Abundant Debt and Robust Valuations Characterize First Quarter
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With a strong 2017 in the rearview mirror, mergers and acquisitions (M&A) activity in the first quarter continued last year’s themes of high valuations and strong use of debt.
According to GF Data®, middle-market deal valuations and use of debt remain robust, with an average TEV/EBITDA multiple of 6.9x and an average Debt/EBITDA multiple of 4.2x. In addition, middle-market companies are reporting the highest rate of revenue and employment growth since one year ago, and confidence in the local and global economy is at an all-time high of 94%, according to the National Institute for the Middle Market. Most businesses remain willing to invest.
"Confidence in the local and global economy is at an all-time high."
The slowdown in completed deals between the fourth quarter of 2017 and the first quarter of 2018 is not altogether a surprise. According to GF Data, the number of deals completed during the first quarter of a given year typically lags the number of deals completed during the preceding fourth quarter by approximately 25%.
The number of deals completed across North America during the first quarter of 2018 decreased by 18%, according to PitchBook. More positively, PitchBook noted an additional 973 deals, totaling an estimated $451.3 billion, have been announced but have yet to close. Given the number of deals yet to close, combined with a relatively strong U.S. economy, it is likely the number of completed deals will increase through the remainder of the year.
"It is likely the number of completed deals will increase through the remainder of the year."
A challenging M&A environment continues for financial buyers as many corporates have chosen to compete with private equity firms, resulting in rising multiples and squeezing out any margin for error on the part of private equity buyers. As a result, buyers are placing a premium on quality companies. According to GF Data, companies with above-average financials received a quality premium of 21%, in line with recent history and well ahead of the historic level of 10%. GF Data defined “above average” as companies with EBITDA margin and revenue growth rates above 10%, or with one of the metrics above 12% and the other at least at 8%.
In addition, the valuation spread observed during the first quarter of 2018 between larger ($50 million to $250 million) and smaller transactions ($10 million to $50 million) increased significantly over 2017 levels — from 2.0x to 3.4x trailing EBITDA — and remains elevated over historical averages.
"Middle-market companies are reporting the highest rate of revenue and employment growth since one year ago."
The first quarter saw the 90-day LIBOR continue to increase, ending at 2.31% on March 31. Average senior and subordinated debt spreads continued their downward trend during the fourth quarter of 2017.
Other indications of stability can be observed — GF Data shows stable debt multiples between 2017 and the first quarter of 2018, with average senior debt-to-EBITDA ratios unchanged at 3.4x. For deal values between $10 million and $25 million, senior debt-to-EBITDA multiples returned to more historical levels.
According to Thomson Reuters’ Leveraged Loan Monthly, new origination of middle-market leverage loans for deals below $100 million was $5.4 billion during the first quarter of 2018. That figure is down 41.3% from $9.2 billion during the first quarter of 2017, and down 23.7% from $7.1 billion during the first quarter of 2016. The total value of middle-market leveraged loan originations during the first quarter of 2018 was its lowest quarterly amount since the first quarter of 2009.
Credit Impact on Valuations
Average equity contributions for middle-market transactions rose from 49.5% during 2016 to 53.0% during 2017, according to PitchBook. Increased equity requirements to complete buyouts reduced returns for private equity funds without a change in valuations. Leverage, measured by debt to EBITDA, declined by 0.4x between 2016 and 2017.
At Wipfli Corporate Finance Advisors, we continue to see stability in the M&A and credit markets along with investors’ strong appetite for above-average companies. Banks remain eager to lend money in support of companies that demonstrate the ability to grow revenues and profits and manage their businesses effectively.
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Footnote: Middle-Market Definitions: GF Data ($10 million-$250 million), PitchBook ($10 million-$1 billion), Thomson Reuters LPC (Less than $100 million)
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