On November 16th, Aethlon Capital’s Sima Griffith participated in a panel discussion at Faegre Baker Daniels’ M&A Conference in Minneapolis. Some highlights of her remarks appear below:
How has recent M&A deal flow been?
After a robust and near record-setting M&A market in 2015, some steam was lost in 2016. The first half of the year was softer and lighter than we expected.
In 2015, we were speeding down the highway at 80 mph, but in 2016, we slowed down for road construction as buyers became more cautious.
The 2016 M&A market was a story of the “haves and have nots” with high quality, large companies selling for 12-14x earnings, versus smaller acquisition targets with “warts” or “hair” on them selling for significantly lower multiples of 4-6x EBITDA.
In the first nine months of 2016, Thomson Reuters reported deal volume was down 35% over 2015.
What are the reasons buyers started applying the brakes this year?
I would highlight three major concerns:
- Ultra-high valuations for the best companies with some corporate buyers and private equity funds refusing to compete in auctions that were commanding such high premiums. It became much harder for them to model a good return on their investment.
- The number of attractive acquisitions has diminished.
- And geo-political uncertainty from Brexit to the bruising presidential election and nervousness around that.
That being said, we all saw a rush of deal making in October!
How are strategic and financial buyers behaving in the current market?
Many private equity funds are employing a buy and build strategy, buying smaller companies to add on to the platform companies in their portfolios. This also helps bring down the high multiples they may have paid in an expensive market. For example, if they previously paid 9x EBITDA for a platform company and then buy one of its smaller competitors for 5x EBITDA.
In the first nine months of 2016, 64% of companies that private equity funds bought were add-on acquisitions.
In an overcrowded market, with sky high valuations for the best performing companies, some PEs returned money to their limited partners because they couldn’t model a healthy return on investment. Returning money to limited partners is something private equity funds are loathe to do!
Strategic buyers tend to be more cautious as they have a fiduciary obligation to their shareholders. That being said, publicly traded companies need to show Wall Street earnings growth which is harder to do in an economy that is only growing 2%. They also have competitive pressures and are in a race to gain market share. 2016 saw several mega deals from big companies with big budgets, such as the DELL Computer EMC merger, Microsoft’s splashy deal to buy LinkedIn and Wal-Mart’s acquisition of online retailer JET. Right here in our own backyard, Abbott acquired St. Jude medical for $25 billion, funding the cash portion of the acquisition with cheap medium and long-term debt. We also saw Sherwin Williams announce they were buying Valspar for $11.3 billion in cash.
In summary, low interest rates and the need to show growing market share and earnings are fueling these mega deals.
What will be the key drivers in 2017?
Interest rates, the economy, and the supply of companies for sale.
Interest rates have been low for several years and have made financing acquisitions relatively cheap. Once the Fed starts raising rates, which increases the cost of borrowing for those using debt to fund their acquisitions, you’ll see M&A activity slow down. However, as long as the economy remains relatively healthy and there are no shocks to the system, we should still see a steady state of M&A. With regards to the supply, assuming valuations don’t significantly decline, I expect the baby boomer generation to continue to bring their companies to market throughout 2017.