A wise man once told me that sometimes the best lessons in life are our failures. We learn more from our mistakes than our successes; sadly, most folks spend more time basking in their triumphs than analyzing their failures.
So far, this year has been an interesting ride in the stock markets around the world. Seems like each day brings new gloom and reasons to be pessimistic despite the fact that in the U.S., at least, the economic fundamentals appear to be very sound.
As M&A professionals we are aware of the fact that the general public, and many business owners, closely track the U.S. equities markets and often make the mistaken assumption that these markets also drive M&A activity. Indeed, historically in some cycles they have closely followed deal making activity. However, especially in the lower middle-market, deal making often thrives despite stock market fluctuations.
The title on Forbes.com caught my eye recently as I was doing some research: “Four Reasons 2016 Will Be a Strong Year for M&A.” The premise of the article is that the underlying factors driving a record year in M&A last year are still in full force to make 2016 an equally good year if you are in the market for a buyer of your company.
It is interesting that the M&A industry gets a bad rap largely from a limited number of huge transactions that have gone awry throughout the years. This makes sense because larger deals get all the press and historical review from academicians, while smaller ones often fly completely under the radar. And this is unfortunate because the reality is the vast majority of deals closed every year are valued under $100 million and are mainly very successful for the acquiring company.
One of the most reliable indicators of future M&A activity (which is typically measured in deal announcements and/or deal closings by most research groups) is the current level of deal launches in the market. Obviously for confidentiality reasons, M&A firms like Generational Equity don’t announce publically when they initiate an engagement. You can imagine the confidentiality issues that would cause.
However, independent sources who manage virtual data rooms – electronic rooms where deal makers store confidential data for buyers to review – have been gathering generic research for years on deal activity. In the past this was all done manually in conference rooms where folks would be sequestered for days on end reviewing documents. Now it is done electronically.
Synergy – the term is probably used too much in investment banking circles. I would bet that there are more synergies discussed than actually pan out in the real world. And if you ask a dozen investment bankers to define it, most would come up with the old 2+2= 5 analogy. Synergy is like beauty: tough to define but you know it when you see it.
That’s why I always keep my eyes open for scenarios that are truly synergistic to share with you folks. A merger was recently announced that involved two companies that had been operating as separate portfolio companies for The CapStreet Group, a private equity firm located in Houston that “invests in growing middle market companies in Texas and other Sunbelt states and partners with management to accelerate growth and improve profitability.”
M&A activity trends can be closely correlated to several leading indicators. One of the indicators is the number of deal launches. Logically if deal initiations are increasing, one can assume that deal closings will eventually go up as well. Of course, as with any sales process, 100% of new engagements do not close within the first 12 months. However, launches are an effective leading indicator of future deal closings.
A few weeks ago, Axial, a leading online network that connects business owners with investors and buyers, published their predictions for lower middle-market mergers and acquisitions in 2014. I always look forward to these Axial updates because not only are they accurate but they are also informative.
As we have examined in previous articles, a number of analysts are predicting that we are on the cusp of a new M&A market upswing. These typically occur post-recession naturally, but in this case it is also driven by a number of other external factors such as record low interest rates, committed capital with equity firms, and strategics sitting on hoarded cash post-recession.
One of the earliest economic concepts we all learn is the law of supply and demand. Nearly every industry goes through the supply and demand cycle. Generally speaking, when the economy begins to grow, demand typically outstrips supply, driving prices up. Conversely, as the economy slows, supply is greater than demand, and prices fall. And this cycle goes on and on.