Heading into the final quarter of 2019, a record level of capital continues to pursue a small pool of “A-plus” assets, while global political and economic uncertainty dominates headlines. How are buyers and sellers capitalizing on these trends?
We assembled senior Harris Williams professionals from a wide range of Industry Groups and geographies to find out. Here, we share their insights, including three emerging buyer strategies and how sellers can make the most of each.
Still a Sellers’ Market
Compared to last year at this time, competition for top-quality assets remains intense.
In fact, it’s intensified. With M&A volume below its 2017 peak, a limited number of deals are being chased by an expanding group of buyers, from strategic buyers and private equity groups to family offices, patient capital funds, infrastructure funds, core funds and special purpose acquisition companies (SPACs) (Figure 1).
“The private equity asset class is continuing to mature, and as that happens, different kinds of buyers are participating,” says Bob Baltimore, a managing director in the Business Services Group. “Whether they are SPACs, core funds, infrastructure funds or family offices, more competition for investment opportunities is good from the seller’s perspective.”
Figure 1: M&A Volume Declines from 2017 Peak
Source: Thomson Financial
Those buyers are looking for growth. As shown in Figure 2, earnings per share (EPS) growth has slowed among S&P 500 companies in recent quarters, increasing the imperative to grow inorganically.
“To support elevated valuation levels, many public companies need to deliver significant growth to their shareholders,” says Tim Webb, a managing director in the Industrials Group. “Often, the organic opportunities are not enough, and they rely on M&A to fuel incremental growth.”
And, as shown in Figure 3, corporations have cash to spend: S&P 500 aggregate cash positions (excluding financial companies) have hovered near $1.5 trillion over the past few years.1
Figure 2: Declining Earnings Growth
Source: Standard & Poor’s
Figure 3: Strategic Buyers Have $1.5 Trillion in Cash
Sources: FactSet and Preqin
Financial investors are eagerly seeking opportunities as well. More than 900 private equity funds around the world secured in excess of $450 billion in commitments in 2018 alone. During the first half of 2019, the 10 largest funds raised nearly $80 billion, about 25 percent more than the capital amassed by the 10 largest funds during the first half of 2018.2 Today, there’s more than $1 trillion of private equity capital seeking investments globally, providing continued upward pressure on valuations while fueling economic growth.3
Blips, Not Bumps
Even with this backdrop, today’s geopolitical and global trade concerns are stealing headlines and affecting some deals. For example, as noted by Webb, reviews by the Committee on Foreign Investment in the U.S. (CFIUS) are delaying transactions between international buyers and companies possessing critical technologies. In addition, says Webb, tariffs have created uncertainty for companies with international footprints, both from a sourcing and sales perspective.
Daniel Wang, a managing director leading the firm’s efforts in Asia, reiterates this sense of uncertainty. At the same time, he says, the impacts on cross-border deal-making are limited, particularly for consumer products businesses. “On recent visits with Chinese buyers interested in U.K. and U.S. assets,” he says, “hardly any groups raised U.S.-China relations as an obstacle to working together.”
Likewise, Jeff Perkins, an Industrials Group managing director based in Frankfurt, has noted some Brexit-related concerns, but no substantive impacts on M&A: “While we’ve seen some reduction in the number of deals going to market, Brexit is not affecting multiples for quality assets in growth-oriented end markets. Most buyers are taking a long-term view and seeing good growth potential over the next 10 to 20 years.”
John Neuner, a managing director in the Consumer Group, echoes this sentiment: “The best leaders are managing their businesses for the long term. These geopolitical issues are often relatively short-term blips that don’t change a business’s long-term strategy.”
“Buyers continue to line up for top-quality assets, just as they were a year ago,” continues Neuner. “In fact, for high-quality companies that check all the boxes, people have gotten even more aggressive and are moving faster. It also seems like there’s a smaller group of true A+ companies in the market, with more buyers competing for fewer deals.”
Even so, the potential returns of direct investment in great private companies continue to attract new buyers. “Every buyer is now modeling in a down cycle,” says Geoff Smith, a managing director in the Healthcare & Life Sciences Group. “They are doing the math and still buying good businesses that perform well across different economic cycles.”
Three Key Buyer and Seller Dynamics
How are buyers and sellers adjusting to this dynamic environment? As we describe below, stiffer competition for top-quality assets paired with business cycle concerns are driving three key buyer behaviors—each of which sellers can integrate into their own strategies.
Paying for cycle resilience, while seeing value in some cyclicality
Of course, no business is perfect, but some are clearly better positioned to weather a down economic cycle than others. As summarized by Webb, “Buyers are stretching for businesses with limited cycle exposure, and at times underwriting to lower returns to deploy capital.”
“Investors continue to favor businesses that are entrepreneurial in nature and can reinvent themselves in a dynamic economy,” adds Baltimore. “Businesses like that should continue to garner large valuations.”
