% and 53% positive for the first and second weeks of July, respectively. We think “marginally” is the telling word here when describing these positive signs, with uncertainty and caution still prevailing among investors, buyers, sellers, and lenders.

Looking Ahead
With the information above looking at M&A activity in the recent past, let’s take a look at the future. In early July, IntraLinks and mergermarket released the results of a survey of global M&A practitioners taken in April and May of 2010—the results of which are resoundingly positive. 89% of North American respondents expect the level of deal activity to increase over the next year, and 80% of the respondents expect the bulk of the North American M&A activity to be in deals of $500 million or less over the next 12 months—a big change from the recent past when M&A activity was comprised principally of multi-billion-dollar deals.

Based on the recent increase in activity we have experienced and on reports from other investment bankers and private equity firms, we agree that the volume of M&A transactions for middle-market companies will continue to build for the balance of this year and for the next several years to follow. It is clear that there is pent-up demand on both the buy- and sell-side:

On the Buy-Side:

• Private equity firms have in excess of $500 billion of committed capital they must invest before the investment periods for those funds lapse. They are paying premiums for well-run companies and are increasingly flexible in structuring transactions, often willing to provide capital for recapitalizations, as well as to make both minority and majority investments.
• Domestic corporations have almost $2 trillion of cash on their balance sheets. Though still cautious, they see acquisitions as an important component of their growth strategy. They are often paying significantly higher prices than what private equity firms will pay for well-run companies that fit into their growth strategies.
• Foreign corporations still see investing in U.S. companies as safer than investing in other areas of the world.

On the Sell-Side:

• Many company owners who were forced to put their retirement plans on hold during the recession are now seeking liquidity as business is improving, debt is increasingly available for transactions, and as buyers become more active.
• In 2009, private equity firms were internally focused on managing problems in their portfolios. As investment periods of current funds are winding down, they need to get liquidity in order to raise new funds, so they are now anxious to sell portfolio companies.

What Does All of This Mean for Middle-Market Company Owners?
It has been challenging for many middle-market companies over the past several years as management has been forced to deal with the difficult economy. Buyers recognize that many of the companies that have survived and are now beginning to grow again present significant upside opportunity. Both financial and strategic buyers have waited for the economy to show signs of improvement, and have therefore let business owners bear the downside risks until the risk of revenue decline is behind them. It is now time for those company owners, who have managed through difficult times, to capitalize on what they have accomplished.

In this changing and volatile environment both buyers and sellers are making concessions on valuation, terms, and deal structure. Buyers are willing to pay higher prices to meet sellers’ price expectations, and sellers are willing to be more flexible on terms and deal structure in order to achieve higher valuations.

With the many positive signs of an improving middle-market M&A environment, we believe it is a good time for owners to explore liquidity alternatives and potentially selling part or all of their company. We at Barnard/Montague welcome the opportunity to work with owners and their advisors in exploring the avenues to maximize valuations.