Nearly three out of four potential buyers are either actively engaged in an acquisition or open to pursuing one this year, Citizens Commercial Banking reports in its eighth annual Middle Market M&A Outlook.
When organic growth slows, companies often turn to acquisitions, says David Dunstan, a founding member of Western Reserve Partners LLC (owned by Citizens Financial Group).
“It really is a great time to be a seller because valuations are high,” says Dunstan, president and managing director of the financial advisory firm for mid-market companies. “But it’s still an important time to be a smart, thoughtful and aggressive buyer if you want to grow your business beyond whatever modest organic growth you can achieve in this environment.”
In this week’s Dealmakers News, Dunstan shares key takeaways from Citizens' survey of 600 U.S. companies.
The most recent earnings releases for public companies only showed about 13 percent earnings growth (cumulatively) — a slowdown compared with historic quarters.
“So, while we’re still growing, we’re growing at a slower rate, meaning there’s going to be a desire for accelerating that growth,” Dunstan says.
With record levels of cash still sitting on balance sheets and interest rates remaining relatively low, this trend will drive buy-side acquisition activity, he says. (Even with interest rate hikes, the cost of debt is still relatively low, and lenders remain quite interested in putting money to work.)
Meanwhile, most sellers see M&A as a growth strategy, particularly with regard to divestitures. More than half of sellers surveyed indicated a primary interest in selling either a piece of their core business or a non-core asset or division.
Because the typical sale process can take eight to 12 months to fully close, sellers may need to prioritize M&A initiatives in 2019, while they remain in a strong position.
“It’s not nearly as attractive to put your material together and have conversations with buyers when you’re seeing a decline in your orders and your backlog,” Dunstan says. “And, it makes it more difficult to tell an exciting story and get full value in that kind of environment.”
Stable or higher valuations
Though prices will come down at some point, most executives don’t expect it yet. Despite high multiples, the majority of buyers see prices rising in 2019; sellers are evenly split between expecting stable valuations versus higher valuations.
Still, as the economy softens — most executives expect the M&A market to change in the next three to five years — buyers that have retreated from the current market’s premium valuations will likely show interest again.
Global forces at work
Both buyers and sellers are showing a high level of interest in international deals — 60 percent and 52 percent respectively — but the political climate between the United States and China is shifting the dynamic. The M&A activity between the two countries decreased 94.6 percent from 2016 to 2018, going from record high levels of $55.3 billion to just $3 billion, according to Mergermarket 2018 M&A Report.
“Outside of that, we still see a pretty active international M&A environment,” noting that the firm recently closed two buy-side transactions for a Swedish company acquiring U.S. companies. “We’re continuing to see demand in other parts of the world as well,” he adds.
A reflection of the whole
The M&A trends from the broader nationwide survey reflect those in Ohio, Dunstan says. It’s a strong environment with a lot of interest in doing transactions.
More and more privately held companies are reaching out and looking for advice on the M&A environment, Dunstan says. “We’re often amazed at the quality of companies, both in Cleveland and Columbus, between, let’s say, $10 million and $50 million of EBITDA that a lot of us aren’t aware of,” he says. “Many don’t even realize these companies exist, but they’re in every industrial park. It’s exciting to see.
“We’re seeing software companies, service companies, health care companies, industrial companies that are growing, that are attractive, that are contemplating growth, contemplating acquisitions and also contemplating bringing on private equity or strategic partners in sale transactions.”
Discover more key findings from the Middle Market M&A Outlook 2019, which was fielded in November and December 2018 to C-suite executives at U.S. companies with annual revenue from $50 million to $3 billion.