With valuations at record highs, however, Harris Williams professionals are seeing a subtle shift in buyer behavior. “As valuations for the most in-demand assets continue to diverge from the rest of the field, some buyers are starting to take a contrarian view,” says Neuner. “They’re looking twice at sectors and businesses where expectations are not for 15x-20x multiples.”
That includes businesses with some element of cyclicality, yet solid long-term potential. Soaring valuations for cycle-agnostic businesses are one driver of this trend, according to Luke Semple, a managing director in the Energy, Power & Infrastructure (EPI) Group. “In comparison, more cyclical businesses at lower multiples are starting to get second looks,” he says.
“The buyers we work with know a cyclical company isn’t a bad company—it’s just one that’s going to ride the waves,” says Baltimore. “But hopefully, over the long term, it will continue to trend up and to the right. It’s our job to help buyers understand how that may make that company more appropriate for investors with a longer time horizon, so they can enjoy more of the peaks than the valleys.”
Some buyers are choosing to focus on smaller targets, also with a view toward long-term growth. This approach can also yield dividends in terms of innovation: “Because of the value of innovation coming from many smaller consumer companies, strategic buyers can, in effect, ‘outsource R&D’ by taking this approach,” explains Kelly McPhilliamy, a managing director in the Consumer Group. “In fact, that was a significant driver behind Unilever’s acquisition of graze, a direct-to-consumer healthy snack company we recently advised.”
Larissa Rozycki, a director focused on family-owned businesses, has seen several private equity funds targeting smaller assets as well. “They’re seeing the potential upside, and the benefits of getting in earlier, and they’re probably going to hold it for a little longer with the intention of building scale,” she says.
Other buyers are giving second looks to firms facing challenges. “In Europe, we’ve seen certain investors focusing more attention on companies with relatively modest growth and profitability profiles, but also with the potential to unlock operational efficiencies,” says Julien Oussadon, a London-based director in the Technology, Media & Telecom (TMT) Group. “Those situations tend to require more work, and therefore can be more attainable.”
Seller Response: Proactively collect the data that supports your story
To capitalize on this trend, be prepared to share the ups and downs of the business. “At this stage of the M&A cycle, buyers want to see more lengthy historical performance data,” says Rozycki. “They want to know what happened during the last recession to understand how that company and its sector performed, and what the business may do if another recession happens.”
“Be upfront and transparent about any challenges your business faces, and have the data available that supports your view of your company’s long-term prospects,” advises Baltimore.
Another key: Thinking early about identifying a targeted group of buyers that will see your business’s potential and run hard after it. “Whenever we have a business that falls somewhere along that spectrum—whether it’s a growth business, a smaller company or one with some cycle exposure—we spend a significant amount of time upfront thinking about the parties that will see its value and understand its story,” says Neuner.
Playing to core strengths, wherever they lead
In an ultra-competitive and dynamic environment, differentiated expertise matters more than ever. “When you’re competing for in-demand assets, understanding your core strength is more important than ever,” says Baltimore. “When you have unique experience, you can bring a differentiated angle, which is key to underwriting a higher return in the long term.”
Perkins sees the same dynamic in Europe: “To prevail, you have to know exactly where you are going to take that business, because if it is a great asset and everybody is after it, you’re going to have to develop it. You should have conviction around the companies that could be add-ons, the new products or services you can introduce, and the new markets you can enter.”
Oussadon adds that buyers are increasingly taking the time to cultivate such differentiating expertise: “Buyers are being more selective, and for those assets they choose to pursue, they are front-loading due diligence six to 12 months before the process even starts. That gives them a view of their angle, and helps them develop an edge against the competition.”
At the same time, the limited number of assets—and the looming risk of a cycle shift—is pushing some buyers to think laterally. As Smith explains, for example, some types of healthcare businesses are seeing increased interest from buyers outside the industry: “Several financial investors, many of whom are not historically healthcare investors, want to invest in the industry because of where we are in the cycle.”
Semple sees a different shift underway in his industry: “Infrastructure investors are increasingly active beyond hard asset-type businesses, expanding into service-oriented acquisitions with recurring revenue.”
Likewise, says Neuner, some consumer and retail investors have shifted their focus toward services, particularly businesses with recurring revenue. “Our recent clients in the home and property services and fitness segments have seen very strong buyer interest,” he says, specifically citing Servpro, Home Franchise Concepts, Neighborly, Authority Brands, Taymax and Impact Fitness.
Another strategy for buyers seeking assets in sought-after segments is to invest in the supply chains serving them. “In the consumer segment, we’re seeing financial investors move into the supply chain, whether that’s contract manufacturing, private label manufacturers or packaging suppliers,” says McPhilliamy. “Doing so helps them participate in attractive sector dynamics without betting on a singular brand.”
Seller Response: Get ahead of the curve with potential buyers, and think laterally
“In today’s competitive market,” says Smith, “if something doesn’t fit with buyers’ expertise, and they don’t feel like they have an angle or a way to compete, they’re more likely to stand down. As sellers, that makes it more important to know who the right buyers are, and be able to show how assets fit their strategies.”
