Such was the gist of a recent Morningstar report, “Making Sense of M&A Amid Market Turbulence.”
In it Morningstar is taking a much more sober view of the M&A market than it did earlier this year. Then, Morningstar was very upbeat about merger prospects and forecast the return of blockbuster deals. It also believed the credit markets were primed for increased takeover activity.
The Chicago-based investment research firm changed its tune after August’s volatility, which stemmed in part from the lingering debt crisis in Europe. While Morningstar isn’t completely gloom-and-doom, the fund group now believes that a prevailing sense of uncertainty about equity and credit markets “may keep some potential buyers on the sidelines over the near-term, while making lenders more selective with the deals they choose to back stop.”
However, the M&A market isn’t dead, Morningstar says in the report. Deals will come, but at a slower pace. And the long-awaited return of the $10 billion LBO? Forget about it. Morningstar now expects large-cap deals to be put on hold until next year. However, many small-to-mid cap names will still be in play.
Credit market have weakened since early August’s implosion but haven’t deteriorated to the point that it hinders all M&A activity, Morningstar says. Capital is still available from large banks to support solid LBO targets and debt capital market groups are still able to provide commitment letters. However, syndicate desks have become much more selective, and commitment letters are incorporating additional pricing and capital structure flexibility.
So what does this mean? While there are still many discussions going on, deals are slowing and taking longer to close, PE and banking sources tell me. “All the volatility in the market has people in a pretty risk-averse mood,” one banker says.
Smaller deals, those with less than $20 million to $25 million EBITDA, still have a number of institutions looking to providing financing for deals, one source says. Lenders like Madison Capital, NXT Capital and Golub Capital as well as commercial banks like BMO, PNC, Fifth Third, SunTrust are still looking to put money to work. Most of these deals are being clubbed, the source says.
But larger deals are having a harder time finding financing, the source says. “As you move through the first wave of finance providers you start to get in to the hedge funds, etc., who drive up the spreads and the fees, which make the deal very expensive,” the source says. “Underwritings can be tough as the larger arrangers are hesitant to be too aggressive on the flex they offer as they can’t be certain as to where the pricing will shake out and they don’t want to get hung.”