Category Archives: M&A Markets

Topics related to Mergers & Acquisitions

Middle Market M&A heating up as Private Equity seeks growth

Global M&A value in the first three quarters of 2014 exploded to US$2.5tr up 52% from US$1.7tr last year, according to Mergermarket.  That points towards returning to the M&A boom levels of 2005-2008.  At the peak of that, global M&A value reached $3.7 tr. (M&A surge in Q3 2014, back to precrisis levels).

US represent around half of global activity with M&A value edging towards US$1.2 tr in the first nine months of 2014, already over the US$965 bn for the whole of 2013 according to Mergemarket and reaching towards 2007-8 territory.  Most of the increase has been fueled by the return of mega deals, ie those over $5bn.  Middle market deals although not following the same explosive pattern, grew as well. North American M&As between $250-$500m reached $54m during the first half of 2014 compared to $70m in all 2013. At the lower bracket $5-250m, M&A value reached $61m in the first half of 2014 compared to $102m for full year 2013.

Activity in the private equity space has lagged behind that of the overall M&A market. The first half of 2014 saw 432 buyouts in North America for US$80bn total worth. That was a 13% decrease from first half of 2013 (US$92bn) according to Mergermarket. Private equities, contrary to the past have stayed away from large LBOs and instead turned their attention to middle market and exiting past investments.

North American M&A Size Split 2008-14

Interesting highlights about middle market M&A and the Private Equity in the US:

  • Middle market matters: According to the U.S. Census, there are 360,000 middle size companies in America (with revenues between $5m – $1bn), 95% of which generate less than $100m but a large number of jobs. Mid-size companies increased revenue by 7.5 percent in the third quarter of 2014, compared with 5.5 percent for Standard & Poor’s 500 Index, according to the National Center for the Middle Market. According to Robert Slee, a researcher specializing in this area, 75% of middle size companies destroy value as they usually produce returns below their cost of capital (The New Math of Middle Market M&A, Robert Slee  The Value Examiner, July/August 2009).  Hence there’s significant potential for growth and value creation.  PEs get increasingly involved in this space and own around 10% of mid size companies, usually the top performers.
  • Middle market definition varies by region: Transactions involving middle market companies are considered those below $1bn in value, and more often below $500mn. Actually a good reference point are deals between $250-$500m and at the lower end between $100-$250m. That is according to US standards. Average deal sizes in Europe and Asia are almost 50% below those in the US. Therefore a deal considered middle market or even small by US standards might be a mega deal in the context of a cross-border transaction and by that attract much more attention from local regulators and communities.  Therefore, it has to be approached with increased level of diligence and sensitivity, reminiscent of that for mega-deals.  Well experienced M&A advisors can make all the difference in these situations.
  • Success is not straightforward in midmarket: Although the large number of targets and potential for value creation, it’s not easy to score a home run. Companies are often the extension of their owners’ lifestyles and not clearly distinguishable and investable (Private Equity 2013 Update and Success Factors for Value Realization).  So PEs often pass. In other occasions certain PEs will be the first time investors that professionalize a company and then sell to a more experienced PE to scale up the businesses.  Other difficulties arise from inefficiencies in locating interesting deals, limited attention span, liability risk, and high pricing. So often advisors and PEs complain that many good deals fall through the cracks.
  • PE changing priorities: go solo, go small, drop past weights and aim for growth

Top PE Investments

  • Exits: Not surprisingly, much of recent PE activity has turned into exiting older investments. This is not that easy. According to Mergermarket, PE firms are having difficulty to recoup boom-era investments (EMEA Deal Drivers 1H2014). Because of that, holding periods have increased to six years compared to around three in 2007 (PE Market Update 2013).  Secondary offerings are the most common form of exit nowadays, a change from the IPO heavy past, and represent a large part of middle market transactions as well. Seventy-three percent of PE managers in a 2014 poll expected to exit investments through secondary buyouts in the next year. More than half of respondents expected the industry to sell to a strategic buyer, with 39% choosing IPOs (Global Private Equity Outlook 2014-2015, Duff&Phelps, Shearman &Sterling, Mergermarket).

Private Equity Exits-Buyouts 2007-14

  • M&A Industry focus: much about niches. Certain sectors are more represented in middle market M&A such as consumer products, business services and manufacturing, while mega deals are more concentrated around healthcare, energy and tech, even though mid size deals also take place involving niche players. Private Equities in particular focus on consumer, TMT, biotech and subsectors in industrials, business services and technology.  Notable PE transactions this year: Red Lobster’s acquisitions by Golden Gate Capital ($2.1bn), First Data’s by KKR ($3.5bn), Ortho-Clinical Diagnostics’ and Industrial Packaging Group’s by Carlyle for $4.2bn and $3.2bn respectively (Preqin Quarterly Private Equity Update 1Q, 2Q 2014).
  • Middle market valuations rising: As middle market deals grow in popularity there’s increasing competition between buyers, be it PE firms or strategic investors and hence valuations are rising (with corporate acquirers having the advantage of synergies). This reduces the number of desirable targets and deals are becoming more expensive. Multiples (EV/EBITDA) for the $50-250m bracket went from 6.5 in 2010 to 8.5 in 1Q2014 another sign of increased market activity (Axial Forum, Valuation Inflation: Middle Market Multiples on the Rise, John Slater, Focus Investment Banking, July 9, 2014).  Multiples in larger middle market transactions ($500m to $1bn) have risen to 12x in 3Q14 according to Factset (US M&A Trends & News Oct 2014).
  • Future PE trends and the middle market: Even though the loss of spotlight to mega deals, the overall trend is positive.  PE managers polled by Mergermarket expect increased activity in 2014-15 (Global Private Equity Outlook 2014-2015, Duff&Phelps, Shearman &Sterling, Mergermarket). On average, cross-border transactions are expected to make up 30% of activity.  Main drivers will be consolidation, changing demographics and consumer tastes, technology, debt financing, PE exits, globalization and value creation. Success planning will create a wave of liquidity events as baby boomers that own mid size companies will retire. At the same time, although the consumer sector is cautious there’s always creative destruction and opportunity from new products. For example the Greek yogurt mania in the US created a new segment with explosive growth in less than ten years with a startup, Chobani, being the market leader. Finally, technology is creating ample startup opportunities.
  • Dry powder is at record levels but is not for free. The amount of available capital for Private Equity investment hit a record high of $1.14 tr in June 2014 globally, even higher than in 2006-2008, according to Preqin (Private Equity Has More Than It Can Spend). However the landscape has changed. PE deals are becoming more competitive and considering some boom era failures, managers have to prove their merits by bringing returns. Working only through sourcing inefficiencies, financial engineering or IPO exits are not enough to generate alpha.  Value creation has become more important (Private Equity 2013 Update and Success Factors for Value Realization). In this sense a secondary offering might make sense when the buyer has experience in a particular sector.  Actually there’s even talk about outright acquisitions of PE firms as well.
  • PE regulatory pressures and fair value adjustments: Another interesting development over the last years is that private equity companies now have to fair value their portfolios on a continuous basis for reporting purposes. According to SFAS 157 (a.k.a. ASC 820) under US GAAP as well as IFRS 13 under International Accounting Standards these equity investments should be recorded at market values, when listed or based on comparables listed companies if not and in the absence of both conditions on financial modeling. PE managers were not used to this level of scrutiny in the past.  This, apart from creating a lot of work for valuation professionals and back offices, it is also a source of frustration for deal makers who now have to support book values many of which were made under better times.  But it also adds transparency.


By Pete Chatziplis, CFA, ACCA, MBA. The articles published here do not necessarily reflect the views of the Transatlantic Business Forum.

We predicted it! M&A Activity Surge in Q3 2014 back to precrisis levels

Alongside the stockmarket, there’s another sector now starting to erase recession losses: Mergers & Acquisitions. Activity in the US has surged in the first nine month of 2014 helping uplift global volumes towards precrisis levels.

In the first three quarters of 2014 global M&A value reached US$2.5tr up 52% from US$1.7tr in the same period last year, according to Mergermarket (Monthly M&A Insider 3Q 2014 edition). By comparison global M&A volumes have hovered around $2.3 tr following the 2009 crisis, so we have already covered that ground in three quarters. It seems that 2014 will end strong contrary to 2013 when the US government shutdown slowed the market. By comparison in 2006-2007 M&A spiked to $3.7 tr. We have actually predicted this breakthrough in our last year’s post (M&A 2013 Activity Update, the Middle Market and Critical Success Factors) by analyzing US GDP, stockmarket and economical cycle patterns. It seems that at least in the last couple of cycles M&A breaks out towards the end of the cycle while GDP growth stays strong and the stockmarket starts to level out. As we noted last year, “looking at the latest two economic cycles, the fact that we’re four years in the current one, the economy keeps on growing and the stockmarket is breaking new highs could one bet, just even by looking at the graphs(below), that M&As will come back with a bang in 2014 or most probably 2015?” Admittedly there’s a heavy US weight on this argument but then again North America is the largest M&A market and hence barometer of global activity. In any case there’s no need for a question mark anymore.

7. M&A DJIA and GDP %yoy and Points synthesis_Corrected
Based on that, we can very well be looking now at a few good years of M&A activity, assuming that nothing happens to end the trend prematurely. The discontinuation of QE, robust corporate profitability and sound balance sheets all point towards that. We can expect the M&A boom to persist even as stockmarket growth tapers off or even reverse since M&A activity to some extent lags behind it. M&A may even persist during the first years into a downturn when companies rush to acquire weaker competitors.

M&A Motivations: growing, expanding and the taxman

Main drivers behind M&A have been buying resources or market share to consolidate presence. In a tepid GDP environment this is preferred to organic growth. Access to technology and IP play also a part especially in internet and pharmaceuticals while resources and consolidation is mainly a driver in energy, consumer, pharmaceuticals and telecoms. Another recent motivation has been US tax benefits arising from inverse transactions and headquarter relocation although this practice has attracted attention and was criticized by the US Treasury. The main however factor behind the M&A explosion is the return of large transactions involving listed companies same as in the 2006-2008 boom period. The difference this time around is that the main driver is strategic investing rather than LBOs and PE activity.

Geography breakdown: US in the center with strong cross border M&A

The highest M&A activity has been reported in North America rising to $1.2tr from around $950bn the same period in 2013, ie a 25% increase! The region’s comparative attractiveness increased both for foreign and domestic investors, something precipitated by US$ strengthening and some re-shoring. Europe, amid challenging economic conditions, has seen good growth especially in the first half of 2014 reaching $722bn in the first three quarters, 12.5% up compared to full year 2013 according to Mergermarket. UK has been leading the charts there. Asia continues to grow and gaining weight in global M&A reaching almost 19% of global value in 3Q 2014 with significant activity in China, Japan and recently South Korea.

