- Active sectors: tech, industrials, consumer products
- Tax-policy changes, tariff concern yet to weigh on PE
- Human capital top of mind in late stages of cycle
The economy is proving resilient and sponsor-driven M&A shows no indication of a slowdown, as buyers prove willing to pay up for assets they believe in.
“While we may be in the 8th inning, this 8th inning may last another three years, and people are not in the business of sitting on the sidelines,” Mike Hogan, a managing director at Harris Williams, said.
Private equity-led deal count totaled 586 in the second quarter through June 20, with about $110 billion of disclosed value for those announced and closed, according to Thomson Reuters data.
That compares with 630 transactions and about $120 billion of value in the year-earlier period. Deals were down 7 percent and value fell a bit more than 8 percent.
While the pace of dealmaking may have slowed year over year, the number of deals coming to market seems to be growing, industry experts said.
At the same time, financial buyers flush with cash are fighting over businesses that have come off of years of growth, keeping prices at all-time highs.
“It feels like we’ve been in this recovery for a long time, which we have,” Hogan said. “But relative to companies’ growth prospects, we aren’t seeing signs of a retreat.”
“[We’re seeing] very strong company performance and a tremendous amount of capital available, whether it be debt or equity,” agreed David Brackett, managing partner and co-CEO of Antares Capital. “As a result, we’re seeing more companies coming to market.”
That is enabling sponsors to sell companies off good numbers, Brackett said. Across Antares’s portfolio of more than 400 middle-market companies, trailing 12-month Ebitda is up 9.9 percent from a year earlier, compared with 8.8 percent at the end of Q4 2017, he said.
Strength in the debt markets is also supporting deal momentum.
“We haven’t had an air pocket in the credit markets in nine quarters … which is very rare,” said TwinBrook’s Garrett Ryan, who heads the capital-markets team for the firm’s middle-market direct lending loan business.
“There is usually something that comes along that gives you jitters. Because of an absence of that, the market has continued to get frothier.”
In the latest quarter, tech led the industry pack, producing 88 transactions though June 20, Thomson Reuters reports. Industrials and consumer products followed, with 74 and 68 deals, respectively, the data service said.
Healthcare produced some of the largest announced transactions during the quarter, led by KKR’s about $9.9 billion deal for physician-staffing giant Envision.
Separately, Veritas Capital, in an about $4.9 billion take-private, took out Cotiviti, a payment-accuracy company serving the healthcare industry.
Elsewhere, Blackstone put significant capital to work in the real estate industry through more than one billion-dollar-deal. Its largest: Gramercy Property Trust, which commanded a $7.6 billion valuation.
And in other notable activity, electronic-payment company VeriFone agreed to be taken private by Francisco Partners for about $3.4 billion.
While the M&A environment looks poised to stay strong for the foreseeable future, Harris Williams’s Hogan said he’s observed a couple of unifying concerns across a broad range of companies and the PE community.
One is the ability to attract and retain talent. “The job environment is very tight, almost across all industries,” Hogan said. “Filling that labor pool is putting a little pressure on wage rates. It’s a consistent issue.”
The other is continued geopolitical uncertainty, which is beyond anyone’s control and has heightened recently amid trade-war anxiety, he said. “We haven’t seen that ripple into affecting [sponsors’] appetite for M&A.”
The tax-policy changes, including the cap on interest deductions, also haven’t had any meaningful impact on M&A, Antares’s Brackett said.
So far it seems to be a wash, he said. “I can’t think of a deal where someone has said, ‘We want to limit the debt because of the cap on interest.’”
But while both the brewing trade war and tax-policy changes have yet to curb PE’s appetite, history says downturns come eventually.
One concern this late in the recovery, Brackett cautioned, is that many sponsor partners weren’t active in or haven’t been through a full cycle
“From what we see on the credit side, that talent has been diluted. My sense is that has probably happened on the PE side, too,” he said.