“You need to look at the dynamics of the business and assemble the right grouping of people, and engage them earlier,” agrees Baltimore. “Overall, we’re having a lot more of that kind of dialogue, and for the last several years we have been designing and running narrower, more customized processes.”
The focus on finding an angle quickly also requires sellers to prepare for earlier buyer inquiries. “Buyers are looking for more information earlier, and for more direct dialogue with the company’s management and owners,” says Neuner.
As a seller, it’s also important to understand and demonstrate potential adjacencies.
“For example, retail investors may possess real estate and customer service expertise valuable to healthcare businesses,” says Smith. “3PL investors could have fulfillment and logistics experience valuable to online retail businesses. And infrastructure investors may have relationships and knowledge that transfer from investing in hard assets to investing in related services. Proactively think through these possibilities and how to position your business accordingly.”
Offering seller-friendly deal structures, including minority investments and equity rollovers
According to our senior professionals, competition-driven valuations and cycle concerns are also resulting in an increase in minority deals and equity rollovers. Such transactions appeal to sellers who want to stay involved in their businesses and share more richly in future success, thus providing an edge to buyers in a hyper-competitive environment.
“If you look back two or three decades ago, the choices were very limited: Take your company public, get absorbed by a larger competitor, or sell it to one of a limited number of generalist private equity groups,” observes Neuner. “There are so many more options today: fund size, industry or geographic focus, length of hold and minority versus majority deals. Some of the more creative and accommodating structures are enhancing deal volume, because they let buyers deploy capital while allowing sellers to lock in a win in a great market. These structures also can help sellers remain invested in strong companies with incremental upside.”
Perkins says that minority deals are gaining traction in Europe as well: “We are seeing many European family-owned businesses strongly considering this step to help them achieve growth while maintaining control of their companies.”
Beyond appealing to sellers, equity rollovers and minority deals can provide distinct buyer benefits. “Minority deals can help buyers get first-mover advantage,” explains Rozycki. “Often, they want to be the first capital into an asset, which allows them to make the specific financial and operational optimizations they think are best for the business.”
Buyers are also aware of the power of preserving an acquisition’s “DNA,” notes McPhilliamy, and see minority deals as an avenue to do just that. “Acquisitions can fail when a major corporation integrates an asset and loses what’s special about it,” she says. “Strategic buyers are increasingly willing to pursue structures that allow founders and executive teams to retain upside in their high-growth business. We have also seen more strategic buyers operating acquired businesses independently to preserve their unique DNA while enabling them to leverage the global capabilities of the broader organization.”
During a recent trip to China, South Korea and Japan, Wang and McPhilliamy noted strong interest in such offers among potential Asian buyers of U.K. and U.S. consumer businesses. In particular, deal structures that ensure ongoing engagement of a company’s management team can address some Asian buyers’ hesitation to run global businesses without regional expertise and relationships. “Almost all the buyers we met with asked about management rollovers,” says Wang. “For some, it was a prerequisite to making a deal.”
Seller Response: Emphasize partnership over price
When alternative deal structures are on the table, it’s more important than usual to pay close attention to cultural fit and alignment on strategy. In particular, buyers offering minority deals tend to have long-term relationships in mind, and often will seek to “put their stamp” on the business. As such, it’s crucial to be sure you can work with them for years to come, and that they bring skills and knowledge that can help you take your business to the next level. Such qualities should outweigh short-term considerations such as slightly more favorable deal terms.
“In a minority deal scenario, it’s less about price,” says Baltimore. “It’s more about finding the right partner that has a shared growth vision and brings the right resources to the table.”
That takes time and preparation, and the ability to compare complex offers. “The more we can talk to sellers upfront and help them think through what they’re looking to accomplish, the smoother that process is going to be,” says Rozycki. “As we’ve discussed, there are a lot of options that business owners aren’t necessarily aware of, many of which can be complex.”
As a seller, it’s also important to have trusted partners with experience in alternative deal structures who can help you navigate their complexity. “As we’ve seen in several recent client engagements, there are lots of options to consider and to compare between various proposals,” notes Smith.
Amidst financial and political uncertainty, the M&A market continues to attract capital from a wide and growing pool of buyers.
With intense competition for the most select assets driving prices higher, a growing number of buyers are seeing the value in companies that may require more work or that have an element of cyclicality. And as they seek to prevail in this ultra-competitive environment, buyers are increasingly looking for novel ways to gain advantage from differentiated expertise. Another offshoot of today’s strong competition: more seller-friendly deal structures, which can deliver significant benefits to both sides of a transaction.
For each of these buyer trends, there are corresponding approaches sellers can take to maximize the value of their businesses, including being proactive with data, starting relationships earlier and focusing on partnership over price. Perhaps most importantly, sellers should keep in mind that conditions are prime to take a great company to market.
1. FactSet, Preqin
2. Private Equity International Fundraising Report H1 2019
3. FactSet, Preqin