Jim Lawson is chairman and managing director at Lincoln International, which he co-founded in 1996. He has over 25 years of experience in marketing and negotiating the sale of manufacturing, distribution and service businesses. He was kind enough to chat with us regarding trends in the private equity middle market as well as M&A, among other topics.
With private equity dry powder still at elevated levels and strategics pursuing M&A at a rapid clip, it appears PE firms will have to contend with strategic buyers in competitive auctions for some time. What are some of the ways PE firms are sweetening deal terms to win auctions?
PE firms are using three non-price factors. First, PE firms are asking to pre-empt or front run a sale process. For clients that value certainty of close, this is an effective tactic. Second, they are offering more seller-friendly terms on escrows and other terms. Strategic buyers are not always as flexible. Third, they are leaning heavily on getting management on their side, and having the sellers prefer the financial buyer because of that is the preference of management if the terms are close.
Due to sheer competitive pressure from PE firms seeking to put dry powder to work and strategics, could there be a fundamental shift to PE buyers crowding the core and lower middle markets?
The shift of larger PE fund considering middle market and lower middle market deals has been going on for some time. This trend is continuing. What we see is that some middle market PE firms — in reaction to this crowding from above — are now buying lower middle market opportunities that they may have passed on in prior years.
Some think that the buffer of current high levels of capital may prevent higher interest rates having much of an effect on dealmaking. What’s your take?
A dramatic change in interest rates that has a material impact on slowing GDP will have slow down M&A because it will impact the performance of companies and the optimism of buyers. The much more likely scenario of slowing rising interest rates is not likely to have a material impact on M&A. In fact, we think a rise in interest rates will increase the supply of private company sellers. We talk with many private company owners that have thought about selling, but the low interest rate environment makes selling your company and reinvesting the proceeds at 2.5% 10-year treasury notes interest rates unattractive. If interest rates go up 100 basis points, the annual return for owners that want to own safe treasury notes increases 40% and the price in a buyout based on normal LBO assumptions only decreases by about 3%. Therefore, somewhat higher interest rates could actually increase mid-market M&A volume.
Middle market multiples have plateaued around slightly higher levels over the past few quarters, but what could drive an increase? Will uncertainty regarding factors such as oil & gas futures keep them at current levels?
We do not think that middle market multiples will go up. They will stay steady or go down. The reasons for this include the following:
- The supply of buyers and capital is very strong now and unlikely to get materially stronger.
- Prices on M&A transactions are already back to approximately 2007 levels.
- The stock market in the U.S. has been very strong and has as much or more risk to go down as interest rates rise as it does to go up. Stock values help to motivate strategic buyers to be aggressive in M&A.
What other factors driving M&A do you find most interesting nowadays? What have we not touched on that you think could become a major driver?
One negative factor is the strong U.S. dollar. We are seeing many U.S. companies with either material export sales or competitors that import a material amount of their products from places such as Europe and Japan are being hurt by the strong dollar. Either their export sales are being hurt, and/or they are losing make share in the U.S. to imports. This is particularly true of manufacturing companies. We see industrial M&A being flat to down.
One positive factor is that the baby boomers are now retiring and looking to sell their privately owned businesses. With some rise in interest rates (see comments above) we think the supply of private companies for sale will increase substantially.