Summer 2010 – Middle Market Analysis

The market is still slow, but smaller transactions gain momentum.

In early June, Dealogic announced its latest report on merger & acquisition (M&A) activity through May 2010. The hope – at least among those who sell companies and those who have companies they want to sell – was that we would begin to see a recovery from 2008 and 2009. Unfortunately, the numbers don’t reflect a broad recovery. Fortunately, the news is much better for companies in the middle or lower middle market, where activity is definitely picking up.

Announced deal volume in the US totaled just over $354 billion through May, which is 14.7% below the same period last year according to Dealogic. That ranks as the second slowest start in the last 7 years (only 2008 was slower, with total deal volume of $336 billion through May). But the real story behind this decline is the dearth of large deals. Only 7 deals above $10 billion had been announced globally through May – the lowest total in the last 5 years. And while that might be holding the M&A market back from an overall recovery, it has little if any impact on most business owners who are planning their retirement. A more meaningful trend for these business owners is the pace of smaller transactions, which appears to be improving – significantly.

The average transaction size through May 2010 dropped to $159.49 million, which is its lowest YTD figure since 2003. This drop is the direct result of a very large number of smaller transactions. In fact, the number of announced US transactions through May increased to more than 2,200, which is 66% higher than the same period last year and 63% higher than the same period in 2007, which set all-time records for M&A volume.

It is difficult to pinpoint the conditions causing such a large number of relatively smaller transactions this year; however, it is easy to hypothesize:

• Credit for acquisitions is still much tougher to obtain than it was 2-3 years ago. And the challenge in getting debt finance appears to be directly proportional to the size of the transaction;
  
  
• Mezzanine or subordinated debt is available to fill the void left by traditional lenders; however, mezzanine debt is substantially more expensive for the borrowers. Consequently, acquirers would rather use less of it, which may be helping to drive deal sizes down; and
  
  
• Prospective acquirers are sitting on hoards of cash and they are looking to put it to work. The Federal Reserve reported in June that nonfinancial companies had $1.84 trillion in cash and other liquid assets as of the end of March, up 26% from a year earlier. Cash made up about 7% of all company assets, which is the highest level since 1963. And Private Equity firms have accumulated an all-time high $450 billion overhang (the difference between funds raised and equity invested).

So, prospective acquirers who have large sums they need to deploy to generate returns but who are not able to get much/attractive debt finance appear to be doing the only logical thing: turning their attention to smaller transactions, and getting lots of them done.

The market activity is a good sign, especially for most business owners who are contemplating a sale to facilitate their retirement. Even so, this may not be the right time to celebrate, especially if your sales and/or income are lower than they were in 2007. If you are in that position, or if you are simply trying to determine if now is the right time to plan/execute a sale, read ASG Principal Ed Kirk’s article on Planning a business sale.

For more information on current market conditions, call 425-450-4800 or email info@asgpartners.com.

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