Most analysts have predicted that the current PE-backed M&A boom will exhaust itself when the sprinting credit market finally stops to catch its breath.
But Robert Keiser and Matthew Toole, analysts at Thomson Financial (peHub’s sugar daddy), made a strong case this morning that the boom times are attributable to more than just cheap debt. And for Keser, Thomson Financial’s vice president of proprietary research, that means that the buyout good times aren’t about to come to a crashing halt—or even slow down in a significant way. In a presentation to reporters, Keiser laid out what he called his “recipe for a bull market in buyouts.”
One: Favorable financing. Big check. Even if the debt markets continue their pullback, they’re retreating from historically optimal conditions. Comparatively speaking, debt is cheap.
Two: Attractive acquisition targets. Check. Keiser looked at the S&P 500 and determined that, in aggregate, those stocks are now trading at roughly 15x forward earnings, about average for the last 20 years. That’s almost half the forward P/E ratio of the last buyout peak in the late 1990s and early 2000s, according to Keiser’s research. It suggests to him that, contrary to popular belief, the increased buying power of private equity hasn’t already pushed prices into the stratosphere. Yes, average EBITDA multiples are getting uncomfortable, but that’s a reflection of the bigger targets that LBO firms are pursuing, Keiser said.
What’s more, Keiser found that public companies are swimming in cash: Cash on the balance sheets of S&P 500 companies has swelled to nearly $3 trillion (!), up from $500 million in 1994. (Corrected from 2004–ed.) Either strategic buyers will become more active players—providing a nice exit market—or buyout firms still have plenty of cash machines left to take private. Either one is good news for PE.
Three: A very liquid exit market. Check. See previous paragraph, and add to that a healthy IPO market, Keiser said. Both global M&A and IPOs are at all-time highs, according to Thomson Financial. Additionally, LBO shops have raised such immense piles of dry powder that secondary transactions should be plentiful enough to provide good exit opportunities.
The last ingredient is macroeconomics. Keiser pointed out that M&A activity and the nation’s GDP tend to move together (67 percent correlation). According to Thomson Financial, U.S. M&A as a percentage of GDP is now at about 4 percent, about 3 percentage points lower than it was during the last boom cycle. There’s still room to grow, Keiser said.