“Everyone is struggling with the notion that there’s nothing economically that indicates we’re going to hit a recession soon,” TwinBrook’s Ryan said.
“It’s a challenging market. … People know it’s going to happen, and the only thing you can do is to be prepared by having the appropriate number of staff to manage a portfolio through the cycle.”
Pick spots, put best foot forward
Absent evidence of a pullback, the market froth is shaping the behavior of both buyers and sellers.
Sponsors are more selective about how they play in a process, when deals continue to command record valuations, Hogan said.
PE buyers recognize that their odds of success in this market are low, so they are picking their spots carefully, Hogan said.
Greater emphasis on asset selectivity is also being fueled by what Hogan likened to a “bandwidth issue.” While the amount of equity capital has risen dramatically on the sponsor side, the number of partners at a given firm hasn’t grown nearly as fast, he said.
“It’s counterintuitive,” agreed Jeremy Holland, who leads Riverside Co’s North American origination team.
“While the overall market activity continues to grow, what we see is narrowing the number of opportunities you’re going to work on,” he said.
The same can be said for the lenders.
While the volume of deal opportunities coming in has grown significantly, Ryan said, the number of deals TwinBrook is spending time on is roughly equivalent to a year ago.
That means you end up “saying no” more frequently to sponsors, he said.
In a frothy market you always see more transactions because a lot of suboptimal deals come to market, he said.
Firms’ willingness to stretch for and pay up for the best assets is also driving up prices of more middle-of-the-road assets, said Justin Ishbia, founding partner of Chicago’s Shore Capital Partners.
“In these environments it’s really hard to find a great company,” Ishbia said. “Price is not as relevant for some of these players. Even if a buyer overpays for a smaller company, if it believes in the space, it can still be a win.”
The increasing aggressiveness of the “bridesmaids” — the losing bidders in an auction process — reflects just that, Ishbia said.
When a leading asset trades in a given segment, it’s not uncommon to see the runners-up actively pursue the next best or next largest two, three, four, five companies, he said.
“It’s one way to mitigate the wounds of losing a deal,” he said. “These parties lost and want to get into the ballgame today.”
From a seller’s perspective, tightly run processes remain more common, Holland said. Sponsors have realized the benefits of restricting auctions to a smaller batch of highly specialized firms that know the space well, he said.
“They believe that they can quote-unquote clear the market,” he said.
“For us, it’s important that the market knows about the depth of our expertise in those bespoke processes,” he said.
That’s also prompted more focus on the depth and professionalism of the origination function in PE, reflected in the aggressive hiring of senior people who are fully dedicated to the business-development function, Holland said.
“It’s important for private equity teams to have concerted professionals in the market maintaining that mind-flow within,” Holland said.
Menu of options
One more point: The past 12 to 24 months have evolved such that financing structures are more deal-dependent and sponsor-dependent than ever before, Brackett said.
Some sponsors prefer a broad syndicate with the best terms and price; some want a megaclub with a few select groups to execute, and others love the speed and certainty of unitranche financing.
“People really want a menu of options and alternatives,” Brackett said. “Folks are very sophisticated now.”
The nature of a competitive environment where speed and certainty is increasingly important has also caused the lending business to adapt.
Borrowers and their investment banks are demanding expedited sales processes, and lenders are forced to forgo some things they would normally do to get a deal done with a sponsor, Ryan said.
In other words, features like established lender form documents and marketing periods are frequently not accommodated under a compressed time frame, he said.
“Lenders are really pushing hard to establish a first-time relationship with a sponsor,” Ryan said. “Getting a deal done with a sponsor is a way to access that sponsor going forward.”
10 largest announced and pending deals by U.S. sponsors, Q2 2018
2008-2018 pending and closed deal number and disclosed deal volume, in billions
The most active LBO dealmakers of Q2 2018
Top 10 U.S. sponsor deals closed in Q2 2018
U.S.-based disclosed deal value for closed deals by quarter, in billions