Why? Because corporate America is doing well and international corporate earnings are very strong. In the U.S., as a share of gross domestic product, after-tax corporate profits are near their historical high of the last 60 years, and companies have excellent cash positions. Moreover, businesses in the b-to-b sweet spot are growing stronger, with overall industrial output growing at a 4.1% rate into the third quarter. Manufacturing in particular is growing at 6.2%; business capital expenditures are growing at a 7.9% rate.
Nonetheless, we face a situation where treasuries are absorbing funds that businesses need to continue their growth—and, in some cases, simply for day-to-day operations. We hope that the Federal Reserve will ease interest rates by approximately 50 basis points, or 0.5%, before the end of the year. If they do not, the risk-reward ratio will deteriorate. If the Fed does not act to reduce rates, it is gambling with trends that would exacerbate the current debt crisis and push the economy closer to recession.
In M&A, the popular perception is that the markets have closed down. The reality is that the level of activity depends very much on industry sector and deal size—just as it normally does. In our own industry, which is characterized by smaller companies, deals are being made at the midsize level and below, virtually without a hitch. Moreover, buyers are paying prices that reflect steady multiples. What has changed is the debt structure. While multiples that reflect a company's price have remained fairly steady, the multiples of how much acquiring companies may borrow have changed radically. Financial institutions are now lending 4 to 6.25 times EBITDA to buyers—but this now includes senior and mezzanine debt. (Before the crisis, borrowers were looking at offers of a "whopping" upward of 9 times trailing 12-month EBITDA debt leverage.)
For deals in midflight, the change in the credit markets has been dramatic and, in some cases, enormously disruptive. But it's important to keep our perspective. As investment bankers, we know all too well how easy it is for small difficulties to derail deals, at least for a time. And a change in attitude on the part of lenders is by no means a small difficulty. But these difficulties will assail only the relatively small number of deals that were already in process during the big change. Buyers and sellers are now attuned to the new reality.
In fact, for both strategics and the many private equity-controlled platforms with credit lines in place, the next quarter represents a major opportunity. For strategics, of course, this is a major opportunity because they can do deals internally. For both strategics and private equity-owned firms with lines of credit in place, they can buy—and they are buying.
Quality companies are not only maintaining their multiples but will continue to command premium prices. While those companies that are riding high debt leverage and producing mediocre results are not going anywhere.
Quality—in the eyes of buyers—has a very specific definition. It involves four key factors:
- Excellent management. Buyers are looking for name-brand managers with excellent track records and real bench strength.
- Markets served. Buyers are looking for markets that are dynamic and growing—as ever—but they are also looking for markets that are relatively protected from the credit markets.
- Financial performance and control. Buyers take huge comfort from companies with their financial house in order and walk away from good companies with weakness in this area.
- And for b-to-b companies especially, a working, revenue-producing, profitable, digital media platform (or at least a digital integration plan that is well along the path of full implementation) that is well-integrated with print, events or whatever other revenue streams have previously characterized the company.
What's new in all this is an increased emphasis on quality—not only on the quality of the company for sale but also on the quality of the acquiring company, as defined by lenders or public markets.
On the other hand, while the odds for opportunistic buying may have diminished, companies lacking some of these strengths are available for much more reasonable prices—prices which will allow post-acquisition investment to bring them up to speed.
Roland A. DeSilva is managing partner at DeSilva & Phillips. He can be reached at [email protected].