2. Global M&A Value

Cross-border M&A volume surged 132% so far this year to account for 39% of global activity according to Reuters (Global M&A at seven-year high as big corporate deals return), assisted to a large extent by inversion deals. U.S. cross-border M&A saw record volumes, both inbound and outbound. There were $205 bn in outbound deals during first nine months of 2014, with UK companies being the top targets. The U.S. was also a top destination for inbound M&A at $305 billion, led by Canadian and German acquirers according to FoxBusiness (Deal Frenzy: 2014 Sees Record M&A Volume). Transatlantic dealmaking i.e. that involving American and European companies more than doubled in the first half of 2014 to €128 bn, a 156% increase according to Mergermarket (EMEA Deal Drivers 1H 2014). Asian companies are also investing in the US to gain market access. Main drivers for cross border transactions are access to consumers and IP Although human capital is the primary driver for only a small number of transactions (8%) and that mainly in search of a lower cost base, it is nevertheless one of the most important considerations (25%) for M&A success. Other concerns are employee retention, cultural barriers, politics and regulatory framework. Cross-border acquirers are mainly shopping for consumers in emerging markets, resources in Africa, intellectual property in US and Japan, manufacturing assets in Europe or for lower cost production elsewhere (Baker McKenzie, Going Global: Strategy and Execution in Cross-border M&A, June2014).

Industry breakdown: Oil, drugs and streaming

Energy has seen the highest activity both globally (18% of deal value) and in the US, followed by pharmaceuticals (16%) and then consumer and industrials. Below we briefly cover trends and notable deals in these sectors in US and Europe, which are the main focus areas of this blog.

Energy: Activity has been driven by consolidation and access to resources. The largest transaction in the energy sector involves the consolidation of the Kinder Morgan group for a total value close to $70bn. Recently Halliburton announced an offer for Baker Hughes for $35b. Falling oil prices may accentuate consolidation trends.

Healthcare has seen high activity in 2014 even though some large announced transactions were later aborted. Pfizer unsuccessfully bid for AstraZeneca ($116bn) and Abbvie for Ireland-based Shire ($54bn), at least as this is written. After a long drama Dublin based generics drugmaker Actavis succeeded in its $66 bn pursuit of promising botox maker Allergan. It has been speculated that tax benefits were part of some of these transactions and that may have affected their prospects since they cannot alone substantiate a transaction. On the other hand a much more credible driver are operational efficiencies especially when it comes to realigning business lines. For example Bayer AG bought Merck’s consumer business for $14bnn and Eli Lilly bought Novartis’ Animal Health division (€3.9bn). Other than that Walgreen acquired UK’s Alliance Boots for $24bn to expand internationally and Actavis bought US’s specialty producer Forest Laboratories (€16.8bn) in its quest to grow. In the medical device sector Medtronic Inc bought Dublin based Covidien Plc (€34bn). Apart from large deals there’s also activity in the lower end of the market, especially with biotech companies where PEs also participate. There’s also interest in the convergence of software and healthcare services to increase operating efficiencies and patient treatment.

Consumer: notable deals so far are the $16bn acquisition of US’s Beam distiller by Japan’s Suntory, increasing coverage in the premium spirits sector as well R.J. Reynolds’ acquisition of Lorillard Tobacco for $27.4 bn seeking consolidation in a highly regulated sector. Burger King proceeded with the $11 bn purchase of Canada’s coffee-and-doughnut chain Tim Horton which although denied, some speculate can offer tax benefits. Note as well of acquisition underperforming Red Lobster casual dining chain by private equity.

TMT: M&A activity in telecoms is driven by consolidation and convergence between the various TMT sub-sectors (wireless, broadband, content, cable). It’s interesting to see how technology and market developments in broadband cost and content delivery will shape up the industry going forward. Notable transactions in the US are Comcast’s proposed takeover of Time Warner Cable at $45.2 bn to build scale and AT&T’s $48.5 bn purchase of DirecTV. Let’s not also forget Murdoch’s Twenty-First Century Fox $75bn aborted offer for Time Warner. In Europe Altice acquired mobile operator SFR from Vivendi ($17bn) to complement its telecom services. Oi SA, Brazil’s biggest phone company, agreed to merge with Portugal Telecom (€8.6bn) to form a large transatlantic operator. On the technology side, high margin revenue growth is the main driver for M&As in big data, social media, mobile computing and Software-as-a-Service (SaaS) sectors. Technology and internet saw significant activity in the US notably with Facebook’s $19bn WhatsApp acquisition.

Financial services: activity is subdued compared to the years before the crisis. Regulation, legacy issues, capital restrictions have decreased appetite in banks. Regulators are wary of further consolidation in the sector. The financial technology space however is much more attractive and evolving and will see a number of deals (for example in payments and IT infrastructure). M&A is also sluggish in insurance with some activity arising possibly from international expansion such as Japan’s Dai-ichi Life’s acquisition of Alabama-based Protective Life (US$5.7bn). It’s interesting to see as well how new healthcare coverage laws in the US will play out. Finally there’s consolidation in asset management with smaller or underperforming managers in a difficult fundraising environment being absorbed. There’s even talk of acquisition between private equity companies.

• Apart from the above, interesting transactions involved European cement makers Holcim and Lafarge (€29b) while Volkswagen acquired Swedish truckmaker AG Scania for €6,6bn to further consolidate its presence.

Deal Size: Return of the mega deals and Middle Market heating up

As already mentioned mega deals are currently the main factor behind M&A growth. Mega deals in the US where they are more frequent, accounted for 42% of the overall M&A value in the first three quarters of 2014 up from around 28% in the years following the 2009 crisis. As a matter of fact, mega deals, those of over $5b in value have reached 2007-2008 boom levels, another indicator of the M&A market returning to precrisis territory. Average deal size in North America in Q3 2014 is at its highest since Q2 2007 at US$371mn, mainly due to some high value transactions (Mergermarket Monthly Insider 3Q 2014). Mega deals are less frequent outside the US though. Average deal size Europe and Asia is generally smaller. In the first nine months of 2014 average deal size there was almost 40%-50% below the US.

We have a specific interest in middle market transactions in this blog. Although the mega deals are taking up the spotlight, there’s large volume of deals taking place in the background with significant value created or lost and alongside significant effects for local economies. Middle market deals offer room for significant value creation as we argued in our past posts and require significant input by management and advisors to bring fruit (Private Equity 2013 Update and Success Factors for Value Realization). Furthermore a deal considered middle market or even small by US standards might actually be a mega deal in another region and by that attract much more attention by local regulators and communities so have to be approached by increased level of diligence and sensitivity, reminiscent of that for mega-deals. For that special attention and M&A advisory requirements we do not view middle market deals from a US size standpoint in the global context. Well experienced M&A advisors can make all the difference between success or failure in the context of cross-border transactions both in the pre-acquisition and post-acquisition phase in the same way as for highly visible mega deals.

Total value of US Middle market deals in the $250-500m range amounted to $54m during the first half of 2014 compared to $70m for all 2013. In the higher $500-2bn bracket value reached $143m in the same period in the first nine months of 2014, compared to $233m in full year 2013. So activity here is satisfactory even if not at the same level as for larger transactions and off course there’s a high volume due to smaller deal sizes. Certain sectors maybe more represented in middle market M&A such as consumer products, business services and manufacturing while mega deals are more concentrated around healthcare, energy and tech, even though mid size deals also take place there involving niche players. Deals here can be driven by value creation, consolidation (you may call that scaling up), succession or financial distress. There’s significant room for value realization in the presence of experienced strategic investors or operating partners. For that, specialized funds with a middle market focus have lately been setup. PEs are more keen in the middle market especially in niche subsectors in industrial, business services and technology. For more information on middle market M&A and value creation you can refer to our past posts: M&A 2013 Activity Update, the Middle Market and Critical Success Factors, Private Equity 2013 Update and Success Factors for Value Realization, Middle market cross-border M&As set to grow.

3. NAmerican M&A Split 1H2014

Even though the loss of the spotlight to mega deals, the overall trend is positive in middle market and deals are becoming more expensive. Multiples (EV/EBITDA) for the $50-250m went from 6.5 in 2010 to 8.5 in 1Q2014 another sign of market health (Axial Forum, Valuation Inflation: Middle Market Multiples on the Rise, John Slater, Focus Investment Banking, July 9, 2014). Multiples in larger middle market transactions ($500m to $1bn) have risen to 12x in 3Q14 according to Factset (US M&A Trends & News Oct 2014). The outlook is positive for middle market considering among others the exit planning for the many baby boomer business owners in this part of the economy. Other drivers are consolidation, changing demographics and consumer tastes, technology, debt financing, PE exits, globalization and value creation as we have covered in the past.

Private Equity: Home-cleaning

Activity in the private equity space has not followed the overall M&A market’s explosive growth. The first half of 2014 saw 432 buyouts in North America for US$80bn total worth. That was a 13% decrease from in H1 2013 (US$92bn) according to Mergermarket, but then again last years there were a couple of mega deals that made the difference. Apart from large deals, those over $1b, the bulk of buyouts are valued at less than US$100m, so we are really talking middle market here. As a matter of fact that makes more sense as we covered on past posts (for example Large Private Equity Deals-that 800 pound gorilla). Most of the PE focus is on consumer, TMT, biotech and manufacturing.

It’s worth noting that much of the latest PE activity is not in buyouts but in working through the backlog of prior investments. According to Mergermarket PE firms are having difficulty to find trade buyers to pay the premiums necessary for sellers to recoup boom-era investments (EMEA Deal Drivers 1H2014). Because of that, as we noted last year, holding periods have increased to six years compared to around three in 2007. You can also refer to our last year’s update for more information about PE trends: Private Equity 2013 Update and Success Factors for Value Realization.

4. PE Activity 3Q2014

Secondary offerings are the most common form of exits nowadays, contrary to the past. Seventy-three percent of PE manager in a 2014 poll expect to exit investments through secondary buyouts in the next year. More than half of respondents either plan to or expect the industry to sell to a strategic buyer, with 39% choosing IPOs (Global Private Equity Outlook 2014-2015, Duff&Phelps, Shearman &Sterling, Mergermarket).

The landscape has changed in PE investing. Although capital is available one has to prove its merits by bringing returns. Working through sourcing inefficiencies, financial engineering or IPO exits are not enough to generate alpha. Value creation has become more important. In this sense a secondary offering might make sense when the buyer has experience in a particular sector. Actually there’s even talk about outright acquisitions of PE firms as well. Outside that however the sector’s outlook is positive. Based on the previous poll PE managers expect increased activity in 2014-15. On average, cross-border transactions are expected to make up 30% of activity.

