Middle-market merger and acquisition activity should continue to improve for the fourth straight year in 2006, driven by a growing economy, strong debt and equity financing markets, substantial amounts of uninvested private equity capital and higher stock prices, according to "2006 Middle Market M&A Outlook," a new report released by Robert W. Baird & Co. Inc. of Milwaukee.
For 2005, middle-market M&A activity was up 8 percent to 3,733 deals, representing an 11 percent increase in total deal value to $349 billion. Overall, median middle-market transaction multiples continued to climb during the year, reaching 10.4x EBITDA, up from 9.9x EBITDA in 2004 and 7.1x in 2002.
Divestitures continued to be a major source of deal flow and accounted for 42 percent of all middle-market deals and 49 percent of total dollar volume. Cash remained king in the middle-market in 2005, with 75 percent of transactions done on an all-cash basis.
Technology companies continued to dominate middle-market deal activity, representing 20 percent of all transactions, the same as in 2005 and in line with the overall M&A market. Health care was the next most active segment at 10 percent, followed by industrial and financial, each contributing 9 percent of the total transactions.
The real estate sector showed the largest increase with an 86 percent gain, while telecommunications experienced the biggest decline with a 21.7 percent drop in the number of deals. A similar pattern held true for dollar volume, with technology again holding the largest share at 16 percent, while telecommunications experienced the largest decline with a 29.2 percent decrease.
The ready availability of capital from a variety of sources remains an important component underlying the growing number of M&A transactions, according to the Baird report.
"Historically low interest rates, the increased flow of investment dollars to private equity funds and the increasing interest shown by cash-rich hedge funds in the debt lending market are all contributing to the availability of cash, which should continue to drive M&A deal activity," said Steven Bernard, director of M&A market analysis at Baird and the author of the Baird report.
Baird predicts that corporate M&A activity will continue to increase in 2006, driven by a number of positive factors, including strategic considerations, stronger corporate earnings, higher stock prices and elevated corporate confidence. Private equity firms will provide significant competition for those assets, according to Baird.
Baird notes that disclosed transactions indicate a relatively modest increase in the number of private equity-driven M&A transactions in 2004, with the number of deals up by 4.1 percent. However, it goes on to point out that there were 840 non-disclosed transactions in 2005, most if not all of which involved a private equity firm. Taking those deals into account, overall private equity activity grew by 23.6 percent in 2005 to a total of 1,251 deals. Including non-disclosed deals, the percentage of overall middle-market transactions involving private equity would have jumped to 33.5 percent in 2005 from 29.3 percent in 2004.
"With corporate buyers and private equity firms both holding substantial amounts of cash, we expect to see a very active year for middle-market M&A in 2006," Bernard said.
What They Are Looking For
Baird Capital Partners, the buyout private equity arm of Milwaukee-based R.W. Baird & Co. Inc., invests primarily in business services and manufacturing firms. David Pelisek, partner with Baird Capital Partners, said he and other decision makers look for the following characteristics in companies they’re considering for purchase:
Solid Track Record of Success
"We want them to be profitable, and not a turnaround situation. We’re not interested (in turnarounds) unless they’re easy fixes. We’re looking for something we can bring value to. They can’t be a sinking ship."
Solid Market Position
"They need to have market position so when an economic downturn comes, the company doesn’t fall apart."
Alignment with Baird’s Portfolio and Existing Services
"When we buy a business, we don’t sit back and hope it does well. We figure out what we can do to make it better – whether those are new relationships, new talent at the board of directors’ level, in-routes for lower cost manufacturing or new distribution routes."
Leadership That Works
"We need a CEO that we feel we can scale the business with. We try to grow the business, and we have to have a team that can grow with the company. We’re not going to get it done. It’s their show."
Planning for the Future
"We’re looking for businesses that have thought about their ability, through acquisition or growth, to go to the next level of size or value. We want businesses that can grow their EBITDA (earnings before interest, taxes, depreciation and amortization) 75 to 100 percent in five years. That’s not every company."
