Wall Street Journal Headlines Economic Gauge – An Update
We haven't updated our WSJ Headlines Economic Gauge since January because it was indicating consistently positive results in the economy—that is, until June of this year, when it headed decisively negative. (Followers of our blog will recall that we created our WSJ Headlines Economic Gauge under the premise that the count of the Wall Street Journal finance-related article headlines with a positive, neutral, or negative tone can provide an indication of the perceived health of the economy.)
The quarterly results show a consistently positive trend from Q2 2010 through Q1 2011, but an abrupt change to the negative in Q2 2011.
And the monthly results for 2011 show even more dramatically the move into the negative, particularly in June, when the unemployment rate worsened, though there was some improvement in July.
Lastly, while July's headlines in general were more positive than negative, yesterday's WSJ Edition – July 29, once again turned decisively negative as our leaders continue to be at an impasse on the debt ceiling and many other related issues.
The Gauge is a reflection of the increasing uncertainty facing businesses, particularly middle-market companies. We hear it, read it and see it every day in the media: persistent domestic unemployment, continued weakness in residential real estate, increasing cost of commodities, lack of consumer confidence, regulatory burdens making it more difficult and expensive for business to grow, banks maintaining strict credit standards, increasing costs as a result of recent healthcare legislation, weakness in European markets, conflagration in the Middle East, and on and on.
So, what does this mean for middle-market company owners?
Many of our clients have been considering selling their companies, but with business generally being off since mid 2007 they have not been able to achieve the valuation they need in order to retire. In the expectation that the economy would be improving in the near term, many have opted to continue operating their companies in an effort to grow them to the point that they could sell them for an acceptable valuation. However, they are finding the continuing uncertainty in the economy is making growing their bottom line more challenging than they had anticipated.
We would like to offer an alternative for company owners who find themselves in such a situation.
A Strategy for Owners of Middle-Market Companies:
Get partial liquidity now and take a second bite out of the apple later.
A number of our middle-market company owners have recently asked us to assist them in evaluating strategic alternatives. These shareholders have determined that they are not yet ready to sell their companies for two primary reasons:
- They are still passionate about what they do and are not yet ready to exit their business totally and retire.
- Their business valuation has not yet achieved the level they need in order to sell 100% of the company.
Yes, they understand:
- Investments must be made to grow their companies in order to achieve the valuation they will need to meet their long-term personal financial goals.
- As they get older and are contemplating retirement, they are more averse to risk—meaning that they would like to get off personal guarantees to their banks and are no longer comfortable making significant long-term-payback investments in their companies.
- It is an increasingly difficult business environment with many challenges that are beyond their control, such that running the business the way they have in the past may not generate strong enough bottom-line results.
In response to such requests, we are recommending that companies consider what investment bankers call a "recapitalization" strategy. This is an investment mechanism whereby a subordinated debt fund lends to the company or a private equity fund invests capital in it acquiring a majority or minority stake in the company. In either situation, the current shareholders maintain operating control and the current management team continues to run the business. This strategy enables the shareholders to take some money out of the company today thus diversifying their personal assets. At the same time, the new financial partner can provide additional resources to help weather the continuing challenging economic environment as well as to take advantage of opportunities for growth. With a recapitalization strategy, the owners and the investors have the same objectives: improve the company's operations to increase its potential for growth and maximize its value, so that current shareholders may take a second bite out of the apple in 3 to 5 years.
Our experience in the private capital markets and our work with numerous privately held companies have shown that plenty of institutional capital is available for the acquisition of exceptional middle-market companies. Presently, private equity and subordinated debt funds have in excess of $500 billion of committed capital that they need to invest, while domestic non-financial corporations have an amount approaching $2 trillion of cash on their balance sheets, with acquisitions being an important component of their growth strategy. However, there are fewer companies that meet their investment criteria or for which the valuations are at levels acceptable to shareholders. Nonetheless, merger and acquisition activity has been steadily recovering from its low point in 2009, though much of it is currently focused on larger companies, with about 30% of the activity taking place between private equity firms ( i.e. private equity firms selling to and buying from other private equity firms). But this increased activity is a good precursor to a rebound in the middle-market arena. As this segment recovers, the dearth of sound middle-market investment opportunities means that investors with pent-up investment needs are increasingly flexible in structuring transactions. This results in an increased number of funds willing to invest in recapitalizations to help companies grow, the primary objective being the sale of the company in 3 to 5 years.
It is important to note that valuations for middle-market companies are improving. Although the chart below is a bit deceiving in that many private transactions are not reported at all so the average multiples paid are actually somewhat lower, the trends are clearly positive.
Several clients have engaged us to represent them in executing this recapitalization strategy, presenting their companies to multiple sources of capital—both private equity and subordinated debt funds. It is our goal to find the right investor with the least dilutive structure on terms that best allow the company and its shareholders to accomplish their objectives. We also feel that the investors we seek for a company must share the same values, vision, and plan as those of our client. With the objective of maximizing value when the company is ultimately ready to be sold, a good financial partner can assist in improving corporate governance, in expanding distribution channels, and in financing acquisitions that the shareholders may not want to undertake on their own.
With our deep knowledge of the private capital markets and the recapitalization process, the partners of Barnard/Montague are ideally suited to assist middle-market company shareholders explore their strategic alternatives to achieve liquidity.
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Barnard/Montague Capital Advisors is a San Francisco–based investment bank providing sell-side and private-placement advisory services to privately held, middle-market companies throughout the western United States. The firm's primary focus is on companies with revenues between $20 million and $250 million in a diverse range of industries.
Please contact us if we can be of assistance:
Bailey S. “Biff” Barnard, Sr.
925-386-6171
bbarnard@barnardmontague.com
Jeanne Montague
415-928-2183
jmontague@barnardmontague.com
David B. Sloan
415-992-25463
dsloan@barnardmontague.com
