Talking Deal Prices: Pros fret as multiples spike above 10x EBITDA

Overall M&A deal prices averaged 16x EBITDA in the United States in 2015 as of June 26, up from 14.8x EBITDA for all of 2014, according to Thomson Reuters Loan Pricing Corp. The figure for 2015 marks the highest EBITDA multiple since at least 1996. These figures include all M&A.

By contrast, U.S. sponsors seem to be more restrained, even as prices continue to rise. Average purchase price multiples for buyouts jumped to 10.02x EBITDA in 2015 as of May 30, up from 9.07x EBITDA in the year-ago period, according to S&P Capital IQ.  

When they do buy companies, U.S. sponsors are putting more skin in the game, with equity contributions in buyouts rising to 39.8 percent in 2015 as of May 30, from 35.9 percent in the year-ago period, according to S&P Capital IQ. The bigger checks may mute investment gains down the road.

This year marks the continuation of lofty stock market prices chilling take-private deals from sponsors, while cash-rich strategics outbid private equity firms on larger transactions. 

A list of the top M&A deals of the year is led by the $81 billion acquisition of BG Group Plc by Royal Dutch Shell, followed by the Charter Communications deal to buy Time Warner Cable Inc for $78 billion.

Private equity firms remain absent from the list of richest deals. The largest on the horizon may be a reported offer of $10 billion by The Blackstone Group and Carlyle Group to take ATM maker NCR private, but no formal announcement had been made as of press time. The deal would rank as the largest this year from private equity firms, but it’s dwarfed by some of the bigger M&A transactions emerging weekly from the corporate world, such as ACE’s deal to buy insurance company Chubb for $28.3 billion in cash and stock.

Lofty purchase prices continue to dim the outlook for returns.

Carl Thoma, managing director at Thoma Bravo, said he’s been crunching numbers and worrying whether private equity as an asset class will continue to provide superior returns to public equities.

“It’s a little scary right now,” Thoma said during his keynote address at the Buyouts Chicago conference. “I’ve never seen them higher in my life… As long as we deliver super returns, we’re in great shape. I feel like we’re getting way out over our skis.”

Over the next couple of years, GPs should have plenty of companies to sell into a strong pricing environment, but after that, returns may be pressured. Thoma said he is advising GPs to start coaching their LPs on expected returns.

“Try to be realistic on exit multiples,” Thoma said. “If we’re down to [returns] of 10 percent, then we better hope the stock market is at 6 percent. But if the stock market is at 8 or 9 and we’re at 10, our share [of LP dollars] will start to come down.”

In this pricing environment, sponsors find themselves focusing more on add-on deals and sourcing as a way around paying full price. Another method is offering company owners and managers a second bite at the apple to sweeten a deal.

Sean Cunningham, managing director of GTCR, said the Chicago-based firm focused on working with management in its recent growth equity investment in Rx30, a developer of pharmacy management software. Cunningham declined to provide any specific financial data on the transaction, but he said there’s plenty of room for expansion by helping independent pharmacies compete by using Rx30’s software.

“We think we bought it at a fair value in part because we’re going to partner with CEO Steve Wubker, who’ll be a meaningful equity owner,” Cunningham said. “We have a strategy to grow the business and hopefully create more value down the road. The partnership was definitely a big part of our ability to acquire the business.” 

Arrangements like this will likely become more common if the current pricing bonanza continues.