Alex Lykken April 15, 2015
As part of our recently released 2Q 2015 U.S. PE Breakdown Report, we talked to Jamie Spaman, a Managing Director with Murray Devine, about valuations in the market and his expectations for 2015 activity. To get your copy of the report, head over to our Reports Library, where it’s free to download.
With valuations as high as they are, where are PE firms looking closest when valuing today’s companies, especially with sellers having the advantage?
It certainly continues to be a seller’s market and therefore we continue to see private equity firms focus on building their current portfolios through add-on acquisitions. These types of acquisitions allow private equity firms to benefit from the synergies they create with their current platform companies, ultimately allowing them to compete with strategic buyers. Moreover, as it relates to returns in an environment marked by high valuations, add-ons allow businesses to quickly scale up. Depending on the sector, this can allow firms to benefit from multiple arbitrage upon exiting the business or offer some cushion against multiple degradation at exit in a potentially rising interest rate environment.
Another area where we are seeing more activity because of today’s valuation environment is carve-out transactions. When a company decides to exit a business line by selling it off, there is generally less competition from strategic buyers for those assets and private equity firms can therefore find better pricing. These kinds of assets also lend themselves to both private equity’s hands-on approach and longer-term time frame, as most firms today can dedicate resources to create truly independent, stand-alone companies that may require some heavy lifting.
Finally, we also see firms continuing to focus on middle and lower middle market acquisitions where they are most likely to be able to add value to growing companies. Even as these areas have faced increased competition, rising valuations are motivating some sellers in this market segment who would not otherwise be considering a sale at this stage of their growth.
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By most accounts, lenders have become more aggressive in the market, especially for PE-led deals. Have they made any adjustments in their loan structures to account for today’s valuations? Are they concerned about the current environment?
While we have seen more aggressive lending on some private equity deals, it seems that loan structures have remained largely the same. There’s been some talk about cov-lite loans making a bit of comeback, but this appears to be primarily in the larger end of the market. It is worth noting that we have seen deals lately with more leverage than in the past few years but, recent data has shown average leverage is down for larger LBOs, so that may be a trend that is just emerging. Overall, 2008 and 2009 are still pretty fresh in people’s minds, so we anticipate that lenders will continue to lean towards higher quality borrowers while they test the waters with more aggressive deals.
Generally speaking, what is the sentiment in the market right now concerning valuations, from your point of view? Do you expect deal multiples to remain elevated through 2015?
Higher valuations are a direct result of lower borrowing costs and the use of higher leverage seen over the last several years. As long as these trends continue, and it looks like they are, we will continue to see multiples remaining high throughout 2015. Of course, this means that while private equity firms remain largely willing to pay for quality, finding these deals at reasonable valuations continues to be a challenge. On the other hand, as sellers, private equity funds are able to reap the benefits of the higher valuations as they exit existing portfolio companies.
Please feel free to share any additional insights or comments that we haven’t touched on.
We believe that multiples are likely to remain flat or continue to rise slightly during the foreseeable future. Accommodative debt markets, coupled with strong equity markets, will continue to support current valuation multiples barring any macro-economic shocks. That being said, dealmakers are watching the Fed very closely–anticipated interest rate hikes could certainly spook some buyers or at the very least give outliers pause, which could serve to suppress acquisition multiples. However, on balance, we believe that the abundance of strategic buyers as well as financial sponsors with ample capital to invest will see to it that competition stays high for already scarce deals.
Jamie Spaman joined Murray Devine in 2004. His responsibilities include the leadership and management of valuation and financial opinion engagements. Since arriving at Murray Devine, Mr. Spaman has worked on numerous engagements across a variety of industries including business services, food processing, retail, medical/pharmaceutical products, industrial products, technology and financial services. He has led and participated in the research, due diligence and financial analysis for valuation engagements of business enterprises, debt and equity securities, and intangible assets for tax and financial reporting purposes as well as financial opinions related to solvency, capital adequacy and fairness.
Featured image courtesy of Wikimedia user Bernd Untiedt.