PE Q&A: Intrepid’s Jonathan Zucker Discusses the U.S. Middle Market

June 12, 2014

We recently had the chance to ask Jonathan Zucker, senior vice president and head of capital markets at Intrepid Investment Bankers, a few questions about the current state of the U.S. middle market. To access PitchBook’s 1H U.S. PE Middle Market Report, which details the data figures mentioned below, click here.

Jonathan Zucker

Jonathan Zucker

Q: According to our data, purchase price multiples for middle-market buyouts reached a record 10.5x in 2013, up from 8.4x in 2012. How much of an effect has that had on your clients? Have you seen more broken deals because of it?

A: Due to these increased multiples, we’re seeing more business owners opportunistically exploring the market. In today’s environment, a significant part of the investment banker’s role is to help avoid broken deals by assisting sellers with assessing potential suitors and identifying who is credible and who is not. It’s about evaluating a buyer for the potential fit with the seller’s company and brand vision. We have to know and understand the buyers and their track records, vet proposals, and evaluate what the proposals mean for our clients, economically and in terms of the company’s brand legacy.

Despite the big jump in valuations, middle-market deal activity was resilient in 2013 (1,160 deals in ’13 vs. 1,310 in ’12) and total capital invested didn’t decline much, either ($285 billion in ’12 to $260 billion in ’13). Are buyers looking past the price tags on some of these deals? What’s behind the resiliency?

Globally there is increased capital overhang—the proportion of money raised by PE funds that has remained uncalled is significantly higher than it has been in recent history. This may lead to increased competition between funds, which may lead to higher price tags. Couple this with the fact that strategic buyers are sitting on record liquidity, and you have set the stage for yet higher-priced acquisitions. There seems to be a finite number of good companies for sale right now, and when one hits the market, both PE funds and strategics are willing to stretch for it, knowing that they are supported by an extremely robust debt market.

Buyers are incorporating significantly more debt for middle-market buyouts these days—the median debt percentage was up to 61.5% in ’13, compared to 53.1% in 2011. Moreover, the median debt-to-EBITDA multiple rose from 4.8x in ’12 to 6.4x in ’13. At the height of the buyout boom in 2006, that ratio topped out at 5.7x. Are buyers just taking advantage of the optimal credit conditions while they’re here? How far do you look into this?

I think you hit the nail on the head. While leveraged loan volume and debt multiples have steadily been on the rise since 2010, default rates have remained very low by historical standards. More and more lenders have entered the middle-market space and buyers are taking advantage of the ample supply of capital. Obviously, we know what happened last time ratios where this high…a few years later we saw default rates rise. Hopefully that won’t be the case this time around.

How do you think the second half of 2014 is shaping up for deal-making in the U.S. middle market?

It looks to be shaping up to be a busy second half. There is not a lot of organic GDP growth right now. In this type of economy, big companies need to make acquisitions in order to grow or fill out a product or service offering. In terms of sellers, some of our clients, while generally optimistic about their growth prospects on a standalone basis, don’t want to miss the opportunity to sell their companies for a possible premium multiple while the market seems to be strong.      

Feel free to add any additional comments or observations that we haven’t addressed.

One thing worth noting is that while overall loan volumes continue to rise, actual middle-market loan volume has remained fairly stagnant since 2010. New middle-market debt funds continue to pop up, with a mandate to lend not only to the traditional folks—sponsor-owned companies—but also to entrepreneur-owned businesses, many of which don’t have much experience accessing the capital markets. With our capital-raising practice, we’re seeing an up-turn in clients looking to refinance debt or recapitalize their companies. We’re helping them navigate the landscape and access opportunities that would not have been available a few years ago.

Featured image courtesy of Wikimedia user Wolf3012



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