Company valuations have been steadily increasing over the past several years and a seller’s market has taken a strong hold. Now, there are signs this cycle has reached its peak, and some experts think EBITDA multiples have become inflated and the bubble could burst when the economy hits turbulence.
“We’re starting to see different structures and prices that defy logic a little bit,” said Chris Riegg, partner at investment bank Promontory Point Capital in Milwaukee.
“When you see a time when you have high multiples and money chasing deals, typically when you’re trying to get as much return as you can, you’re going to put a lot of leverage on it,” said Bill Penkwitz, also a partner at Promontory Point.
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For one recent deal Promontory Point completed, New Berlin-based Pieper Electric Inc.’s June acquisition of Green Bay-based HiTech Controls and Manufacturing Solutions, the firm had to vet more than 100 companies to find one that was a good strategic fit, a good value for the seller and a great return for the buyer, Penkwitz said. There were many potential acquisitions on which the multiples were too high to make sense.
PPC helped Pieper reduce the list to 16 potential targets and then three, said Rick Parra, president and chief operating officer of Pieper. The primary consideration was assuring the company culture was a fit and the firms would integrate well, but then financials came into the mix.
“The other two that made up the (top) three were a little bit smaller and a little bit less mature, I’ll say, in their business life cycle, so HiTech, clearly the cultural was the closest fit to begin with,” Parra said. “When it came to valuation, looking at HiTech, it was a combination of meeting our needs and the needs of the seller.”
Even if a recession hits, Parra feels confident in the final choice Pieper made and its future prospects in the automation market.
“We’re very comfortable that we made a good decision here,” he said. “It was a strategic move for us to go there and we think that market will grow at a pace different from our core business and that’s why we focused on that industry.”
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Most experts agree that valuations are especially high at the moment, but some are hesitant to call them unwarranted.
“Bubble’s a hard word to use until it pops, and then you can call it a bubble,” said Tom Kintis, president of CGK M&A Advisors in Waukesha.
“In my experience over the years, private company valuations track with public company valuations and the fact that we’re over Dow 19,000, really all you need to know is that private company values are very high, probably at all-time highs, just like the public company values,” said John Emory, Jr., president of investment bank Emory & Co. LLC in Milwaukee.
As far as leverage, most deals are still appropriately structured, he said.
“I am seeing more aggressive lending currently than in the past, but not a higher proportion of debt, because the overall price is higher,” Emory said. “I’m not seeing reckless lending. Lenders are still being disciplined, but are stretching a little more than they may have the last few years.”
Of the four deals he’s recently closed, Kintis said none of the buyers were borrowing more than 2.5 times EBITDA for the purchase. When debt makes up 3 or 4 times EBITDA, then it becomes cause for worry about overleveraging the transaction, he said.
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“People are certainly using leverage, but I wouldn’t say that it’s overleveraged,” said Victoria Fox, managing director at Milwaukee investment bank Eisen Fox & Co. LLC. “The difference that we see is that buyers are putting in more equity.”
A combination of low interest rates and a competitive market, in which strategic buyers and private equity firms alike have excess capital to invest, has contributed to high valuations and unique deal structures.
“There’s so much money out there, you can actually put more equity into the deal rather than borrowing money from the bank,” Kintis said. “Not only does private equity have a ton of money, banks have so much money they don’t know what to do with it.”
“Interest rates are still and have been very low, which helps companies take on larger amounts of debt at lower cost,” Emory said.
When a company does sell, particularly on larger deals, multiples are at what some consider record levels.
“I’ve seen stuff that used to go for five now going for six times (EBITDA). Do I think it’s a little high? Yes, especially if we’re going to hit a recession soon,” Kintis said. “I’ve been doing this since ’87 and I’ve never seen multiples, on a consistent basis for companies, this high.”
But Fox thinks valuations could rise even higher, at least in her niche.
“For the deals we do, kind of the lower middle market, the values I think are still on the high end, but we’re not seeing crazy multiples like some of the larger deals are seeing,” she said. “While it’s a good valuation market…it’s hard to say if you’re at the peak or not, but we’re certainly at a high point.”
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“I’m not sure that multiples are necessarily record high, public company multiples aren’t, but values are and that’s because earnings are high,” Emory said.
“Private equity groups largely think we are in a pricing bubble, that prices and multiples are unsustainably high, so they’re trying to sell and have been selling for the last few years any companies that are positioned appropriately in their life cycle to sell.”
Most experts don’t expect the good times to end in the near future unless there is a recession or major tax change. But several cautioned it’s difficult to predict when a peak will become a valley.
“There’s nothing out there that I see that will change this,” Fox said. “Multiples have been up in this range for a while.”
“The multiples are still solid as a rock,” Kintis said. “We’re still at that high level.”
“I’ve never had this many calls from private company owners wanting to start a sale process as right after this election,” Emory said. “You need to expect that this strong selling environment is going to last a substantial amount of time when you start a sale process. If you start to get nervous that we might have a recession in two years, then you need to start now.”
“The likely cause of a recession would be triggered by international tension,” he continued “If we end up in a heated situation with a major foreign power, the stock market could go down, which could trigger a real recession. That’s something you just can’t know. When the door shuts, sometimes it shuts hard and fast for these owners.”