M&A demand continues to outpace supply

Proposed tax changes could further heighten activity

Among the largest southeastern Wisconsin deals in the first half of the year was Komatsu Mining Corp.’s $3.7 billion acquisition of Joy Global Inc.

There were 6,504 announced U.S. mergers and acquisitions deals in the first half of 2017, totaling $583.9 billion, according to Thomson Reuters. The total deal value fell 15.9 percent, from $694.7 billion during the first half of 2016, but the number of deals was up 17.3 percent, from 5,544 in the prior year.

Industrials led the way in the total number of worldwide deals in the first half of the year. Measured by total deal value, the energy and power sector came out on top.

Among the largest southeastern Wisconsin deals in the first half of the year was Komatsu Mining Corp.’s $3.7 billion acquisition of Joy Global Inc.

Exit multiples varied by industry, but in the U.S., high-technology companies commanded the highest multiples, at 27.4x EBITDA. The lowest U.S. multiples were reported in telecommunications, at 9.1x.

Of particular note in Wisconsin, U.S. industrials companies commanded 15.1x EBITDA in the first half, up from 9.8x in the first half of 2016. Consumer products and services multiples saw a meteoric rise year-over-year, from 4.4x in the first half of 2016 to 17.7x through June 30 of this year.

There are a few national and global factors that could have an impact on M&A activity in the second half of the year.

If the major corporate tax reform promised by President Donald Trump goes into effect, it could drive higher deal flow by leaving companies with more cash on their balance sheets, said Steven Barth, partner and co-chair of the Transactional and Securities practice at Foley & Lardner LLP in Milwaukee.

Another Trump administration proposal to offer a lower one-time tax on capital held offshore by U.S. corporations as an incentive to repatriate the funds could also increase strategic deal activity. If corporations bring back cash, they would likely deploy it into additional M&A, Barth said.

“Do they pay down debt, do they pay out dividends, do they use it to fund acquisitions? Our view is that a lot of that extra liquidity is going to be put to work with companies being much more aggressive in their acquisitions,” he said.

“If we repatriate capital, that can only help the M&A market,” said Ronald Miller, president and managing director at investment bank Cleary Gull Inc. in Milwaukee. “It probably helps the megadeal market and doesn’t have as much of an impact on the smaller deal market.”

The repatriation tax would have different levels of impact depending on how long it is in effect, Barth said.

“If it’s permanent, (companies) can take their sweet time of bringing (cash) home,” Barth said. “If it was something of a temporary tax holiday, the flow of money into the U.S. … has to be used by this company somehow.”

But Tammie Miller, managing director at Milwaukee investment bank TKO Miller LLC, argues bringing back foreign cash won’t increase deal flow because it won’t solve the supply problem.

“(Buyers) weren’t waiting for cash to be able to make acquisitions because they have it already,” she said. “What they want is companies to buy and there’s definitely a shortage of those.”

And most of the corporations repatriating cash are in the technology and pharmaceutical sectors, which aren’t strongly represented in Milwaukee, Tammie Miller said.

At the moment, those potential changes haven’t affected M&A activity, Barth said.

“Right now, it’s too speculative to have any impact,” he said. “If it starts getting closer, if there was a bill that was passed by the House, for example, before it gets to the Senate, then it would start impacting the timing of deals.”

“Until there’s more clarity in what the government does, I’m not seeing an impact either way,” Ron Miller agreed.

Fiserv Inc. is expected to close on its $89 million acquisition of Monitise plc in the second half of the year.

Interest rates are still very low and banks are eager to lend, so it’s relatively easy for companies to borrow money. Corporations’ balance sheets are strong and the value of their stock is at record highs. And private equity funds have lots of capital to deploy. It continues to be an ideal environment for robust M&A activity.

In the first half of the year, among the largest southeastern Wisconsin deals were Komatsu Mining Corp.’s $3.7 billion acquisition of Joy Global Inc. and Chicago-based Hill-Rom Holdings Inc.’s $330 million acquisition of Milwaukee-based Mortara Instrument Inc.

In the second half of the year, Brookfield-based Fiserv Inc. is expected to complete its $89 million acquisition of Monitise plc.

In Milwaukee’s lower middle market, deal flow was slow in the first quarter but picked up in the second, Ron Miller said.

“I think it’s a combination of a really strong financing market, more stability in the economy and slightly improved macroeconomic data,” he said. “Maybe the election put a little bit of a pause or question about what was going on. Now it’s pretty much business as usual.”

There continues to be more demand than supply in the marketplace, and plenty of money chasing too few deals, Ron Miller said.

“There’s hardly a private equity fund or a public company or private company that isn’t a buyer in this environment,” he said. “It’s just hard to find the targets. For a 2 percent growing economy, it’s kind of hard to find organic growth. There’s really a continued trend towards add-on acquisitions.”

Because of the short supply, private equity firms are showing more flexibility in what they’re willing to consider, such as companies with EBITDAs as low as $2 million, Tammie Miller said.

She’s seeing more family- and founder-held, medium-sized businesses, particularly among retiring baby boomers, start to prepare to come to market, which could gradually add to the local supply.

“The mom-and-pop-owned, salt of the earth manufacturing companies are just moving a little more slowly, I think,” she said. “They’re asking, ‘Is my family ready for this? Am I ready for this?’ So they’re a little slower to come to market.”

All that demand means prices are up, and buyers must differentiate themselves in whatever way they can.

Multiples have increased over the past three years, up more than 1x EBITDA in the lower middle market, Ron Miller said.

“7x is the new 6x,” he said. “We have some lower middle market companies that are commanding double-digit EBITDA multiples. But those have strong management teams, predictable cash flows and a very refined business plan.”

Companies in the business services sector, specifically packaging, are particularly hot right now, Tammie Miller said.

“Even our companies that we’re taking to market that have some challenges are getting 10 to 15 offers at really high prices,” she said. “That’s an indicator that the market is really hot because normally those would be a challenge to sell.”

Industrial firms with exposure to the energy sector saw some softness in the first half, Ron Miller said.

On the flip side of the increase in valuations is higher buyer scrutiny, he said.

“Sellers need to be extremely prepared if they want to achieve a really high price,” he said. “If you’re selling a company at 5x, the buyer’s willing to look the other way on small imperfections. If it’s 10x, they will make sure that you fix anything that isn’t perfect.”

Looking ahead, U.S. M&A activity would likely only be slowed at this point by an unexpected macroeconomic incident that dramatically impacts markets and economies, the experts agreed.

“I don’t see the dynamic changing for the next 12 to 18 months unless there’s an external shock to the system or event,” Ron Miller said.

“We’ve been saying for two years now, it’s going to be something, it’s going to be something,” Tammie Miller said. “It might be interest rates rising. It will be some macro event that impacts valuation that will slow activity down. It’s going to happen.”

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Molly Dill, former BizTimes Milwaukee managing editor.

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