Doug Brosius sees today’s deal market as frenzied.
“There is a high level of activity and companies have high valuations,” Brosius said at the 2019 ASPIRE conference earlier this year.
Deal data matches up closely with the last peak, noted Brosius, a partner at PNC Mezzanine Capital. In 2007, there were 12,904 M&A deals announced. In 2018, there were 11,686.
“The activity level is consistent with the last peak,” he said. “I think the interesting part is if you look at deals done by private equity firms in 2007, which again was a very frenzied year, average valuations were 9.7 times EBIDTA. In 2018, the average price is up to 10.6 times. So, we’ve had at least a turn of multiple expansion.”
In fact, valuations have been above the 2007 peak for the last five years, Brosius said.
Brosius shared his insights into what is driving these high valuations and how they are impacting his approach to deals.
What’s driving this sustained level of high valuations?
It’s not really leverage. If you look at debt providers, the average debt to EBDITA multiple for PE deals in 2007 was 5.6 times. In 2018, it was 5.6 times. Leverage has been relatively consistent.
I don’t think lenders, including ourselves, learned lessons last time. I think our credit companies are being a little bit more prudent. Interest rates have started to creep up a little bit. So, I think that is normalizing leverage levels.
But what that really tells you then is, back in the prior peak, equity contributions were 40 percent of deals. Now, they are over 50 percent. So private equity firms are having to put in more equity to do these types of deals. That keeps these valuations high. Why is that happening? Well, there’s $1.2 trillion of private equity money that needs to be invested.
The stat that blew me away was if you look at over the last three years, there’s been 3,800 private equity funds raised in the U.S. That’s not even getting into things like family offices, alternative capital that’s coming into this market. There is just a lot of activity in the space.
Has this hot market affected your processes for doing deals?
You have to assume that the competition for any given deal is high. It is going to get a full valuation. Yeah, you’re going to try to negotiate the best price, but you are going to be in a competitive environment.
I think there’s two ways to look at it. You identify what you’re looking for. This is the type of business. This is the sector I want to be in. There’s a lot of sector-focused funds that are out there, that say, ‘Hey, we’re going to go hard after this deal.’
We have another approach. We’re a generalist fund. We do a lot of different business models. We’ve spent a lot of time the last three years saying, ‘What has happened in our history where the deals haven’t gone well?’
We have looked at what are the main reasons that we haven’t done well on a deal. Our big things are bad management or a management team didn’t have good alignments and industry focus. Or, we didn’t either understand the industry, or there was a disruptive event.
How do you guard against those risks?
We are frontloading our processes and spending as much time as we possibly can — and probably three times as much time as the investment bankers want us to — with management. And if there is a process that won’t allow that. ‘Hey, you’re coming in; you’re going to get an afternoon with management. You might get one follow-up phone call.’ We’re out. It’s going to be a very staged interaction. You’re not going to get the type of feedback that you want to get on the management team.
On industry, let’s frontload that as well. We’re not experts in every sector, but if it’s not in something where we can either get access to some experts or we have history, we will again leave the process.
We’ve done over 90 deals, so there are industries where we’ve done five, six deals. We bring to bear some type of assessment of the industry. Is there some technology risk that’s going to disrupt the business? It used to be, ‘Is there a technology out there that’s going to replace this product or do it better?’ Now, we look at it and say, ‘Is there a technology out here that’s going to change how this product is delivered to the end consumer or how it’s distributed to its customers?’ It’s a much broader question on technology assessment.
How else has the market changed your operations?
If you have an A+ culture and management team, you’re getting the ridiculously high valuation, so sometimes we’re looking at fixer-uppers so we don’t have to pay that top valuation. We’re willing to do that.
We have a longer time horizon as well. We can be in deals seven, eight years, but you cannot go into a deal and say, ‘I’ll figure it out after close.’ You have to have that assessment.
In 75 percent of our deals, we’re changing out the CFO. And it’s not necessarily, ‘This person is doing a bad job.’ But the person who’s at a $5 million EBIDTA company is not going to have the same skillset that they are going to need for a $15 million company. And that could be the same for sales professionals, marketing, HR.
We have the plan ready and we’re hitting the ground running because, again, now you have to pay the eight or nine times for a fixer-upper, and you’ve got to be able to move things along a lot faster.