Dow Jones LBO Wire, January 2, 2008:
The middle market survived last year’s credit crunch relatively unscathed. Indeed, some industry practitioners say they even see an uptick in deal prospects for 2008.
Since the summer, M&A advisory firm Harris Williams has seen a 25% increase in pitches, a benchmark for deal prospects whereby bankers solicit sell-side mandates, firm co-founder Chris Williams told reporters in a recent breakfast meeting.
That was echoed by Jeff Rosenkranz, managing director of investment bank Piper Jaffray Cos. “We’ve seen a big pickup in pitch activities,” Rosenkranz told a conference December in New York. “The middle market is somewhat immune” to the liquidity crisis.
The bankers’ views are borne out in data from research firm Dealogic. While megadeals have come to a virtual stop since July, middle-market transactions have maintained a buoyant - albeit subdued - pace.
As of Dec. 27, in the $1 billion-and-above range, no more than $5 billion of transactions were announced every month since July, down from a monthly average of roughly $30 billion in the first half of this year, the data shows. No deals over $10 billion were announced since July.
But in the mid-market, deal volume has come down from the first half of 2007, but the decrease is less pronounced. For deals valued at $100 million to $500 million, the monthly average of announced deals since July was $2 billion, down from the average of $3 billion in the first half.
One reason for middle market’s resilience, bankers say, is that those deals typically contain a smaller percentage of debt financing than do mega-buyouts. Smaller LBOs normally include debt financing totaling no more than six times earnings before interest, taxes, depreciation and amortization, compared with eight times or higher for mega-deals.
Another reason is that many middle-market deals are driven by factors other than the availability of debt. Buyout firms looking to raise new funds may put portfolio companies on the block to ramp up returns. Owners of family businesses may hang up “for sale” signs for estate-planning purposes or for lack of successors to the business.
Those sellers are less concerned about wringing out the “last dollar” from buyers than, say, boards of publicly traded companies, Williams said.
There is also a theory that sellers may be rushing to unload assets before the market turns further south. “They are trying to get to the market sooner rather than later,” said Rosenkranz.
Still, market participants say deal activities will not resume to levels seen in the past few years, as banks digest the hangover. Sellers will have to adjust their valuation expectations, while buyers must be more innovative in order to get deals done.
Over the past few months, deal makers have come up with new tactics. For example, they are doing club deals, using more mezzanine debt, and putting in more equity than they normally would. Sellers, too, have chipped in with so-called seller financing, whereby they foot part of the bill in the form of notes.
“The (middle-)market is very entrepreneurial and adaptable,” said Hiter Harris, a co-founder of Harris Williams.