RIVERSIDE ADVISORS, INVESTMENT BANKING FOR THE LOWER MIDDLE MARKET | 1 LOWER MIDDLE-MARKET REPORT M&A MARKETS OUTLOOK Affiliate of PMCF MARCH 2018 2018 ECONOMY The U.S. economy finished strong in 2017 and is expected to gain strength in 2018 as consumer spending, pro-business policies of the Trump administration, and potential infrastructure spending feeds the economy. Consumer spending is supported by a robust job market that has a historically low employment rate of 4.1% and the passage of the Tax Cuts and Job Act increased “take-home pay” for most Americans. According to the Office of Management and Budget, the Trump administration has withdrawn or delayed 1,579 planned regulatory actions in 2017, effectively freeing businesses to focus on their customers and is unleashing business investment. The economic impact of consumer spending and business investment has led to consensus estimates for 2018 GDP to exceed 3.0%. If Washington agrees to an infrastructure spending bill, then GDP estimates may be revised higher. With the economy steaming forward, businesses in most industries are apt to benefit, realizing increased revenue and cash flow. Business owners exploring strategic alternatives will benefit from developing detailed, supportable revenue plans and budgets that factor in the strong economy. Revenue plans created from a bottom up approach with an action plan to achieve Riverside Advisors is dedicated to advising family and entrepreneur-owned businesses in the lower middle market with values up to $20 million. the revenue will allow business owners to track progress and provide visibility for the full year projection. Bottom up revenue plans can be based on a sales channel, customer by customer or project by project basis, or other metric that logically tracks the business. Buyers of companies tend to pay higher valuations for businesses that have demonstrated visible growth. Despite a reduced level of transactions in recent quarters, all signs point to a perfect time in the cycle to sell a business. Strong earnings growth, historically low interest rates (although rates are rising in 2018), enormous amounts of capital available, and strategic buyers seeking acquisitions to drive revenue are all creating a near perfect storm for sellers of well-positioned businesses. Valuation multiples continue to march higher as too few quality companies are on the market. 2018’s M&A market will make many business owners willing sellers and handsomely rewarded for their efforts building their business.
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R I V E R S I D E A DV I S O R S , I N V E ST M E N T B A N K I N G FO R T H E LOW E R M I D D L E M A R K E T | 1
LOWER MIDDLE-MARKET REPORTM&A MARKETS OUTLOOK
Affiliate of PMCF
MARCH 2018
2018 ECONOMYThe U.S. economy finished strong in 2017 and is expected to gain strength in 2018 as consumer spending, pro-business policies of the Trump administration, and potential infrastructure spending feeds the economy. Consumer spending is supported by a robust job market that has a historically low employment rate of 4.1% and the passage of the Tax Cuts and Job Act increased “take-home pay” for most Americans. According to the Office of Management and Budget, the Trump administration has withdrawn or delayed 1,579 planned regulatory actions in 2017, effectively freeing businesses to focus on their customers and is unleashing business investment. The economic impact of consumer spending and business investment has led to consensus estimates for 2018 GDP to exceed 3.0%. If Washington agrees to an infrastructure spending bill, then GDP estimates may be revised higher.
With the economy steaming forward, businesses in most industries are apt to benefit, realizing increased revenue and cash flow. Business owners exploring strategic alternatives will benefit from developing detailed, supportable revenue plans and budgets that factor in the strong economy. Revenue plans created from a bottom up approach with an action plan to achieve
Riverside Advisors is dedicated to advising family and entrepreneur-owned businesses in the lower middle market with values up to $20 million.
the revenue will allow business owners to track progress and provide visibility for the full year projection. Bottom up revenue plans can be based on a sales channel, customer by customer or project by project basis, or other metric that logically tracks the business. Buyers of companies tend to pay higher valuations for businesses that have demonstrated visible growth.
Despite a reduced level of transactions in recent quarters, all signs point to a perfect time in the cycle to sell a business. Strong earnings growth, historically low interest rates (although rates are rising in 2018), enormous amounts of capital available, and strategic buyers seeking acquisitions to drive revenue are all creating a near perfect storm for sellers of well-positioned businesses. Valuation multiples continue to march higher as too few quality companies are on the market. 2018’s M&A market will make many business owners willing sellers and handsomely rewarded for their efforts building their business.
2 | R I V E R S I D E A DV I S O R S , I N V E ST M E N T B A N K I N G FO R T H E LOW E R M I D D L E M A R K E T
QUARTERLY GDP GROWTHThe U.S. economy grew 2.6% in 4Q17 representing a reduction from the past two quarters which both exceeded 3.0%. The 4Q17 growth was unfavorably impacted by two factors that should reverse in the first part of 2018. Non-farm inventory had a negative contribution of 0.7% and is likely to lead to an inventory build in 1Q18. Strong consumer spending led to imports increasing at their fastest rate in more than seven years and a negative contribution of 2.0% to 4Q17.
The Federal Reserve Bank of Atlanta’s GDPNow forecasting model is forecasting 1Q18 GDP of 3.2%. Overall expectations are very positive for 2018 fueled by continued deregulation, tax reform and strong consumer spending.