There were no large private equity transactions in 2014, such as those for ketchup maker HJ Heinz or computer company Dell in 2013. Actually most of large transactions were secondary offerings. On the buyout side we can note Red Lobster’s acquisitions by Golden Gate Capital from Darden Restaurants ($2.1bn), First Data’s by KKR ($3.5bn), Ortho-Clinical Diagnostics’ and Industrial Packaging Group’s by Carlyle for $4.2bn and $3.2bn respectively (Preqin Quarterly Private Equity Update 1Q, 2Q 2014).

Another interesting development over the last years is that private equity companies now have to fair value their portfolios on a continuous basis for reporting purposes. PE managers were not used to this level of scrutiny in the past. This, apart from creating a lot of work for valuation professionals and back offices, it is also a source of frustration for deal teams who have to support book values many of which were made under better times. According to SFAS 157 (a.k.a. ASC 820) under US GAAP as well as IFRS 13 under International Accounting Standards these equity investments should be recorded at market values, when listed or based on comparables listed companies if not and in the absence of both conditions on financial modeling. That’s where the fun begins.

Market values were considered unreliable during the big recession, the theme then was “market dislocation”. Finding comparable companies may sound simple in theory but in reality not many companies are really the same. Although they may operate in the same sector they may differ in product lines, profitability, leverage or other. In fact much can be said and many adjustments made, hopefully well-indented, in the process of selecting a reference sample. Finally, as a last refuge one would revert to financial modeling usually cash flow models. Although this approach is ordinarily used in M&A deals and security analysis, quite justifiably so as it captures future benefits and conceptualize business paths and aspirations, it was initially faced with skepticism in the context of fair value reporting. That is may be due being a novice in the traditional compliance space and because it extensively relies on business assumptions that are open to manipulation or difficult to be verified and substantiated for compliance purposes. In any case the market is adjusting to that and it may be another motivation behind secondary activity besides the fact that funds have a certain horizon, they are setup and closed to make room for new capital raising and new focus as market opportunities change.

Outlook: M&A world is looking up!

We are expecting M&A growth to persist in 2015. After all, as we mentioned last year “as optimism keeps settling in among at least the investment community, this is an environment that buyers will feel comfortable or even compelled to make a move or otherwise feel pressure for stock buybacks and dividend payoffs by activist investors”. We’ll stick to that reasoning.

As a consequence we expect significant demand for M&A and management consulting professionals. Interesting to see how this play out with the market pretty much doubling up quickly, coming from a leaner, lower headcount period. M&A professionals are not only necessary but also critical for the execution and success of a transaction. They carry out the deal structuring and execution and then the due diligence, financial reporting and post merger integration. Noone wants to spend significant time and money only to get tangled with unseen liabilities and unrealized synergies; and this happens more often than not as we have covered in the past. Consulting professionals are also important in identifying and carrying out performance improvements, compiling strategic plans, monitoring and executing integration and reporting while assisting management teams through transition.

But the jobmarket is not only improving for M&A professionals but across the board; it’s only that this rebound has been slower compared to previous US recessions. Lower unemployment and increased labor confidence is reflected in the numbers of people switching jobs and in consumer spending. According to the latest US Labor Department data the number of people who quit their jobs jumped to 2.75 million from 2.5 million which is the highest in more than six years while US companies had accelerated their hiring. More than 5 million people were hired in September 2014, the most since December 2007 when the last crisis started to unfold. Off course the overall decrease in unemployment, doesn’t capture differences across skill levels and industries or long-term unemployment and underemployment. However, gradually, increasing labor participation will lead to income improvement and consumer spending. Figures in this area are also looking up. Off course this trend will persist as long as not interrupted by unexpected developments. Challenges to the global economy are seen for example in Europe and Asia. We just prefer to stay optimistic for the near term for this cycle.


By Pete Chatziplis, CFA, ACCA, MBA. The articles published here do not necessarily reflect the views of the Transatlantic Business Forum.

M&A 2012-13 Activity Update, the Middle Market and Critical Success Factors

M&As have to some extent bounced back from the 2009 lows, however they are pretty much hovering around pre-crisis levels. Activity during the last three years seems to be quite out of sync compared to the precrisis highs or the stockmarket comeback. Then again one could argue that this is just the normal way of things and that the stockmarket hike is due to the QE or the 2006-2007 mergermania to the abundance of leverage. On the other hand M&A cycles move in 5-7 years intervals so we may just be waiting for the next big story that will spark a boom.

Global M&As reached $ 2.2 tr in 2012, barely posting any growth from 2013 with North American deals at $943bn up 5% from the year before. These figures amount to 2/3 of the 2006-7 deal value. We have to go back to 2004 to note an increase of a mere 2.3% CAGR which actually lags even GDP growth, at least when it comes to the US. There’s always talk of growth but for the time being it pretty much sounds like Beckett’s “Waiting for Godot” play: it’s unclear what the next big thing will be and when will come, let alone if it’ll come, but then again that’s always the case.

1. Global M&A 2006-2012

In the first three quarters of 2013 global M&As reached $1,607 bn according to Mergermarket; a 5.5% increase over the same period in 2012. US at roughly $535bn accounted for 40% posting a 22% increase while Europe for 30% at roughly $480bn and a meager 2.4% growth. Taking into consideration that 2012 had a quite strong M&A finish, it’ll be interesting to see how things will evolve at year end as there are fears that the US government shutdown may have cooled the market. Total global PE buyout reached $259bn in 2012 with US representing almost half of that. PE activity has grown at 25% post 2009 lows in Europe and Asia but in the US, where PEs are more prominent, growth was double that at 50%, according to Bain. In the first three quarters of 2013 PE buyout activity reached $ 194bn a 11.6% increase over 2013. For more information about recent PE activity you may refer to our post here.

The M&A increase in the US is attributed to the existence of cash, return of mega deals but also public to private deals. Bigger US deals were those of Verizon Wireless ($124bn), Heinz ($27bn) and Dell ($20bn) the latter two being PE driven. In Europe that has been going through fiscal crisis and recessionary pressures, among the most prominent deals were this for Virgin Media ($25bn).

So, where is the M&A market heading? Let’s try be a bit inquisitive in this blog by looking at the connection between GDP and stockmarket; apologies to academics and analysts who thought of this before. Looking at GDP, DJIA and M&A trends in the last 10-15 years we see that the stockmarket has overreacted to the crisis and didn’t keep pace with GDP growth, only recently catching up. So probably things are just starting to look up. Despite talk of exuberance, the average P/E ratio at the NY Stock Exchange (Dow Industrial) is 17.95 compared to 14.45 a year ago. S&P500 P/E is at 18.85 compared to 16.5 according to WSJ data. Although valuations seem quite hefty they as well depend on what point in the cycle we stand and what’s the ability to generate extra profits. Still valuations are much lower than during the crisis when average stockmarket P/Es reached three digit figures, so exuberance may still be kept in bay. On the other hand when DJIA growth patterns exceed those of GDP such as in 2001 and 2007, it doesn’t turn out that well, with the exception maybe of the post great recession era. On the other hand M&As are usually slow to follow the other two upward trend; often lagging by a couple of years.

2. US and Global M&A DJIA and GDP

Cross Border M&As: Focus on Emerging Markets

True to our focus in this blog let’s see what happened to cross-border deals especially in the transatlantic space. Cross-border M&As are almost half of global activity compared to much lower importance a decade ago, an indication of today’s interwoven globalised world. During the last years there has been some decrease, especially when it comes to outbound activity from Europe, while US interest in Asian and emerging markets remains strong. Main cross border inbound/outbound deals in the Americas last year were Grupo Modelo’s acquisition by Anheuser-Busch ($20bn) and Sprint by Japan’s Softbank ($35b). Among the more significant outbound deals were Liberty Global’s acquisition of Virgin Media ($21.8b) and Alliance Boots by Walgreens ($6.7bn). Cross-border deals are more evident in the energy sector.

In the transatlantic space activity has been pretty much subdued, staying below the precrisis highs. Total transatlantic deals amounted to $180bn in 2012 ending lower than in 2011, with an average size of around half billion US$. By comparison during 2008 transatlantic deals reached $ 270 bn (see our past blogpost about Transatlantic M&As in 2008). NorthAmerican buyers took the reigns over European, reversing an earlier trend that saw European companies being the ones most often making the leap across the Atlantic, trend especially profound in the aftermath of the latest US crisis. UK and Ireland were the most active markets for inbound activity in Europe.

Although international expansion makes sense for large companies we have argued here that it’s also the obvious move for middle market companies that can this way grow to global niche players once a product and operating model is tested in their domestic market. However the challenges are in analyzing and executing the deal and finding qualified advisers with global exposure and experience with middle market peculiarities that are able to be profitable at this level of fees and challenging global regulatory framework. The Big4 along with a handful of boutique investment banks and consultancies may be able to carry out this role, but one has to research their value proposition before committing.

Industry Sector Activity: The Return of Tangibles: TMT, Energy, Industrials

Sectors with particular M&A interest in US are TMT, Energy, Industrials and Pharmaceuticals. Industrials along with Business Services tend to have more activity due smaller deal size and higher frequency. In a change of times Financial Services have been lagging in importance, a far cry from mid 2000’s, but then again the sector has had its fair share of troubles post crisis (Source: The Future of M&As in America, Merrill Datasite and Mergermarket, 2013).

There are different drivers for transactions across industries. Low growth and interest margins as well as technology and compliance burdens drive M&As in financial services, same with insurance. Consolidation is the theme in TMT, especially when it comes to digital and mobile transition. In pharmaceuticals is about getting access to smaller companies with promising drugs. In consumers is about cash rich companies using reserves and expansion, same with energy where buyers are looking for smaller targets with resources. Industrials are looking for expansion to new markets as well as consolidation benefits. The affordable healthcare act changes the competitive landscape in the healthcare sector and is expected to increase consolidation between insurers, hospitals and independent practices (Source: NA Deal drivers 2012-13).

M&A Pricing: kept lower for now

Global multiples have decreased post crisis from the low teens to well into single digits. In 2012 the average EBITDA multiple was at 8.8X down from 9.1X in 2011. Multiples further fell in Q1 2013. US multiples were at 9.3X in 2013. Tax cuts expiring in 2012 pushed down multiples as US shareholders rushed to realize investments before capital gains rates shot up. In Europe multiples were much lower at 8.6X, down from 10X in 2011 but let’s bear in mind that Europe is going through a recessionary phase and fiscal crisis that puts pressure on earnings. Most of activity is intraEuropean continuing a long consolidation trend. Multiples in Asia fell because of economic slowdown.

