The high-end mergers and acquisitions market is shaping up to have a slow year in 2008. However, the small to middle market, which dominates the deal landscape in Wisconsin and the Midwest, will be largely protected from a recession. Private equity firms still have billions of dollars to invest, and many business owners are still looking to sell this year.
“Despite all of the talk about private equity (backing away), there is still a record amount of money waiting to be put to work,” said Steven Bernard, director of M&A market analysis with R.W. Baird & Co. Inc. “Most (PE firms) buy small to mid-market companies and are not as dependent on credit for financing. Private equity is still going to be a component of deal activity, albeit slower paced than in 2007.”
Total mergers and acquisitions activity is expected to slow in 2008, Bernard said, largely because of the record levels of 2006 and 2007.
“We still have a fairly strong public company balance sheet,” Bernard said. “It’s been an ugly last few weeks in the market, but there are still relatively high valuations. It should line up to be a healthy year, but it will look ugly compared to last year.”
However, the local deal landscape looks just as active now as it did at this point last year.
The first half of 2008 looks very active to Linda Mertz, managing director of Pewaukee-based investment banking firm Mertz Associates Inc., based on the number of clients her company has booked. And she’s optimistic about the second half of the year.
“My client prospect pipeline is just as strong now as it was 12 months ago,” Mertz said. Her firm finished 2007 at levels very close to 2006, when it had a record year.
Many of the companies that Mertz helps take to market or helps buy other companies are healthy now, which makes her believe buyers and sellers will still be active in 2008.
“The companies I’m talking to, their businesses are good,” she said. “They have good backlogs and good orders coming in. It doesn’t matter what the economy is doing, as long as the buyer continues to believe they will do well.”
Ron Miller, managing director at Cleary Gull Inc., a Milwaukee investment banking and financial management firm, agreed. He said Cleary Gull has 14 active engagements now, the highest number with which it has started a year.
The firm matched its record 2006 performance in 2007, and it’s preparing for potentially record-breaking volume in 2008. Cleary Gull hired several new employees to work on its investment banking side in late 2007 to prepare for a busy 2008.
“We expect 2008 to improve,” Miller said. “We’re expecting double-digit growth.”
The firm expects volume to continue at least until the November elections.
“We have a window before the election and when taxes are likely to change,” Miller said. “I think the rush this year will be strong.”
Unlike the highest end of the M&A market, banks have not started pulling back on middle-market deals, Miller said, and he doesn’t see that happening this year.
“We’re seeing almost equivalent offers (to last year),” he said. “Middle market lenders never got irrational. They did not and have not pulled back on their propositions.”
In fact, there is now an abundance of available debt and equity capital available for transactions, Miller said. While economic uncertainty could tighten lenders’ purse strings, it doesn’t seem likely, he said.
“I’m very interested if banks will start to pull back because of (economic) uncertainties,” he said. “There is still a feeding frenzy for good deals. A good deal still has tremendous demand, both from banks and (private) equity.”
Grace Matthews Inc., another Milwaukee investment bank, sees similar circumstances. While it deals almost exclusively in mid-market deals of less than $500 million, about two-thirds of Grace Matthews’ deals are made outside Wisconsin.
“With transactions under $500 million, we’re seeing a little more expensive debt, but availability hasn’t changed that much,” said Ben Scharf, a director at Grace Matthews. “And we’ve been able to get pretty aggressive with banks to get values to where we need them to be.”
Grace Matthews had a record year in 2006, and its 2007 levels were very close, according to Scharff and John Beagle, managing director with the firm. During the two years, the firm closed more than $1.2 billion in total deals. And the firm appears to have a comparable amount of work booked for 2008.
“We should do $500 million to $700 million, and we’ve got half of that booked already,” Beagle said. “(The market) hasn’t moved for high-quality clients. And good fishermen can catch fish whether they’re biting or not.”
International M&A activity will pick up in 2008, and international buyers will be increasingly interested in Midwestern manufacturing companies, said Victoria Fox, managing director at Emory & Co., a Milwaukee investment banking firm. European companies appear to be particularly interested in Midwestern companies now, she said.
“We are currently working with two European clients who are specifically interested in smaller industrial companies in the Midwest,” Fox said. “They are targeting companies in specific product niches with $10 million to $20 million in revenue, which is smaller than you might have seen in past years.”
All dealmakers surveyed for this report said 2008 could be an even busier year, if some sellers are spurred into the market by uncertainties caused by the November presidential elections.
“That’s the wild card,” Mertz said. “The people that are conservative say that 2008 will be the last ‘for sure’ year. I don’t think (the government) will change capital gains rates in 2008, but in 2009 it’s coming. That could bring out sellers that would sit on the sidelines.”
PE perspective
While the current environment will likely steer more potential companies toward him, Steven Peterson, managing director-Milwaukee for Brass Ring Capital, a private equity firm with offices in Milwaukee and Minneapolis, says he is more closely scrutinizing companies.
“We are more selective now,” Peterson said. “There were a couple of deals in the last year or two that we let go that we would have chased harder (previously). We turned them down … Because I believe we will have better opportunities.”
Availability of credit doesn’t worry Peterson in the coming year. Instead, he’ll be keeping his eye on energy prices and the economy as a whole. High energy prices could adversely affect many manufacturing companies, which have been attractive targets for many private equity firms.
“For companies that deal with a lot of energy, it could cut into earnings or create problems meeting some of the (economic) forecasts,” Peterson said. “If we see oil prices around $100 a barrel, it has to roll out somehow.”
Even if it slows slightly, M&A activity in Wisconsin and the Midwest will continue at a high level in 2008, Peterson said. Beyond that, he believes the market could slow further.
“My gut says that we’ll be staring at some challenges for the first year and a half after the new president gets in office,” he said. “There’s just some stuff that has unfolded as our economic expansion has gone on that has to be worked through, like the subprime mess.”