M&A MARKET ACTIVITYOverall transaction activity remains subdued compared to recent years. 4Q17 experienced 9,301 closed transactions, down 189, or 2.0 percent from 3Q17 and 3,154, or 25.3 percent from the prior year quarter. The drop in transaction volume in 4Q17 has continued the trend since 2015 of declining activity. The supply and demand effects of the lack of companies for sale is driving valuations ever higher.
4Q17 transaction value has seen a decrease of approximately 25.7 percent from the prior year quarter mirroring the reduced number of closed transactions.
The M&A market is anticipated to gain speed in 2018 as the overall economic environment, abundant capital and lower taxes should drive markets even at full valuations.
MIDDLE MARKET DEAL VALUATIONSTransaction size correlates to valuation: As transaction size increases, valuations tend to increase. Larger transactions have more access to capital, management depth, market position, breadth of products/services and customers. As a result, investors perceive risk to be lower on larger deals and pay higher multiples.
The chart to the right highlights EBITDA transaction multiples by transaction size. For transactions in the $10 to $25 million range, the historical (2003 - YTD 2018) average EBITDA multiple is 5.6x. This valuation is 2.2 turns lower than the average EBITDA multiple for transactions between $100 to $250 million. The valuation gap between large and small transactions appears to be widening when compared to previous reports which indicated a difference of 2.0 EBITDA turns.
R I V E R S I D E A DV I S O R S , I N V E ST M E N T B A N K I N G FO R T H E LOW E R M I D D L E M A R K E T | 3
MARCH 2018
LOWER MIDDLE-MARKET DEAL ACTIVITY
Throughout 2017, the uncertainty of tax reform, international trade and geopolitical tensions resulted in relatively flat transaction activity over the past 12 months. With some clarification on many of these matters, transaction activity should experience higher levels in 2018 than 2017.
Key Interest Rates 2/21/2018 1/19/2018 2/21/2017
Prime Rate 4.50% 4.50% 3.75%
LIBOR–1 month 1.60% 1.56% 0.78%
LIBOR–3 month 1.90% 1.74% 1.05%
U.S. Treasury–2 year 2.26% 2.06% 1.22%
U.S. Treasury–5 year 2.69% 2.45% 1.93%
U.S. Treasury–10 year 2.94% 2.64% 2.43%
Bank Financing Upfront Fees LIBOR Spread
Asset-Based Loans 25–50 bps 175–350 bps
Cash Flow 75–100 bps 350–550 bps
Mezzanine Financing Unsponsored Sponsored
Upfront Fees 2.0% 1.5–2.0%
Current Pay-Coupon 11.0–12.0% 10.0–11.0%
Payment-in-Kind (PIK) Interest 1.0–2.5% 0.5–1.0%
All-in IRR 14.0–16.0% 11.0–12.0%
Note: Bank and mezzanine financing guidance is based on discussions with mezzanine and commercial lenders.
LOWER MIDDLE MARKET HISTORICAL VALUATIONSBased upon GF Data, a deal database derived from lower-middle market private equity funds, deal multiples in the $10 to $25 million range averaged 5.8x EBITDA for the first nine months of 2017. This is a slight decrease from the 6.0x EBITDA in 2016 and has been relatively consistent over the past 5 years. Prior to 2013, valuations for transactions between $10 to $25 million averaged approximately 5.6x EBITDA. The increase in valuations are partially driven by low interest rates, available capital fueled by Federal Reserve monetary policy, and the lack of quality companies available for sale.
EBITDA multiples reflect adjusted EBITDA covering a broad range of industries, and may not be indicative for a specific company. Well positioned companies with visibility of revenue and growth should receive attractive valuations in the current transaction market.
LOWER MIDDLE-MARKET DEAL MULTIPLES (Transaction Value $10-25 Million)
LEVERAGE MULTIPLES (Transaction Value $10-25 Million)
4.0x -
3.5x -
3.0x -
2.5x -
2.0x -
1.5x -
1.0x -
0.5x -
0.0x -2003-2012 2013 2014 2015 2017*
2.2x 2.4x 2.7x2.3x
2.9x
1.0x 0.8x
1.1x
1.0x
0.9x
2016
2.7x
0.6x
Senior Debt/EBITDA Subordinated Debt/EBITDA
3.2x 3.2x
3.8x
3.3x
3.8x
3.3x
Source: GF Data, *September 2017 YTD
The first nine months of 2017 saw transactions utilize higher levels of leverage to finance acquisitions.
RIVERSIDE ADVISORSRiverside Advisors is a middle market investment bank focused on family and entrepreneur-owned businesses. Led by professionals with more than 20 years of experience, Riverside is committed to meeting the unique needs of middle market companies and their owners. Services include sale advisory, acquisition advisory, readiness review and transaction planning, and capital raising.
Riverside focuses on lower middle market transactions up to $20 million in value. Transactions in excess of $20 million are executed by P&M Corporate Finance.