3. M&A Multiples

When it comes to industry specific valuations higher prices are currently offered for energy companies. Can’t resist however to bring up here Al Gore’s reservations over these valuations arguing that they are based on reserves that will never be probably extracted. Better IRRs are offered in TMT rather than energy or industrials as well as better EBITDA. Valuations are low in financial services, less than 1.25 book value. Latin America with favorable demographics and growth prospects for many even better than those in Asia, offer good M&A prospects, hence a solid base for higher valuations. In this context Modelo brewery was bought in 2012 at a 14.1 multiple. Private equity multiples are low as IPOS are down and many exits are realized thought secondary offerings. PE financing multiples are currently at the 7-8 range with average exit multiples at 11 according to Mergermarket. Refer to our post on PE activity in 2012-13 for more info. American Appraisal expects M&A multiples to increase in 2013 as US economy will continue to fair well, Eurozone sort out its problems while Asia continue to grow (Global M&A Valuation Outlook 2013).

M&A Value Realization: Not always getting what you paid for

In order to realize value from M&As it is important to get valuation right as well as due diligence and post merger integration. We are not getting tired to remind Graham’s saying that Warren Buffet goes by: ‘Price is what you pay; Value is what you get’. Getting price and value to meet is not always easy, in fact most of times it doesn’t happen. An example of that comes from a KPMG analysis of stocks of certain companies’ engaged in M&As during 2007-2008. Average size for those deals was at $2.3b with the median at $620m. What KPMG found is that companies announcing deals in 2007 saw prices fall by 8.4% 24 months later, while those during 2008 increased by only 2.5%. As expected those targets with the highest PEs at acquisition offered the worst returns. According to KPMG deals “during exuberant 2007 may not have received the same level of due diligence as those in 2008 when it was much more difficult to complete transactions” (Source: The Common Determinants of M&A Success, KPMG 2011). This disappointing performance may well have to do to some extend, with the overall stockmarket trend. On the other hand one can’t deny the importance of getting the valuation right.

Aside from valuation, critical factors for successful M&As are carrying out an efficient due diligence that will unearth issues and proceed according to a well designed post-merger integration plan that focuses on effective communications, quickly establishing goals (usually under a 100 day timeframe), having a post acquisition plan in place, well before closing and selecting key people. That’s at least according to a survey of M&A practitioners, carried out by Deloitte and Mergermarket in 2012.

4. Critical Factors in Deals-Triplex

Middle Market: the next big thing? Not that straightforward

Although expectations about middle market activity arising from the sector’s massive size and pockets of underperformance, it hasn’t picked up the slack left by the eclipse of mega deals. The market simply seems to lack direction. Activity across segments is moving in tandem. Middle market activity in 2013 (ie deals between $500m-$2b) was at over $800 bn according to Mergermarket or around one third of total global M&A value, posting a small increase over 2011. During 2013 Q1-Q3 middle market deals in the US were valued at $400bn, down 7.7% compared to the same period in 2012. That was mainly due to decrease in Europe and US; Asia shows much more resilience in this segment. Looking at the European-US combined space in the lower middle market ($250-500m) we see that deal value is not that much different from the pre-crisis levels of $150b in 2004 and only at 2/3 of the 2006-2007 highs. What’s important at least is that middle market has recovered compared to after the crisis when it fell to almost 20% of global M&As.

5. M&A Deal Size in Europe and US Doublex

According to Citizens Bank’s 2013 Middle Market Survey, around 80% of middle market companies (defined as those with $5mn-2bn revenue) are currently open in making an acquisition with 20% actively engaged. Acquisitions in this space are of smaller size and more frequent. Buyers tend to buy smaller firms that can absorb more easily. Most of the deals are below $10m in value. Their main M&A motive is to increase revenues. Geographic expansion, adding products or putting cash to work come up frequently too.

Other reasons are buying-out underperforming customers or taking out competitors; objectives may differ in middle market compared to big business. Small firms and tech companies especially are looking at acquisitions as means to add talent and know-how while manufacturing companies as an opportunity to add distribution. Although post crisis there’s better availability of debt financing only about 20% of companies are currently looking at raising capital.
A quarter of the market is also looking at selling to upload outperforming segments, raise capital or create liquidity for their owners. As a common theme, many baby boomers will be looking at monetizing their holdings and retire in the near future.

There is a good case for M&As in this space, as it has depth and room for improvement but also some factors inhibiting it. We have covered middle market and PE activity as well as success factors on earlier posts: Private Equity 2012-13 Update and Success Factors for Value Realization, Middle market cross-border M&As set to grow, Large Private Equity Deals-that 800 pound gorilla.

Critical Success Factors in Middle Market M&As

According to Citizens’ Bank, the main concern when undertaking a middle market M&A is undetected liabilities. Information is more difficult to gather and audit in this segment. Conducting adequate due diligence, losing key employees or clients and off course valuation of the company are other frequent concerns. It seems that most of the middle market executives are aware of the process and don’t shy away from getting involved in them. Almost 70% deals are managed internally with advisors coming in for valuation or due diligence; however the devil is in the details.

6. Middle Market M&A Issues

The “detail” in this context is that traditional valuation techniques might not hold as reliability of earnings, cash flows and attainability of synergies may come into question. This is more often the case than in larger deals. Reliability of information as well as operational rigidities that limit the businesses’ scalability have a direct effect on value. Critical factors potential acquirers should consider before committing to a middle market deal, according to Deloitte, include:
• Strategic fit when it comes to products, markets and culture
• Root cause of depressed or bloated earnings
• Probability of improved financial performance
• Identification and attainability of potential synergies
(Factors for Mid-market Companies to Consider When Evaluating M&A Targets, 2012 Deloitte, Making the Deal Work, 2007 Deloitte)

Another “detail” is that traditional finance theories such as the CAPM may not completely hold in this segment. Cost and access to capital and investor profiles may differ than for large public companies (see Robert T Slee, Private Capital Markets: Valuation, Capitalization and Transfer of Private Business Interests, 2004). There are certain adjustments to be made. Market participants can go by gut feeling or rule of thumbs but often that may not suffice or hold in the eyes of auditors and regulators that come to review them. And the list of details can go on.

Even if however the buyer’s management has dealmaking experience we would argue that the challenge comes in the form of bandwidth availability. Buyers should mind to preserve the value of the business while analyzing the deal or later merging the two organizations. So it’s all about whether management can handle the workload at the same time that doesn’t take their eye from the ball ie, day-to-day operations and customer service. It’s also usually not always possible to leverage the acquired companies’ management as prior leaders may create political or loyalty conflicts that cause more harm than good, let alone not able to perform under the new playbook. Actually as discussed in previous posts, in most cases prior management is replaced.

Best practices approach calls for delegation of the M&A process to external experts or devoted teams, albeit with clear senior management endorsement and commitment. Other specific challenges with middle market M&As arise in the context of cross-border transactions. Knowledge of foreign economic circumstances, business practices, cultures, regulatory and tax regimes is not easily attainable without local expertise. In these cases it is better not to try reinvent the wheel but simply look for competent local or global advisers; problem is that there are not that many middle market advisers with true global reach.

Future Trends: Dare a comeback prediction for 2015?

M&A activity is expected to increase as the economies and stock market recover. In a survey of more than 150 investors and corporate executives performed by Mergermarket in 2013 (The Future of M&As in America, Merrill Datasite and Mergermarket, 2013). Almost 2/3 of respondents expected activity to increase, at least when it comes to the Americas. US companies turn to M&As as means for expansion (access to new markets) vertical integration and synergies. Asian Pacific economies keep on exhibiting strength and local companies see opportunity to acquire targets in US or Europe to gain access to markets and technology. It is expected, in this poll at least, that most of transaction activity will happen in the lower middle market i.e., $250-500m and below. Then again that may primarily indicate frequency and not overall value.

So where will it be the next big thing for M&As if there will be one, and when? Will it be middle market, emerging markets, technology, energy, cross-border, public to private, PE or stock-market driven? We’ll have to wait and see. It seems that after all what the market is missing is leadership, as the popular saying goes, that mainly comes from mega deals and the availability of leverage. That’s what moves the needle.

Looking at the latest two economic cycles, the fact that we’re four years in the current one, the economy keeps on growing and the stockmarket breaking highs could one bet, just even by looking at the graphs, that M&As will come back with a bang in 2014 or most probably 2015? After all, as optimism keeps settling in among at least the investment community, this is an environment that buyers will feel comfortable or even compelled to make a move or otherwise feel pressure for stock buybacks and dividend payoffs by activist investors as lately often happens.

7. M&A DJIA and GDP %yoy and Points synthesis_Corrected

So shall we wait for Godot for a couple more years?


By Pete Chatziplis, CFA, ACCA, MBA. The articles published here do not necessarily reflect the views of the Transatlantic Business Forum.

Private Equity 2012-13 Update and Success Factors for Value Realization

M&A activity has recovered since the 2009-10 lows albeit not mirrored the Stock Market rebound with the Dow hitting and surpassing all-time highs. M&As as well as PE activity on the other side seem to be hovering around pre-crisis levels. During full year 2012 global M&As reached $2.2tr, barely posting any growth from 2013. North American deals reached $943 bn, a 5% increase over previous year. These figures stand at 2/3 of the 2006-7 total deal value. We have to go back to 2004 to note an increase of a mere 2.3% CAGR, which should be in line with GDP growth patterns.

PE Overview: A new Paradigm or Trough?

These lower levels of activity may be just the normal state of things, a new paradigm away from the mega-deals facilitated by excessive leverage in 2006-7. On the other hand PE and M&A cycles move in 5-7 years intervals with PE buyouts representing a sliver of total M&A activity, at around 10%, slightly increasing as a percentage during the last decade. Taking this into consideration we may just be waiting for the next big story that will spark a boom. Furthermore as textbook financial planning has it, a proportion of private assets should be allocated to alternative investments for diversification and excess return purposes. This may as well spark, at some point, PE growth. We will cover M&A trends, segmentation and valuations on another topic. In this we will focus on PE activity as well as ways to increase value and returns by operational means, more so since financial engineering and exits are not that easy.

PE buyouts reached $259bn in 2012 with US representing almost half of that at $118bn, up from $112bn in 2011. Outside US, around 35% of PE buyouts took part in Europe, 11% in Asia excluding Japan, with the balance spread around the world. Although fiscal problems, Europe has been a source of dealflow due to integration, cross-border deals, bottom fishing and privatizations. Average deal size is around $100mn in Europe but 50% higher in the US. PE activity has grown at 25% post 2009 lows for Europe and Asia but in US, where PEs are more prominent, growth was double that at 50%, according to Bain. In the first half of 2013 global PE buyouts reached $144bn (according to Mergermarket) up by 17% from the respective period in 2012.

