Luca Longobardi's Power Presentation At The Oxford Unity Club In NY

Luca Longobardi's Power Presentation At The Oxford Unity Club In NY

What is Driving Increased Merger & Acquisition Activity?

Merger and acquisition activity has dramatically increased in the past three months. Year to date through May 2010, U.S. middle market M&A transactions totaled 2,251, a gain of 77% over the the same period in 2009. A total of 489 U.S. middle market M&A transactions were announced in May 2010; an 85% increase over the prior year period and also the second largest monthly figure since 2000. What is driving this significant increase?

AtState Capital, we are constantly monitoring fundamental factors that drive merger and acquisition and capital raising transactions for our sector's coverage, business services investment banking clients and for private businesses generally.

Each of our key industries have their own fundamental drivers, but generally here are some important trends:

Private Equity Overhang: Private equity groups, those professional money managers who aggregate capital from institutional investors such as pension funds, insurance companies, endowments and corporate investment vehicles to invest in private companies, have over $425 billion of investable capital. Assume this equity capital is leveraged two times, this becomes almost $1.4 trillion of purchasing power. These funds typically have up to five years to make their investments or the commitments expire. Since few have invested capital over the past two years, they are highly incentivized to do deals. This demand for quality middle market deals is good for business owners who desire to sell.

U.S. Corporate Cash Balances: U.S. companies are holding more cash than at any point on record. The Federal Reserve reported that non-financial companies have over $1.84 trillion in cash and liquid assets. Some of the cash is for "rainy day" purposes, but some is for targeting strategic acquisitions. These public companies must grow and one way they do so is through acquisitions.

Industrial Activity and Demand for Industrial Company Acquisitions: The industrial sector of our economy has been robust and a large contributor to improving GNP. Further, demand by buyers for quality industrial companies is up rather dramatically as reflected in high transaction valuations. Prior to 2006, industrial firms generally sold for 6x to 7.5x operating earnings (EBITDA). During the M&A market peak (2006 through mid 2008), they were selling for 8.5x to 9.5x EBITDA. Based on current demand, a low risk industrial company with average growth can generate these same "peak" multiples.

Improved Trailing 12 Month Operating Earnings: Demonstrating improving financial performance, especially operating earnings (EBITDA) over a trailing 12 month period, is a key component to a successful transaction. Many companies are either close or have already moved 12 months beyond their weak months during the depths of the recession. Now they can show a string of 12 consecutive months of solid earnings, which provides comfort to the buyer and indicates future growth ahead.

Risk of Increased Taxes: Most believe capital gains taxes and personal income taxes are going up. Therefore, some owners are contemplating a sale before these tax rate increases become a reality. Business owners considering an exit need to consider what effect a tax increase will have on their after tax proceeds now vs. waiting till after rates go up. Said differently, if owners wait to sell a business, they must calculate the additional earnings that their business must generate in order to obtain the same after tax proceeds as a sale today. Obviously, many variables factor into the answer, but having to generate 5% to 15% of additional earnings is a common answer.

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