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At The Deal's PC Symposium this afternoon, dealmakers weighed in on the impact of today's megabuyouts on the definition of the middle market, how to get proprietary dealflow and the impact of debt multiples. A panel moderated by Winston & Strawn LLP partner Steve Napolitano and including Castle Harlan Inc. vice chairman Gary Appel, Advent International Corp. partner Chris Pike, MidOcean Partners partner Robert Sharp and David Vorhoff, managing director of McColl Partners LLC, said the definition of middle market is constantly changing.
Defining the middle market Sharp said MidOcean defines it as deals in the $200 million to $600 million range. "I think of it more as a business model that one can transform more easily," he said. Buyouts that hit the "sweet spot" of value proposition and downside protection are attractive, he said, those deals with growth characteristics, that are not mature and that could offer exceptional returns. "It's as much valuation as it is the character of the company itself," Castle Harlan's Appel said. The firm looks for prospects where there is an opportunity for rapid growth and rapid change for a business that is professionally managed, but needs help. From a price tag perspective, Advent's Pike said the bar has moved up as megafunds have vacated the upper end of the middle market. In this environment, deals get closer to $1 billion and $1.5 billion. McColl's Vorhoff concurred. "Every year what's going to be defined as middle market will get bigger." Proprietary dealflow Furthermore, as megafunds chase bigger deals, there's less competition at the top of the middle market, so the competitive dynamics are better for those trying to avoid the auction processes, Sharp said. In order to capture proprietary deal flow, it takes a network of advisers, and contacts, who can spot opportunities, establish trust and move quickly to close on them, he said. Appel said Castle Harlan tries to invest in industries it knows well, where it has managerial experts to consult and where it has reason to be there other than just to "participate with blind capital." Frothy valuations The lofty valuations prompted by the megabuyouts have created great opportunities on the sell side for middle-market firms, Vorhoff said. They can take longer before granting exclusivity, and it leads directly to more due diligence. "Some of the process work has clearly been to the benefit of the seller," Vorhoff added. On the question of doing deals without exclusivity, sometimes it's completely unavoidable, the panelist said, but buyers need exclusivity, because of the amount of money it takes to get there. Debt multiples Of the current environment, Sharp said: "The markets are extremely strong. I don't see how they can get much stronger." It is more likely for them to get weaker, he said, and leverage levels to tighten up. But, he added, it's OK because there is liquidity. New investors have changed the dynamics and helped to spread risk. The key is to stick with sound investment principles, he said. The banks are less exposed, Pike said. "Rates are low, and covenants are pretty loose," he said, so companies aren't wheezing under the burden, and the deals generally have more equity than they used to. But when there is a downturn, Sharp said, before you see the leverage go down, you'll see things disappear like covenant-lite. Overall, there are several trillion dollars of purchasing power, Vorhoff said, the "market is deep, going to stay deep for awhile." —Carolyn Murphy Categories Deal Video
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