Global PE Market 2012 - TBF

Sectors of interest for PE investment at least in the US are consumer (B2C businesses), computers/IT, followed by pharmaceuticals and health. Energy is also attractive both in resources and equipment. Biggest PE deals in 2012-13 were: Heinz ($27b by Berkshire Hathaway and 3G Capital Partners), Dell ($20b by Silver Lake partners and Michael Dell), BMC Software ($6b). The Dell deal also underlines the increasing interest for public to private transactions.

Exits: Can I cash my chips please?

Investments don’t worth much more than what you get paid for. Much of the PE activity currently is not in buyouts but working through exiting the backlog of prior investments. As a result holding periods have increased to 6 in 2013 compared to around 3 in 2007 according to Pitchbook. Secondary investments have been gaining attention over IPOs due to difficult conditions there. According to Bain, sponsor-to-sponsor deals tend to historically fair better than other deal types. Almost half of exits in 2012 were realized through secondary buyouts vs. 25-30% five years ago. Other more unique methods such as dividend recaps are gaining traction, especially in uploading large investment. KKR and Bain for example geared up HCA prior to refloating, to take some money out of the table.

Exits by type

Middle Market: Ample opportunity but where’s the value?

PE activity has been affected by the absence of leverage and the eclipse of the 2006-2007 mega-deals (such as Energy Future Holdings (TXU) for $44b, HCA for $32.7b, Equity Office Properties for $39b, first Data $29b, Harrah’s $27b, Alltel $27b, Hilton $26b to name the biggest). In this environment middle market deals (between $250-$1bn ) are fairing much better. It’s easier to maneuver such investments, turnaround and even exit as we have discussed in this blog before (see Middle market cross-border M&As set to grow, Large Private Equity Deals-that 800 pound gorilla). For example the largest ever LBO of TXU has not turned out very well with the company heading to bankruptcy and the PEs that led it, even prominent, such as Goldman Sachs Capital Partners, KKR and TPG Capital, standing to almost write-off their investment (Business Week, Buyout firms clash over energy biggest ever LBO).

Middle market investments also offer benefits when planning exits through aggregating/consolidating companies into larger units and ripping benefits of scale and better valuations. It’s what we’d call “riding up the multiples curve”, ie pretty much scaling up a business by adding activity around a tested operating model and get higher valuations with size. A small company might have good products but what makes or brakes a company is the structure, that’s the reason so many wonderful ideas fail. Access to distribution channels, capital and talent is easier for larger companies.

TEV-EBITDA multiples

There are an estimated 300,000 middle size companies in the US of which PEs own around 35,000 (The New Math of Middle Market M&A, Robert Slee The Value Examiner, July/August 2009). According to Robert Slee, who is probably one of the very few if not the only finance theorist in the context of small/private businesses, 75% of middle size companies destroy value as they usually produce returns below their cost of capital. Cost of capital for small/private businesses according to his calculations is in the high 20s. That is after taking into consideration risk, cost of financing and bypassing CAPM theory that arguably is more suitable for capital markets. These low return patterns can be more accentuated by the fact that much of the owner’s investment is not recorded, such as unpaid/underpaid management time as well as other resources. Although the ample availability of opportunities, it’s not easy to score a home run in the sector. Companies are often the extension of their owners’ lifestyles and not purely an investment. Owners are not willing or not equipped to realize value for their businesses. In these cases it’s simply better to pass. As Graham put it ‘Price is what you pay; Value is what you get’ and in these cases the two diverge significantly. Slee estimates top performers in middle market an additional 9,000 over the ones already owned by PEs. So numbers are not that good, hence PEs prefer to go international where there’s higher demand for capital.

Valuation Multiples: Buying low and selling high, at some point..

Current M&A multiples are below those of the last crisis, although edging higher. PE buyout multiples are usually lower than those for strategic acquisitions but during the crisis spiked over them; another sign of those times. Currently, MA multiples are at the 8 range, having reached low teens, around 12, in 2007 according to American Appraisal. Financing multiples are currently at the 7-8 range with average exit multiples at 11 according to Mergermarket. This is rather low if compared to multiples of low 20s during 2006-2007. Median exit multiples are even lower, close to 8 times, according to Pitchbook. Considering the backlog of rich investments from previous years and challenging exit multiples this is not the best situation. All these indicate a much narrower space for realizing returns which stress the importance of operational gains.

GLobal Exit multiples

PE Turnaround Strategies; It’s more than theory

PE investing is not a straightforward success. Currently one year PE IRR is at 5%, much fueled by mark to market valuations, the change brought about with IFRS and SFAS fair value accounting rules. The five year IRR is at 10% having fallen from almost 30% in 2006-7 and much higher in the 40s, at end of 90s, according to Bain. Hence the academic discussion now centers around the PEs’ elusive alpha.

5 year PE IRRs

So how do PEs create value? We can’t go over the secret sauce in detail here but in general PEs work with performance indicators that are tied to financial performance, which is how they measure their own performance after all. For example ROE based models focus on increasing factors such as Asset Utilization, Profitability and Leverage which pretty much center around sales strategy, cost of capital, cash flow management, cost cutting and getting rid of underperforming assets and units. Asset stripping is a well documented strategy that frees up capital and unrealized value. Pricing is another important value creator. Bain estimates that 1% rise in price results in 15% boost in pretax profits while an increase in sales volume only has half the effect (due to variable costs incurred). This can be achieved with specially targeted sales and marketing strategies.

An example of a recent turnaround story is Kodak. The once blue-chip giant has filed bankruptcy two years ago as its core business gradually failed. The company had been criticized for denying industry changes and remaining attached to its once dominant film business, passing over the digital revolution. After emerging from a private equity backed restructuring plan it just recently returned to the stock market. Under the restructuring plan Kodak sold its film business to its UK pension fund, as well as various patents and inevitably downsized. It now focuses on high-end market segments of packaging, graphic communications and digital imprinting.

Turnarounds though are not easy. Many investments fail, same as for TXU, even if some of the best PEs are involved. According to a survey of M&A practitioners, carried out by Deloitte and Mergermarket in 2012, factors critical for successful M&As, were communicating effectively, quickly establishing goals (usually this is under a 100 day plan), having a post acquisition plan in place before closing and selecting key people.

Deloitte Survey Resuts X3-2b

Value creation starts however with information. This is the foundation and more; without it doing business is like sailing without a compass. Information is important both at the pre-acquisition phase during due diligence, as well as after that through value buildup. An accurate due diligence that will reveal the target’s true operational and financial position as well as a well-planned post integration plan are of paramount importance. Especially with smaller companies due diligence may be more challenging as information may not be there. According to the Deloitte survey, almost half of buyers would spend more time on due diligence. That’s where PE consultants are particularly useful as they bring to the table specialized knowledge and readily deployable bandwidth. Pursuing an M&A is nothing to be taken lightheartedly; it’s a specialized, stressful task that requires detailed planning and execution. Don’t take us wrong, it’s possible that buyers can carry this on their own, but trying to reinvent the wheel while keeping eyes on running own business might turn out particularly costly (ie, don’t text and drive). So when in this situation do yourself a favor and turn to external M&A experts.

Collecting the information is one thing and acting upon it in a timely manner is another. In many cases companies are not ready to operate under PE professionals’ standards that often have blue chip corporate or consulting background; hence high expectations in terms of strategic planning. Urgency and efficiency in implementation is important, otherwise problems tend to linger and front loaded value/cash flows wasted. According to a SolomonEdwards survey, part of the grievance and inefficiencies result from poor communication between target CFOs and PEs. We could add here that communication can’t work if the two speak difference languages. What we mean by that: traditional CFO roles in small-middle companies fall more within the controller/bookkeeper domain. Their primary focus is keeping eye on expenses and cash levels. Planning is not a known quantity. Little is done in collecting information for strategic decision making. CEOs/owners pretty much flow with past norms or gut feeling. Getting to perform at strategic level and communicate with the finance/MBA types of PEs is just about similar to learning another language; a change one may not be prepared for, let alone able to make. Increasing financial literacy or management training is useful. Just clocking in and out may not be enough anymore; consciousness of value factors throughout the organization and even equity in them might help (ie management by objectives models). However that is not always easy if people have not been used to. That’s where PE consultants are again useful. They are called to support these CFOs both at the pre-acquisition/due diligence phase as well as after that in streamlining operations and coordinating communications. Companies like Accordion or Solomon Edwards are building successful business models around that by providing specific resources, bandwidth and knowledge. Accordion has also established a specific service for facilitating information collection and dissemination. Operational partners are also used in improving performance. PEs also usually work with tested interim managers who have industry specific experience and are posted to targets to perform specific functions.

We want to point out here to Peer-to-Peer networks that can also support executives. These are however more useful for independent companies that want to up their game as there can be a duplication with the PEs. Midas Managers or Michael Milken-backed Vistage are such networks. Midas Mentors take a cut of returns they create while in Vistage there’s a cost for participating in meetings. Other formal or informal groups, associations and NGOs exist for the same reason. After all there’s good supply of resources as the recession changes has created a slew of experienced middle managers and executives to tap into. However without being able to control implementation, results can be dubious. Moreover is also difficult to find listening ears that are appreciative of intellectual contributions and able to afford them before it’s too late or for owners to connect with experience that is right in the money.

Finally turnarounds come down to people. On the outside management theories make sense to all but the real challenge is implementation. Many can spot shortcomings in an underperforming company; what’s differentiates the makers is the effectiveness in pursuing and implementing changes. Humans mostly resend change, let alone if those changes challenge a favorable status quo. New PE owners may be in a better position to change things due to the power they are versed with, but this is not always adequate. In fact it can as well backfire. Most of the times however the main problem is, as one of practitioners bluntly put it, “what’s behind the manager’s desk”. According to the Deloitte research, around 2/3 of acquirers state that key personnel is one of the main success factors in M&As. It’s one thing not to be able to do, or don’t want to do something and another ignore its existence (and contrary to Socrates, still believing that you know everything). In these cases it’s fair to make a decision and move on with a management change. A high percentage of executives, especially CFOs are eventually replaced when PEs step in. The CFO role has become indeed quite challenging and tenures have shrunk significantly over the last decades.

PE Outlook

In closing, let’s discuss PE trends going forward. As already mentioned this is not a great environment, at least as practitioners would like, however the picture is not that bleak. One good thing is that there’s a lot of capital available for investing. Bain estimates that the PEs’ dry powder can last for up to 3 more years. Main focus of activity will be North America along with middle market and emerging markets. Fundraising is pretty satisfactory as fund managers are seeking diversification, rebalance their appreciated portfolios as well as the elusive alpha. However capital doesn’t come easy. What’s important in selecting GP teams is consistency of performance as well as having “skin in the game”. After all everybody makes mistakes, it’s how many vs. successes that differentiate the leaders. Stock markets are also getting stronger to facilitate exits. On the reverse route public to private deals, such as Dell’s, are gaining attention and may contribute to the sector’s comeback as did in 2007 (ie the HCA deal). After all however buyouts are justified when the underlying business is healthy, valuation is correct and there’re promising exit prospects. As Warrant Buffet put it: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”.

