3Q2008 - Good News, Bad News

For the last several quarters we have commented on the health of the Merger & Acquisition (M&A) market, and the market for privately held companies in particular. The themes have been consistent: M&A activity this year has been slower than last year, particularly when it comes to the mega-transactions that set records in 2007. However, the market for privately held companies has remained strong, fueled by strategic acquirers who are using cash reserves to grow and by private equity firms with a desire to put their capital to work.

As has been the case for the last several quarters, our conclusions for Q3 are a mix of good news and bad news. For the first 9 months of 2008, global M&A totaled $2.5 trillion, which represents a 25% decline relative to the first 9 months of 2007. However, 2007 was a record year characterized by a frenzied pace of M&A activity, and even with reduced activity this year, 2008 is still likely to be the second or third largest year of M&A activity in history.

For 3Q2008, global M&A volume totaled $907 billion and US M&A volume totaled $403 billion. Those levels of activity are very comparable to the third quarter of last year and show a marked increase over the second quarter of this year. However, 3Q2008 statistics include more than $100 billion (worldwide) related to bank buyouts. Unfortunately, these banks were generally forced to sell because of liquidity issues that can be traced back to bad investments in mortgage-backed securities.

In the first three quarters of 2008, Private Equity fundraising, which acts as an indicator of future M&A volume, totaled $223 billion – an 11% increase on the comparable period last year. This positive news is tempered by the fact that third quarter fundraising alone was the slowest since the first quarter of 2005. Even so, buyout-focused private equity firms were already sitting on war chests of capital, and they have almost doubled those cash reserves this year. Additionally, lending-focused Private Equity groups have raised $36 billion this year, compared with just $3 billion last year. It would appear that lending-focused firms are preparing to play a larger role in financing acquisitions now that credit has tightened up among some traditional lenders.

As Q3 drew to a close, the economy was showing signs of continued weakness, the credit markets were tightening and the stock market was entering one of its most volatile periods in history. As a result, some companies are now having difficulty obtaining credit for growth while other companies are seeing softness in revenues and/or increases in operating expenses. The income statements for these companies are not going to look as attractive as they may have for the last several years.

Given all the factors described above, business owners whose retirement strategies include selling their company are left asking: is this a good time or a bad time to sell. To help decide, look to your company’s operating metrics (rather than the market conditions). If your business is being challenged by the current economic conditions, this may not be the ideal time to sell. Instead, we recommend using the next few years to strengthen the company. After all, the value of a company can be substantially improved with a few years of advance planning. Continued on back.

However, there is always demand for strong companies – particularly those that show stability or even growth while the rest of the economy slows. In fact, companies that demonstrate strength under these conditions are particularly attractive, in part because their resilience is apparent and in part because the demand for acquisition targets is now focused on a smaller supply of companies that appear attractive.

Now more than ever, acquirers are attracted to profitable companies with strong gross margins, loyal customers, tenured employees/management and attractive growth potential. Acquisition financing is more difficult to obtain than it was a year ago, but transactions are still getting done as lenders seek to finance deals that make sense.

In the end, you can’t time the M&A market. The ideal time to sell is when the business is steady or growing, the employee base and/or management team is stable and – perhaps most importantly – when you are ready based on your personal and financial objectives. If you would like to discuss the timing of your sale or if you are interested in planning advice, we invite you to email or call us for a confidential conversation at 425-450-4800.


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