Dale Buckwalter is amazed at today’s deal prices. In 2018, 3 Rivers Capital LLC bid on 27 companies, and some of its bids were as high as nine times EBITDA.
He says 3RC won two bids, and the private equity firm walked away from one during the diligence process. If you’re paying eight times EBITDA, the numbers have to be exactly right. The other — a health care company — closed for 7.5 times EBITDA.
When Buckwalter co-founded the firm in 2006, he and his partners were one of the few willing to buy smaller businesses, but seven times EBITDA was a big number for them. Now, the space is crowded with family offices that have low return expectations, other PE firms and larger entities coming down into the market to do add-ons.
However, the managing partner is keeping in mind that these high prices won’t last.
“We are buying companies now under the assumption that when we sell it, five, six, seven, whatever years later, we’re probably going to sell it for a lower multiple than we paid for it,” he says.
Buckwalter shared his thoughts on the current state of the market during an M&A Roundtable panel at the 2019 ASPIRE conference earlier this year.
How do the high valuations influence your buying strategies?
We’ve got to stick to what we know. This is no time to go learn a new initiative … We won’t even think about a deal these days unless we have an operating partner that knows some sector cold.
We primarily buy family-owned businesses and we try to turn them into private-equity owned businesses, which is a process all by itself and not particularly easy to do. So, the No. 1 issue always is management, but then right below that, if not right next to it, is the culture. Because taking a family-owned business culture and turning it into the kind of high-performance culture a private equity fund expects is a challenge. Everybody’s heard culture trumps strategy. We believe that 100 percent.
(Sellers) want us to meet a management team once and then do a letter of intent. It’s just crazy. We don’t get enough time to know a management team really well.
If we’re going to pay eight or nine times EBITDA you don’t get six months to figure out whether you have the right management team or not. When we paid six times EBITDA and we were going to hold a company seven years, which is what we can do, six months in, you might realize you had to make some management changes and you could do that. But when you start at eight times EBITDA, you just don’t have time for that.
If valuations are so high. Do you see the benefit on the sales side?
We sold Phoenix Rehabilitation and Health Services last year. We were up to about 85 clinics, and there was so much interest in Phoenix that the investment banker had four private equity funds run through the entire process, do all their diligence and basically fully negotiate a purchase price. Four different funds paid four different big accounting firms to do a quality of earnings report and completely finish due diligence.
Valuations are crazy, especially in health care services. In that space you have this thing called pro forma EBITDA. We had 85 clinics. About 10 of them were less than a year old and they’re still losing money, so we added back those losses. Another 20 are less than three years old, and they all ramp up over three years. So, we pretended that all 85 clinics were ramped up through a full three-year EBITDA, called that pro forma, and somebody paid 13.5 times that number.
You mentioned the importance of culture. What’s an example of that?
We bought a company called Deep Well Services. It’s here in Pittsburgh. It’s an oilfield services company. This is a tough group of people. When we sold the company, it was about 300 people. The guys who worked out in the field — because by and large it was guys— work in the cold; they’re tattooed; they’re roughnecks. Everybody said, ‘You will never drive a culture through that kind of a group.’
We use this process I learned at Vistage to drive culture. To us, that means that we design certain behaviors that we insist on and then we drive those behaviors throughout the organization. At Deep Well, they called them the Great Eight, eight behaviors that everybody bought into and we insisted on. Every week, we would focus on a different one. So, every eight weeks, we were cycling through all these behaviors.
It got to the point, when we sold Deep Well, you could walk up to any Deep Well employee, including the roughneck out on the well pad, and ask them what Great Eight were and they’d tell you on the spot. A lot of those things were safety-oriented.
When we sold Deep Well, we were up to 1.5 million manhours without a single reportable incident. Now, did that create a lot of value? I’m not positive, but I know that when buyers came in and looked at Deep Well, they said they’d never seen anything like it. I know that we sold Deep Well for at least a turn and a half of EBIDTA higher than anybody pays for an oilfield services company.
Technology is critical for your due diligence process. How do you see it impacting businesses?
For years and years, if we were buying a products-based company, which we do a lot, the first question, we always asked was: What can China do to this company? These days for that same company, the first question we ask is: What can Amazon do to this company?
We own a company that makes fluid transmission lines for the automobile aftermarket — brake lines, gas lines, that kind of thing. We have about 80 percent market share in North America, and our customers are big retailers like NAPA, AutoZone and O’Reilly. Then, those guys sell brake lines, for example, to job shops, repair shops. About a year ago, Amazon opened the marketplace to sell aftermarket fluid transmission lines, which is not a market that we ever expected Amazon show up in.
Our assumption is every products-based company we look at, eventually they’re going to show up (in). And I think the more complicated that distribution channel looks, the more likely Amazon is going to show up sooner, rather than later.