By Pete Chatziplis, CFA, ACCA, MBA. The articles published here do not necessarily reflect the views of the Transatlantic Business Forum.

Middle market cross-border M&As set to grow

Mergers & Acquisitions plummeted in the aftermath of the 2008 economic crisis; investor sentiment, consumer demand and most importantly financing was simply not there for deals to happen. However, as US corporate profits reached sixty year highs and global economies are growing, M&As are coming back with a bang. Investors regain their risk appetite; strategic investors feel the pressure to use their newfound riches to invest in future growth, either through acquiring technology or market share. Financial investors start flexing their muscles as new capital starts flowing in their funds. Earlier this year BC Partners raised 4 billion Euros ($5.6 billion) for a new fund, Apax is expected to raise around 11 billion Euros by the end of the year (Source: Reuters).

Market Outlook

Although the recent rebound however, global M&As are down 35% compared to the 2007-2008 highs, reaching $2.4 trillion in total value in 2010, according to Mergermarket data. M&A recovery is mainly fuelled by a rebound in the US and Europe, the largest markets, and continued growth in emerging economies.

Almost 60% of the activity took place in Europe and US; of that, middle market deals where $356 billion or around 25% according to Mergermarket data. According to Thompson Financial and Deloitte US Corporate Finance total middle market deals in the US only was $175 billion in 2010. A total of 7,100 transactions were completed with average size of around $80 million. We have no available data for middle market deals in emerging markets but should be high considering the companies’ size there. The following graph illustrates M&As by deal size in Europe and US over the last 7 years, which pretty much spans the latest economic cycle. Deal activity spiked in 2006-2007 fuelled by LBOs. As these are large deals, M&A activity was more prevalent in large cap companies although middle market deals increased as well. Another differentiating factor attached to LBOs and large deals is the high participation of financial buyers; in middle market on the other hand private equity participation is relatively lower, at 13% of all deals (Thompson data).

As economies start to recover there are definitely better days ahead for M&As and especially for the middle market that forms the backbone of most economies. According to CIT and 2010 US Census data, there are 106,000 middle size companies in the US employing 32 million people. Their total annual revenues of $6 trillion compare to $8.3 trillion of the S&P 500 companies. Their total capitalization is estimated at 60% of total U.S. equity market capitalization.

Mid size companies are increasingly expanding globally, tapping into opportunities overseas be it in production resources or demand for their products. According to Mergermarket, cross-border transactions accounted for 31% of all deals in the first half of 2010. In a 2007 survey performed by KPMG’s Global Enterprise Institute four out of ten middle size Colorado companies considered global expansion as integral to their growth strategy and the majority of them actively focused on expansion plans.

This post aims to illustrate the significance and global potential of the middle market M&A sector that often doesn’t attract that much of media coverage. It will also aim to touch upon some best practices to bring cross-border middle market deals to fruition.

Middle market segmentation

Before moving any further let’s make sure we are on the same page regarding definitions. So what really constitutes middle market?

By industry convention, at least in the US, middle market refers to those companies with revenues between mostly $10- 500m and as high as $1 billion at the upper end of the range. The market is divided into lower, middle and upper brackets, with different characteristics in terms of management style and organizational resources; by that we are referring to Robert Slee’s work on private capital markets and more specifically the Slee, Trottier paper on middle market segmentation. Mid market’s lower and middle bracket deals fetch between $10m to $500m as a broad guideline. Price considerations off course depend on case specifics and industry sector, i.e. small companies in basic industries might fetch lower prices than fast growing new economy companies where even low earning figures can produce disproportionately high valuations.

What’s important to note however is that the middle market definition should not be considered unambiguous around the world. Depending on local circumstances such as level of development and industry segmentation the middle market ranges can vary. Looking for example at the graph below the percentage of companies with less than 10 employees is much higher in OECD’s less developed economies pushing higher the middle market mark there compared to US; UK, Germany and other economies in later stages of development.

To our opinion what’s middle market depends on the “big-fish–little-pond” effect: the size of your pond is what really defines where you stand. What’s considered small or middle market in the US might be taken for big somewhere else, just as a large-size US shirt might be extra large somewhere else. What’s the implication of this? There’s a huge difference in terms of self-perception. Hung out with basketball players and you might feel mid size, lead the boy scouts and you might feel a giant. These differences in self-perception make a huge difference in psychology that warrants special attention when approaching a deal.

For example, a midsize company by US standards might be a regional champion in some other country, employing a large number of employees and generating significant wealth for the particular economy. The differences go beyond semantics; they are about management styles and importance in the local setting which all bear implications during the M&A negotiation phase and beyond. Place executives from these two different worlds on the same table and you realize that they don’t only speak different languages in terms of mother tongue or cultural background but also in terms of personal objectives, styles and aspirations. Failure to appreciate that early enough in an M&A process can lead to results that range from amusing to catastrophic.

Deal Drivers

As mentioned above mid market M&As are expected to recover and along with the global economy increasingly become cross-border. According to Mergermarket data, the total value of cross-border transactions rose by 60% in the first half of 2010 reaching 31% of global deal value. Total US outwards middle market deals reached $32.9 billion in 2010 of which 35% landed in Europe (Thompson Financial and Deloitte US Corporate Finance). Add to that the large deals and you end up with total transatlantic deals of $160 billion just to underline the size of the market opportunity that the Transatlantic Business Forum and our blog follow. Outside Europe, large increase in middle market outward M&A took place in Canada, Japan and India.

Alongside the interest from western world to the emerging markets, the Mergermarket data shows that increasingly emerging market companies are also becoming extrovert. Outbound deal activity from the emerging markets rose 318% by value and 111% by deal count in the first half of 2010. According to the U.S. Census Bureau, U.S. companies with a value of $260 billion were acquired or established by non-U.S. owners in 2008 up fourfold from 2003 levels; it is expected that his trend will persist (Source: The Deal: The middle market goes global). There are various reasons for the increase of cross-border transactions. Below we attempt to highlight some of them without aiming to make this list all-inclusive.

• Stage of development: there’s increasing integration across global economies; there’s no denial to that. Globalization allows developed world companies to take advantage of growth prospects in emerging markets as well the later of consumer strength in the former. These opportunities arise from lower but rising GDP per capital levels and lower labor costs in the emerging world (see graph below taken from our recent post about stimulating investment in Europe’s periphery). The latter is a driver for outsourcing, however we would argue that this only cannot be a long term investment criteria as the cost advantage will most probably be sustainable over a specific period. For example there are concerns that although China’s immense production capability, costs there start to grow too.

• Modernization: Developing economies are in the process of modernization; they often start from low value added processes and hopefully move towards higher value added products and higher GDP levels. In this context the large number of promising middle size companies need to retool, upgrade processes to remain competitive as trade barriers fall or labor costs increase. That is crucial in order to preserve their role within local communities. In this context they may welcome foreign input.

• Horizontal expansion: M&As for middle size companies provide a way to grow quickly and break into the large company bracket thus enjoying economies of scale in production, marketing or finance. This growth can be achieved faster and with less risk when existing strengths and products can be leveraged across different regions. Off course this assumes that existing products and know-how can be easily adjusted to foreign environments. In comparison, further penetrating their local niches or even moving into new ones might be too challenging.

• Restructuring/bottom fishing. According to the Transatlantic Restructuring Outlook report published by Debtwire in association with Merrill DataSite it is expected that activity in this area will increase in 2011. Restructuring drivers for North America will be corporate sector distress while in Southern Europe solvency concerns resulting from the sovereign debt crises especially in financial services. Financial distress in Europe’s periphery is a highly publicized problem these days. Additionally Central and Eastern Europe will continue to promote inward investment and modernization. There, as well as in Southern Europe the highest percentage of suitors will be strategic buyers as they could quickly gain market share through a distress sale. But then again, private equity activity has relatively slowed down in Europe.

• Unavailability of capital or of investment options. Companies in developing economies, especially the middle market ones, are usually plagued by difficulty in accessing capital to finance their growth. On the other hand there’s significant accumulated capital and financial know-how in developed countries with limited investment options locally. We believe that this creates significant inefficiencies in capital allocation. Probably for this reason large US banks are looking into assisting middle market companies in their overseas quests leveraging strong capital base and global network (Source: article). On the other side an acquisition in a developed country can provide an emerging economy company access to capital and sophisticated financial products be it through stock market, private equity or bank loans. In this context some companies have pursued reverse mergers to list in the US.

• Access to capital and know-how: According to a UNDP’s report (“Unleashing Entrepreneurship: Making Business Work For The Poor”, UNDP 2004) private sector in emerging economies face certain limitation as it has to operate in corrupted and bureaucratic environments with ill-directed macroeconomic policies and poor infrastructures. According to the report: “even with strong macroeconomic and institutional foundations, three additional factors are indispensable for entrepreneurship and the private sector to flourish in an economy: a level playing field, access to finance, and knowledge and skills”. Entering a developed economy can provide much needed access to advanced technology and know-how.

• Access to natural resources: there’s increasing competition for commodities in a growing global economies. Access to commodities is critical for sustainable growth so we are observing increased interest for investment in natural resources in Africa and elsewhere.

• FX/capital gains: as the US is following a weak dollar policy (low interest rates alleviate the housing market crisis) while emerging economies’ currencies and consumer demand are growing (for example in Brazil, China) there’s a benefit for US companies expanding and investing overseas. We would be critical of investing driven by capital or FX gains only; as this could be speculative and not related to core business. On the other hand there are certainly business owners that may consider building wealth through capital gains (related articles on demand for US manufacturers and capital flows to emerging markets).

• Prestige: operating in a developed economy or in an emerging economy can also enhance some companies’ image. We had to resist the temptation of excluding this reason as it might seem a bit superficial but we think that it is at least in the back of some buyers mind. For example a company can be considered as having growth potential when expanding its global reach and entering an emerging economy while a developing world company can be perceived as playing on another league when operating in a developed country.

Success factors for Middle Markets M&As

Succeeding in executing an M&A doesn’t come easy. The right target should be selected, the one that fits in terms of competencies and management culture, the right price and financing should be negotiated and finally the company can be integrated in a way that resources and time is not wasted. This is not easy; actually a large number of M&As do fail. For a middle market company to succeed in a cross-border transaction or even in a simple cooperation it should select competent advisors and invest on training its management team to deal with issues related to strategic management and international finance in order to fine tune use of capital and maximize shareholder value. Management should also become aware of foreign economies and cultures and walk in negotiations without prejudices or assumptions based on own experiences.

