PErspective Newsletter - Fall 2017

October 2017


In This Solid Environment, Where is the Deal Flow?

By Dan Shea

In today’s 24-hour news cycle, people are constantly bombarded with information. It can be hard to distill everything down to form sound opinions and actionable insights, particularly as political uncertainty persists at home and abroad.

The world of M&A reflects this confluence of factors. Business executives seemed more cautious in the last year when deciding to pursue transactions, and this is reflected in the latest numbers (see Figure I on page 2). Deal activity decreased by over 25 percent in the first half of 2017 compared to the previous year, continuing a downward trend in M&A volumes that began at the end of 2015.

Turmoil in Washington, D.C., and elsewhere, has had a significant hand in this slowdown. Many executives adopted a “wait and see” investment strategy in the period leading up to the election, and again in the early months of President Trump’s administration. The M&A environment is solid, however, and should support a rise in transaction volumes in the near term. 

Source: S&P Capital IQ and BDO Capital Research

Market Environment

Valuations Outshine M&A Volume
Despite muted deal flow, valuation multiples remain very high and have actually increased in recent quarters (see Figure II). We have seen multiples rise like this in the past, moving counter to transaction volumes. This is an asset mix issue. When faced with a deal landscape that seems unsteady, such as during and following a contentious election season, companies with lesser value propositions keep a low profile. The asset mix shifts to a better class of companies for sale—albeit fewer in number—thereby creating a seller’s market and a rise in multiples. Given that it usually takes six to eight months to properly market and sell a company, the mix of companies sold should soon normalize with closing volumes rising and average multiples moderating.

Source: S&P Capital IQ and BDO Capital Research

Good News: Investor Optimism is Undeterred
The public equity markets tell a positive story, rising sharply in the last nine months. The S&P 500 is up by over 17 percent, and the Russell 1000 has had similar results. Advances in corporate profits partly explain the rise, with the aggregate EBITDA of S&P 500 firms up 11.1 percent in the first half of 2017 versus the comparable 2016 period.

Optimism provides the rest of the answer.

Investor optimism resulted in the upward bidding of equities beyond earnings growth, which then expanded multiples. The average EBITDA multiple of S&P 500 firms currently sits at 12.09x, an increase of nearly 9 percent since last November. Anticipation that the new administration will champion business-friendly policies is likely buoying optimism.

Optimism is also evident in numerous C-suite and consumer surveys. The most recent Index of Small Business Optimism, published by the National Federation of Independent Business (NFIB), registered 105.2 this July, just shy of its all-time peak of 105.9 in January 2017. The index cites numerous positives including: sales growth, the ability to increase prices, inventory investment, access to credit, low unemployment and increased hiring, real wage growth and increased consumer spending.

Similarly, 89.5 percent of manufacturers expressed optimism about their own company’s outlook in the second quarter, according to the National Association of Manufacturers (NAM) Manufacturers’ Outlook Survey. This result nears the 93.3 percent reached in the first quarter of 2017– the highest reading since the survey began 20 years ago. The survey cites regulatory relief and the prospect of tax reform and infrastructure investment as major positives.

However, major legislation out of Washington, D.C., still hangs in the balance. Healthcare reform has been tabled (at least for now), and tax reform and infrastructure investment remain undecided. However, the NAM survey suggests that “many important changes have occurred to the regulatory structure with few if any new rules showing up in the Congressional Register. These changes will seep into the regulatory structure with little fanfare, but will have significant impacts on regulation costs paid by small businesses going forward.”

All things considered, the outlook appears positive. A recent Reuters survey of over 100 economists seems to substantiate this view. A majority of economists (59.6 percent) surveyed believe that the U.S. will continue to expand for at least the next two years, some (22.8 percent) suggesting that three-plus years is possible. It appears economic upcycles do not simply die of old age, which is good for all of us.

What’s Next for M&A?
The supply of companies for sale will naturally increase over the next several years, assuming a stable and modestly growing economy. Baby boomers still own 60 percent of privately held companies in the U.S. and, as they approach retirement, a rise in company sales will be inevitable. Adding to the equation are private equity (PE) funds which, on average, have been holding on to companies longer than historical norms. At present, nearly 40 percent of private equity-backed investments are over five years old (source: Pitchbook). Pressure to sell these older investments is building.

The demand for acquisitions will continue to be high. In a slow-growth world, strategic buyers will likely remain focused on inorganic opportunities to expand; particularly given substantial excess cash currently on public and private company balance sheets. Private equity funds are flush with uninvested capital as well. Their fundraising efforts have been remarkably successful since 2013, and the first half of 2017 was no exception. According to Pitchbook, private equity funds raised an excess of $57 billion in committed capital during the period. They are collectively on track for another big year and, combined with yet-to-be invested capital from previous years, most private equity execs are eager to deploy funds.  

Indeed, a more active M&A market is on its way.

Dan Shea is a managing director and head of private equity coverage for BDO Capital Advisors. He can be reached at