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  Market Overview

• Abundance of private equity and corporate “dry powder” available to pursue deals
• Credit availability to support acquisitions increased significantly in the last quarter
• Overall valuations increased from Q2 to Q3 – multiples increased the most for transactions of $10-25M enterprise value
• Though still below 2007 peaks, activity in the lower middle market (deal value up to $100M) has risen steadily since its Q1 2009 low point

U.S. Lower Middle Market M&A ($0-100M) – Closed Transaction Value (Source – CapitalIQ)

Private Equity Groups (“PEGs”) are active in their pursuit of “quality companies”, broadly defined as having:

• Top line growth with predictable revenue streams
• 10%+ EBITDA margins
• Minimal customer concentration
• Strong management teams

This experience is driven by the large amount of capital raised by PEGs that was never put to work due to the unfavorable economic environment. The amount of PEG “dry powder” sitting on the sidelines is estimated to be $485 billion, with $85 billion of that at middle-market buyout shops. Assuming a 50/50 debt to equity ratio implies the capacity to close over $170 billion in middle-market transaction value. Additionally, corporate balance sheets continue to reflect excess cash, and acquisitions are high on the priority list for many of these strategic capital sources.

Deal Flow Continues Upward

Private company transaction volume continues to trend upward, as business conditions have improved and credit availability has increased. GF Data Resources reports that within their tracking universe of over 150 private equity firms, deal activity in the first three quarters of 2010 is up 57% over the first three quarters of 2009 (80 transactions versus 51). 

Acquisition Financing Jumps in Q3

Lenders’ appetite for transaction-related debt appears to be increasing as well. With leverage multiples expanding, buyout firms can reduce the amount of equity per deal and increase their target returns through additional leverage. Total debt increased significantly from 2.3X EBITDA in Q2 to 2.9X in Q3. In the same period, senior debt capacity increased from 1.9X to 2.4X. 

Q3 Valuation Momentum Continues

Q3 valuations hit their highest level since the first half of 2009, climbing to 6.0x EBITDA versus 5.5x EBITDA in the prior quarter. The increase was most notable among transactions valued from $10-25M, where multiples increased sharply from 4.8x to 5.8x.

Debt Markets

Default rates have come down and are now averaging between four and six percent for corporate loans, according to Standard & Poor’s Leveraged Commentary and Data. On the positive side, lenders are actively pursuing performing companies with strong balance sheets and, as a result, pricing is improving. On the negative side, marginally performing companies and those with over-levered balance sheets continue to have difficulty raising capital.

On the Horizon

A large number of debt facilities put in place in 2007-2008 are expected to come due over the next 18-24 months. For those companies who have made it through the last 18 months without payment or covenant defaults, new lines of credit and term loans will have to be in place, likely with more restrictive terms. Business owners should be looking at their current debt levels, borrowing base, and EBITDA, versus current underwriting standards being used by lenders, and be prepared to address any “gap” that might occur.

*Data in this report is used with permission from GF Data Resources, LLC. All recipients agree to be subject to, and comply with the GF Data Resources Terms of Use.