M&A advisors should master a large array of topics in finance, legal, tax and operational matters. This is highly specialized knowledge; therefore a team is necessary with discreet roles. As this is not already enough cross-border M&A advisors should be knowledgeable in both regions to be able to bridge differences in economic circumstances, regulations and cultures. Throw in special regulations associated with foreign investment such as FCPA (Foreign Corrupt Practices Act) and the typical middle market company has enough red tape on its plate to be overwhelmed.

Middle market companies that lack the human capital resources of their larger competitors require increased support during M&As. Apart from that however, planning and executing an M&A can turn out to be a very useful self-evaluation exercise. Working on M&As external advisors bring in valuable technical background and experience from other sectors and transactions playing thus a valuable cross-insemination role. By examining acquisition options companies can evaluate their own competencies and strategy. By valuing acquisition targets they can gain insights on their own cost of capital and value creation record. Thus an M&A can have multiple benefits in shaping up a company in its quest to grow and become more competitive.

The problem with middle market companies is that they don’t reach out to external consultants that often. Cost can be a reason as smaller companies are usually tight with their money, disbelief can be another. On the other hand there’s a limited supply of knowledgeable consultants for middle size companies. Advisors in this market should possess knowledge that is directly applicable to companies of this segment and ability to engage and communicate it. Problem is that much of business literature is created by business schools or consultancies with largely, blue chip companies in mind. Capabilities, objectives and resources of large listed companies usually vary considerably for those of middle market private companies. On the other hand middle sized companies may be underserved by consultants with limited technical background largely depending on empirical knowledge. The ideal solution can be somewhere in the middle where advisors have the right education but also experience in dealing with middle market companies so that they are able to select and apply the most suitable tools for the case in hand.

On the cost side there’s little that can be done for investing on quality. A problem with middle market deals, especially those on the lower range, is that their small size often makes it uneconomical for advisors to work on them on a contingent basis. Work required for large or middle size deals doesn’t vary that much in terms of effort and time; however commission based compensation does. We believe that a solution to that can be provided by technological breakthroughs that make certain processes more efficient. For example advisors increasingly are able to source buyers or targets through online M&A platforms such as MergerID, AxialMarket or others. These platforms can provide liquidity and transparency to private markets, saving the effort in market screening and follow up that bites into transaction fees. We, in the Transatlantic Business Forum are great supporters of the online liquidity platforms (private company exchanges) and follow developments on a continuous basis (if interested further you can read our recent post about main competitors here as well as our presentation on the market ).

For all the above reasons we are very optimistic of middle market prospects both at national level but increasingly cross-border as well. However success is very much depended on getting the right advice.


The Transatlantic Business Forum is a portal, online community of professionals and consulting firm that aims to facilitate discussions on international business and especially between Europe and the Americas and promote and facilitate opportunities for cross border capital flows be it Mergers & Acquisitions, Partnerships or Trade. Contact at:

Private Company Exchanges: $10 billion market but one size doesn’t fit all

Had a great opportunity to listen first hand from Barry Silbert, CEO of Secondmarket, Peter Lehrman, CEO of AxialMarket and Daniel Confino, Founder of MergerID about market trends and different approaches among private company exchanges so thought of sharing. The discussion was organized by the Harvard Business School alumni of New York and held at KPMG’s New York offices (Innovation in Private Company Liquidity, April 4, 2011). Dan Burstein, Managing Partner of Millennium Technology Value Partners and David Weild, former Vice Chairman of NASDAQ also participated.

Private company exchanges (PCEs or online liquidity pools as we like to refer to them) may not have yet gained broad awareness or widespread adoption but they are making headlines by facilitating trading in hot, not listed stocks like Facebook, Twitter, Linkedin, Groupon or Zynga. It is by trading on SecondMarket, that Facebook’s implied valuation skyrocketed to $5obn. As these transactions have lately attracted SEC’s attention and Warren Buffet’s cautionary comments, let’s emphasize that valuations in these platforms are set by demand and supply among sophisticated investors; so it’s a “big boys” game in arm’s length transactions. It is believed that Facebook and some other hot private companies’ stocks have achieved such dispersion and active secondary trading that the line between what’s considered private or public is in essence blurred.

Apart from blocks of stocks, whole companies can as well change hands on these platforms. These “control transactions” aim to create liquidity for business owners and assist their advisors in consummating transactions. As exchange listings might be too cumbersome due to increased regulation and overhead or traditional offline M&As processes might be lengthy and costly, these exchanges create considerable efficiencies. This function is especially useful to middle market where is more difficult to attract buyer attention. More interestingly, they create opportunities for cross-border transactions, linking across global economies. For example, a US company that wants to enter the Polish market can easily research willing sellers there and make initial contacts. On the same time the Polish company can seek strategic buyers or investors around the world. That may erase inefficiencies that exist due to the fact that capital and investment opportunities usually reside in different locations these days. Capital has mainly accumulated in developed countries and opportunities arise in emerging with limited knowledge overlap between the two. This discrepancy in capital supply and demand create inefficiencies that may lead to misallocation of capital, value destruction and wasted resources; simply some capital is not put in use in the best way and companies on the other site may have to bear too high cost of capital and select projects with higher risk profiles to survive.

Benefits provided by this new technology doesn’t come without problems however Many investors or advisors, especially the “old school” often used to make deals face to face in golf clubs through long standing relationships, express disbelief. Some are worried that technology might take away businesses; some are turned away by dubious market participants. There’s some merit in that; quality of input is sometimes questionable. There are cases of buyers or sellers making false presentation of their abilities much like in a “push marketing” fashion; sometimes their intentions are not that innocent. Platforms are making efforts to remedy this by screening participants and providing research. In our opinion however, this poses a dilemma: should companies strengthen controls and by that increase operating costs, transaction fees and unintentionally drive away even legitimate liquidity or rate participants based on performance and simply caution buyers that some homework is required on their site? In the end, that’s part of the value brought on the table by knowledgeable advisors. We support the second option; see our views on operating models here.

As mentioned at the discussion, PCE adoption is increasing. Their establishment is pretty much a wish come true for many buyers, sellers and advisors spending immense amount of time and energy to communicate market opportunities. After all, we are living in a viral world; once an operating model proves itself it can grow quickly. According to the panel, it is estimated that PCEs is a promising market of $10bn. We would place the medium term target much higher. Another interesting point is that not all platforms are the same. Much like stock exchanges and darkpools, PCEs have different operating models and target different clientele. SecondMarket’s model focuses on pre-IPO stock while AxialMarket and MergerID are mainly geared towards control transactions and the middle market.

SecondMarket (formerly Restricted Stock Partners) was founded by Barry Silbert in 2004 to offer liquidity for restricted securities in public companies. Barry mentioned in an interview that had own experience in that from when working at Hoolihan Lockey and had to find buyers for parts of bankrupt Enron. SecondMarket gradually introduced trading for auction-rate securities, bankruptcy claims, limited partnership interests, structured products (MBS, CDOs, ABS), whole loans, private company stock, and government IOUs. Private stock was added two years ago. Trading is mainly geared towards pre-IPO companies and their employees on the supply side and venture capitals and high net worth individuals on the buy side. It has attracted much publicity and fame through trading stocks such as Facebook, Groupon and Linkedin.

SecondMarket surpassed a half-billion dollars in private company transactions since this market was launched in April 2009. In fourth quarter of 2010 transaction fees more than doubled compared to the previous quarter, to all times high (probably helped by the Facebook stock that accounted for around 40% of volume). At the same time market participants rose to 35,000 compared to little more than 5,000 a year ago. Companies with stock trading at SecondMarket, can control trading terms. It comes at no cost to them but sellers have to pay a 3-5% fee on transactions. According to Barry Silbert the differentiating factor between stocks traded at SecondMarket and traditional stock exchanges will at some point simply be the platform used. The companies would then choose the venue that better suits their needs. That’s interesting; after darkpools, stock exchanges may also see business taken away by PCEs in the future.

SecondMarket has already gained market recognition. It was named 2011 Technology Pioneer by the World Economic Forum and one of the “Top Fifty Tech Startups You Should Know” by BusinessWeek. Fast Company recognized it as one of eight startups “brimming with hope” for the financial industry. AlwaysOn Media named it as the overall winner of the “Global 250” list of the top private companies in the world.

AxialMarket (formerly Cathedral Partners) is focused on middle market control transactions basically catering to business owners. It was founded by Peter Lehrman with background in the Gerson Lehrman Group, the online community for on-demand consulting services. Peter is passionate for high tech B2B marketplaces, even where many thought they couldn’t exist. Probably that drove him to establish AxialMarket in 2007; outstanding foresight admittedly.

Since AxialMarket’s inception, over 3,000 privately held companies were sold through it. In the first quarter of 2011 over 500 opportunities, a 12% increase, with over $7billion in revenue and $800M in EBITDA were delivered via AxialMarket. Its platform includes over 1,200 qualified M&A advisors and private business owners. Apart from enabling transactions it also offers proactive research over targets and industries. AxialMarket follows a mixed subscription and transaction model. Most of transactions are concentrated in North America. It has strong presence in the US private equity industry.

MergerID is part of the Pearson/Financial Times group. It was founded by Dan Confino, a seasoned international M&A lawyer now based in London. MergerID leverages a strong global footprint and market insights to provide value added M&A information to its members. After all, Mergermarket a leading information platform for the M&A market, is also part of the FT group. MergerID focuses more on the CFO community and the middle market. It has adopted a membership model charging no commission on deals executed. In the first year of its operation (was launched in September 2009), over 25,000 matches between buyers and sellers have been recorded. Its platform includes more than 1,300 companies in 65 countries that is present.

According to Jonathan Goor, Managing Director of MergerID: “Through MergerID, users can effortlessly access a global audience. The interest in all the BRIC and aspirant BRIC countries as well as in the Middle East and Africa has been fantastic so far…” According to Mergermarket data, the total value of cross-border transactions rose by 60% in first half of 2010 reaching 31% of global deal value. Alongside the interest from western world to the BRICs, Mergermarket data shows that emerging market companies are also increasingly acquiring abroad. Outbound deal activity from the emerging markets has risen 318% by value and 111% by deal count in the first half of 2010.

The above platforms are not the only ones, however they are the early market participants and among the most popular. Many more new competitors have started to appear and raise capital (see our post on that here). Hopefully competition will increase product awareness and liquidity for private transactions. After all maybe PCEs are the best platform for investors and companies especially in middle market: in a stock market plagued by short-termism, analyst pressure, where average stock holding period has fallen to 6-7 months and high frequency trading accounts for as much as 70% of trading, PCEs can be a more suitable venue for some companies and long term investors (even though the motives for investing in facebook stock might be speculative..).

