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The M&A pipeline below $100 million has been a pleasant surprise since credit froze up, but the chill may be spreading.
Lower middle-market deals, loosely defined as those valued under $100 million, have not been affected by the credit crisis as severely as larger deals -- particularly megadeals, which have essentially evaporated. But with capital markets soft, many believe that segment of that market could get hit next. According to data provider Dealogic, 508 such strategic deals, worth more than $12.36 billion, were announced in the U.S. in the first quarter. This was a significant increase over the same quarter in 2007, when 359 deals were announced for a value of greater than $10.2 billion. That's the good news. The bad news is that the number of lower middle-market deals appears to have peaked in the fourth quarter of 2007, when 547 transactions were announced with a total value of more than $12.4 billion, according to Dealogic. Andrew Greenberg, CEO of GF Data Resources LLC, a research firm that provides data on middle-market dealmaking, wrote at the end of last year that "we expect our next [quarterly] report to show that smaller deals did get pulled into the downdraft to a greater extent in the first months of 2008." Greenberg's prediction is reinforced by purchase price multiples for companies with Ebitda of $50 million. In the first quarter, this multiple averaged 8.9, compared with 9.3 at the peak of 2007, according to Standard & Poor's Leveraged Commentary & Data. S&P data suggests that over the past 12 months total enterprise value of adjusted Ebitda fell from 6.5 times in the first half of 2007 to 6 times in the second. Deals in the $25 million to $50 million and $50 million to $100 million segments fell to 6 times from averages of 6.9 and 7 times. "In the next few months, we expect the market segment we cover to continue to be hit by economic uncertainty, tighter credit and weak performance in some sectors," Greenberg says.
Due to their smaller sizes, lower middle-market deals are easier to finance, usually requiring only three to five lenders. Upper middle-market deals -- those in the $500 million and higher range -- are unlikely to get done without at least five lenders, say practitioners. Lower middle-market deals rarely, if ever, involve complex debt transactions with multiple levels of securitization. David Hoffman, a managing partner for New York private equity firm Charterhouse Group Inc., also believes there's been a slowdown in middle-market M&A. "There is still a carryover for sale mandates which were awarded at the end of 2007," he notes. Hoffman expects "new opportunities" for his firm to be down more than 20% this year but emphasized "for us, it's the quality and not the quantity of deals that matters." Not everyone is looking at reduced M&A activity. "Amazingly, we are not seeing any significant slowdown in transaction activity so far this year," says Randy Schwimmer, head of capital markets for New York-based Churchill Financial Holdings LLC. "M&A volume is obviously off for larger caps, and even larger midcaps, but the [lower-middle] market continues to see dealflow." The reason for this is that "smaller deals are easier to finance. Whatever slowdown may be coming hasn't been reflected in our pipeline, which is pretty robust." Another observer says it's too early to tell where the lower-middle markets are headed. William Winterer, a managing partner for Parthenon Capital LLC, says his firm was still able to finance its last few transactions even though financing has been "difficult and expensive." Winterer believes the situation could go either way. "If the economy ends up in a full-blown corporate earnings recession and default rates increase materially, the lending markets will likely get worse," he says. "If the overall economy stabilizes and corporate earnings remain decent, the middle-market lending environment should improve modestly." Other executives, such as Barrington Associates' CEO Michael Rosenberg, remain upbeat about 2008. "Although it may be contrarian opinion, we are still very optimistic," he says. "We see robust deal activity. Buyers are still out there, and transactions are still getting done, as both strategic and financial acquirers are still interested in pursuing high-quality middle-market companies." -- Demitri Diakantonis Categories Deal Video
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