Will the First Quarter Sluggishness Become a 2019 Trend?
After another record-setting year in 2018, mergers and acquisition activity slowed during the first quarter of 2019. However, the slowdown in completed deals between the fourth quarter of 2018 and the first quarter of 2019 was in line with historical declines observed during first quarters of the past several years.
Private equity transaction volumes involving deals between $10 million and $250 million fell by 9.5% on a quarter-over-quarter basis, according to GF Data®. Multiples, however, remained steady as the use of leverage in deals intensified. Both total debt and senior debt as multiples of EBITDA increased during the first quarter, according to GF Data®. The question is whether this is traditional first quarter sluggishness or the beginning of a trend.
Deal activity in terms of count and value declined 17.9% and 32.6% on a year-over year basis, according to PitchBook. Despite lighter deal activity, multiples remain steady as competition for deals remains fierce. According to PitchBook, Limited Partners continue to fund private equity, although a decline in middle market funds relative to mega-funds has been observed.
"Despite lighter deal activity, multiples remain steady as competition for deals remains fierce."
While multiples retreated during the first quarter, the use of leverage in deals actually increased. According to GF Data®, middle-market TEV/EBITDA multiples averaged 6.9x as compared to 7.3x during the fourth quarter of 2018.1 This multiple contraction was less pronounced in the $10-25 million range, with TEV/EBITDA multiples moving from 5.9x to 5.8x between the fourth quarter of 2018 and the first quarter of 2019. During the same time frame, total debt/EBITDA multiples increased from 3.8x to 4.1x, reaching levels last seen at the beginning of 2018.
A challenging M&A environment continues for financial buyers, as many corporates have chosen to compete with PE firms, resulting in fiercely competitive processes 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 and enhanced diligence.
"...buyers are placing a premium on quality companies and enhanced diligence."
According to GF Data®, companies with institutional ownership, above-average financials and post-closing management received a quality premium of 1.7x EBITDA. GF Data® defined above-average as companies with EBITDA margin and revenue growth rates above 10%, or one of the metrics above 12% and the other at least 8%.
1 Middle-Market Definitions: GF Data ($10 million-$250 million); PitchBook ($10 million-$1 billion); Thomson Reuters LPC (Less than $100 million)
The valuation spread observed during the first quarter of 2019 between larger transactions ($50 million to $250 million) and smaller transactions ($10 million to $50 million) decreased to 1.6x, its lowest level since 2014, as multiples moderated in larger transaction sizes. Between 2015 and 2018, this size premium was observed between 2.0x and 2.9x.
The decline in transaction activity observed during the first quarter of 2019 is due in part to lenders more closely scrutinizing deals. At the same time, valuations are off their peak, and other indications of stability throughout the credit markets can be observed. GF Data® shows debt multiples during the first quarter of 2019 at levels not seen since 2017. For deal values between $10 million and $25 million, a more pronounced change was observed, as senior debt to EBITDA multiples increased from 3.5x to 4.3x.
"Consumer and business sentiment are reported to be at levels not seen since before the Great Recession."
Also coinciding with the increased use of leverage was a decrease in the 90-day LIBOR rate for the first time in two years, as U.S. central bankers have struck a more dovish tone in recent months.
Planning for a Strong Future
At Wipfli Corporate Finance, we continue to observe a strong appetite for well-run, privately owned businesses. Banks remain eager to lend money in support of companies that demonstrate the ability to grow revenues and profits and manage their business effectively.
Consumer and business sentiment are reported to be at levels not seen since before the Great Recession. There is a general consensus that the U.S. is in the late stages of the current business cycle — and right now is a great time to consider your goals and options related to your company's succession plan.
Our team of experienced advisors can help you understand and assess all your succession options. Having a well thought out succession plan in place will allow you to enhance the probability of a successful transition and mitigate the risk of having to wait out the next recession or worse: having to exit your company during the next recession.
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