Will be interesting to see at some point research on the cost of capital for companies trading in PCEs versus that for listed companies (especially those not actively trading and not followed by many analysts). And one more topic to research: valuations and volatility of private equity investments based on data from PCE trading; we bet that portfolio managers, wealth advisors and accountants would love to see that.

The Transatlantic Business Forum is a portal, online community of professionals and consulting firm that aims to facilitate discussions on international business and especially between Europe and the Americas and promote and facilitate opportunities for cross border capital flows be it Mergers & Acquisitions, Partnerships or Trade. Contact at:

Private stock exchanges update: Capital starts flocking in; great potential for this disruptive technology

Private stock exchanges is a popular topic for this blog (after all we have as well put together a business pitch for a platform as early as 2009; scroll to the end of the post for the link). We can’t help but revisit the topic as this new disruptive technology starts to gain acceptance, something that will rapidly revolutionize financial markets (and generate some good profit for their users and shareholders….). A long awaited useful tool for investment professionals this technology’s introduction hasn’t been easy and still has ways to go.

One of the earlier platforms, Secondmarket, was developed by a young M&A professional facing a common frustrating feeling among investment bankers that try to shop around large amounts of illiquid investments. It is however the trading of private stocks such as those of facebook that helped attract attention to Secondmarket as well as Sharepost; one more sign of business catching up with technologies in unintended ways. And this way, trading platforms started to become a way for private investors to tap into promising returns, once only accessible to private equities and bank clients through private placements. This has recently led SEC to investigate the valuation of securities in these placements to avoid conflicts of interest; one more indication of those platforms’ increased popularity. Other market participants such as MergerID (part of the Mergermarket/Pearson(FT) group) and Axial Market stay focused on outright sale of whole companies.

Market participants are increasing almost by the day and start attracting investor attention. GATE Technologies recently raised $3.6m of new funding from private investors. Xpert Financial, who raised $3m from famous venture capitalist Tim Draper in 2009, offers an SEC approved electronic platform for secondary offerings similar to Nasdaq. More competitors will probably appear as the market will follow the usual pattern of early product introduction: many early adopters vying to penetrate the market followed by consolidation around the fittest. At this point there’s room for all, as long as they have the necessary funding to reach sustainable operations. Existing platforms operate under different execution/membership models and focus in different markets allowing a choice of service to users, much as darkpools do in the traditional exchanges’ space.

What will be the critical success factor to our opinion is the ability to secure liquidity from both buyers and sellers, through aggressive business development and proactive communication of opportunities. System integrity and credibility is another important parameter which will develop as users and regulators become more familiar with the technology. At this point why wouldn’t regulators some day oblige financiers to execute deals through this platforms rather than offline if they are able to secure sufficient liquidity and better execution terms there (along the lines of the MiFID/Best Execution guidelines) further driving their adoption and trading proceeds?

Apart from trading in promising private company stock; there’s a compelling efficiency rational giving birth to such exchanges. Instead of wasting much of a banker’s time on market screening, cold calling, correspondence, etc, using an online tool one can minimize logistics and focus on the higher value parts of a deal (i.e. negotiating and deal structuring); keeping thus fees low and profits high. This way many more middle market deals will get done; even if don’t look that promising at first sight. There couldn’t be a better timing for this product due to capital demand from startups and mid size companies that need to grow out of the recession at the same time that are underserved by the banking system in the aftermath of the financial crisis.

Other product drivers are: increased familiarization with online trading/platforms (darkpools/online trading have changed the market landscape for traditional exchanges/brokers), increased use of social networking especially by the younger generation of professionals, globalization (in today’s world, sources and users of capital increasingly don’t reside at the same location) as well as increasing numbers of high net worth and knowledgeable investors. The latter can now bypass intermediaries through these platforms directly investing on targets. This can as well revolutionize wealth management. An interesting twist to that are platforms specializing in social investing/giving. These platforms can benefit the sizeable, at least in the US, nonprofit sector but also cure some inefficiencies and credibility problems there. Such example is the GATE Impact platform which is supported by Prudential’s Social Investments program.

Finally, but very importantly, this new technology can serve a great good to financial markets as it will increase transparency over private market transactions and provide a point or reference for finance professionals and regulators to value illiquid investments; a malady behind the latest financial crisis.

We will be following news with excitement and look forward to exponential growth for this product as well as M&A activity, especially in middle market.

You can see our views on the topic as well as the business case for one such trading platform in a presentation/business pitch we prepared as early as 2009:

Private Securities and M&A Electronic Marketplaces; the future is here!

For many years and for many M&A professionals, being able to locate targets or capital in a cost-efficient manner has been an elusive target; especially in middle market deals and emerging economies.  Now things are eventually starting to change with the introduction of the private market electronic exchanges (as I would define them) such as Sedondmarket, Sharespost, Cathedral Partners, Merger ID to name a few.  These platforms constitute exchanges for non listed companies where M&A professionals can source deals.  However, the breakthrough, to my opinion, will come from private investors as well as growth in emerging markets.  Private investors are becoming interested in selling securities that they may have received as part of compensation or participate in promising pre-IPO companies.  This trend will be supported by Generation X’s and Y’s familiarity with social networking as they become active members of the investment community (just to attempt a risky comparison the Ebay model may have many more applications; one of these being in some ways the private markets).

On the other hand these platforms can serve as the bridge between private capital in developed markets and investment opportunities in emerging markets.  Although large institutional investors are present in emerging markets, the majority of opportunities there are of small and medium size, hence overlooked.  Thus middle market is for many years plagued by adverse selection and underestimated, especially in the cross-border space.  Electronic marketplaces can help with communicating opportunities and local expertise and provide the necessary transparency to increase investor confidence.  The final step for the wide adoption of these platforms will come, in my opinion, when they become part of the Best Execution/MiFID framework but there’s some way until we get there and in the meantime they’ll have to prove that they’re sufficiently liquid and efficient.  Price transparency and system integrity would also have to be proved to gain user confidence.  

Follow on additional services could be local market, tax and legal information, executive search and selection as well as my favorite: volatility statistics that will offer hedge fund managers with reliable risk profile for their private equity investments.  These investments appear to have low beta and low correlation to other asset classes.  That may be attributed to infrequent revaluation of such portfolios; something that may change with the introduction of fair value accounting and availability of reliable private market data.

Of course it’ll be some time until these platforms prove themselves but I have the sense that this time is not that far.  Once they do they can change the landscape allowing for more transaction hence higher advisory fees, significant returns for knowledgeable investors and opportunities to grow for companies.  Eventually these platforms will also become prized M&A targets themselves.  As a matter of fact they can be more valuable as part of a suite of services than as stand alone businesses.  Everybody serving high net worth individuals will get interested as well as companies integrating vertically or horizontally such as public exchanges, IT/communication companies and off course Private Equities that will be the main market participants and users.  On the other hand once these platforms mature they’ll be cash cows and attract financial investors or strategic investors that will aim at developing certain M&A markets. 

The above is only a summary on a subject that is of great personal professional interest. I have created a business pitch on this idea and would be happy to discuss further with like minded professionals and investors.  Stay tuned for more updates on the topic.

Global M&As plummet in 2009, Emerging markets and Central Europe faring relatively well

Global M&As plummeted in 2009 to $1.6 trillion (according to Mergermarket data) of which a little less than half in North America (45%) and the remaining split between Europe, where M&A activity nosedived, and Asia and the rest of the world that are increasingly making their mark in the global investment arena.  I’ll be posting more on this in the future.  In the meantime I’ll be highlighting the opportunities that this data suggest for emerging markets.  These opportunities have being around for some time; it’s just only now in my opinion that they’re more emphatically substantiated with figures.  Apart from economical growth, opportunities in these markets may be supported from decreasing number of large private equity transactions in developed markets (due to limited past success and unavailability of leveraged financing) and crowding out of new capital raising from government debt issues. 

Based on recent research that I presented at the 10th NYU Global Business Conference, Central Eastern Europe, the emerging part of Europe, appears to be recovering from the global crisis.  After a shock caused by the credit crunch early in the financial crisis, investor confidence seems to be returning.  Probably this shock was good after all, as capital poured in too far too fast and valuations have gone out of hand (but as Jim Chanos would say, “bubbles are created by credit excesses not valuations”).  As you may see in the attached graph, GDP per capital across CEE is one third of the EU average; the convergence can’t happen overnight as pre-crisis valuations implied.  However opportunities remain there for the knowledgeable investor.  After all we’re talking about an area of 180 million people, growing GDP, EU backing, skilled, relatively low labor cost and contrary to the PIIGS, descent fiscal condition.  However, capacity and infrastructure limitations should be taken into consideration, as well as local sensitivities and practices. 

Regarding industry sectors I would see opportunities in:

–       Energy (GDP growth/investment in efficiency and renewables)

–       Financials (increase in consumer lending)

–       Telecoms (new technologies, DSL)

–       Consumer (rise of middle class)

–       Outsourcing (good workforce, European time zone and proximity)

–       Manufacturing (in the context of global facility diversification)

–       Logistics (central location)

–       Health (population aging)

–       Leisure & Tourism (upgrade of services and facilities)

The NYU conference also covered opportunities in Asia as well as Africa which I see gaining increased attention.  Overall opportunities exist everywhere and an informed global investor should analyze each one in the local context but without missing the global perspective and ignoring good old investment analysis as better opportunities might exist elsewhere and investment analysis is the tool to figure this out.  Act local; think global to remember the old marketing fad.

Large Private Equity Deals-that 800 pound gorilla?

It was a great revelation coming across this very interesting recent article at NY Times ( that supports my belief that large Private Equity deals don’t work that well (I’m sure that there should be other practitioners and research pointing out to this; I’m not claiming the authority here).  The reason is that it’s just too difficult to move around this 800 pound gorilla in the room (although the good fees in trying to do so).  Other reasons is that there might be difficult to re-float a large investment in stable or even decreasing capital markets (taking into consideration demographics and other factors) while increased supervision over large funds may further increase effectiveness and increase operating costs.  Private Equity I believe is more relevant in small-middle market where knowledgeable experts can leverage their experience in business practices and financing.  That calls for a specific structure, business model and skill set in private equity funds and maybe some restructuring in the sector.  Prospects are really unparallel in middle market cross-border investments taking advantage of unavailability of funding but economic growth in overseas markets.  However this trend has to overcome the lack of knowledge/experience in foreign markets and the necessity to build economies of scale and internal structures to make PE work efficient.