After seven years on the rise then two years at the top, average purchase price multiples lowered during 2001 in financial sponsor transactions in most industries.
Prices have come down, on average, one Ebitda multiple to one and a half since their 1997 to 1999 peak. Several factors, including seller attitude, the quality of companies and their degree of cyclicality, the recession and the debt markets, have been most instrumental in the change. But as we progress into 2002, sources say, these same factors will stabilize multiples and perhaps even strengthen them once again. During 2001, the factors for quality deal flow were all out of sync, but the new year may help align them.“In spite of the large amount of dollars available to buy companies, prices did come down last year,” says Kevin Callaghan, a managing director at Boston-based Berkshire Partners. “However, in 2002, there’s even more eagerness to put this money to work. Pricing is beginning to stabilize after at least a year of a dip. It’s even started to tick back up.”
It is important to note that calculating average purchase price multiple for 2001 was a difficult task. Not only were GPs reluctant to share the private information, but there were also far fewer deals in the mix, since 2001 saw only about $23 billion worth of LBO transactions. Additionally, as one investment banking source points out, purchase prices in 2001 were a game of expectations. In a market where Ebitdas were falling, in some cases financial sponsors were willing to pay up on a more normalized Ebitda, hoping that the shortfall was only temporary. For example, a company that was generating $25 million of Ebitda a year ago with a run rate of $20 million now, probably expects to be back to $25 million or higher when the economy turns.
“There are buyers out there that will pay for that and finance the extra purchase price with hopes and expectations of the market coming back,” says Andrew Petryk, a managing director with Brown, Gibbons, Lang & Co.
As a result of this “paying up,” Petryk adds, due diligence took on a whole new meaning in 2001 as potential buyers and lenders sought out more information than ever about potential investments, obviously attempting to cover their bases from all angles.
“Even things like add backs to Ebitda, where you get credit for non-recurring expenses, came under intense scrutiny,” Petryk says.
For Sale Sign Might Be a Sign
Quality of deals and seller attitudes are two factors that go hand-in-hand in the deal-making process. Sources say multiples came down in 2001 because every third company on the sale block was either in trouble or had an owner that was in trouble and needed to liquidate. Many sellers with quality companies that have the option of holding off until a buyer meets their price either got the multiple they wanted, in a few cases, or continued to hold off, waiting for the economy to stabilize – an event that will right many other wrongs in the deal-making process as it currently exists.
Some sources say, however, that many sellers might be kidding themselves, thinking valuations will sky-rocket like they did in 1998 and 1999.
“Seller expectation is adjusting, but it’s not adjusting fast enough,” says Ed Bagdasarian, a managing director with Barrington Associates. “The general consensus is we’ve hit bottom and are slowly climbing out of the recession, which will strengthen valuations, but they’ll be closely tied to performance numbers.”
But, the fact is, there’s still a small number of quality businesses for sale, says Berkshire’s Callaghan. It’s a heyday for those financial buyers that do distressed deals – troubled companies often sell at low multiples – another factor that brought down the average in 2001.
That Darn Debt
The woes of the debt markets also contributed to the 2001 dip in purchase price multiples and will continue to play a key role in the anticipated strengthening in 2002.
“If the buyout fund is able to borrow less, it’s forced to pay less,” Petryk says. “They can only put in so much equity and still get the returns their investors require. Equity from firms is around 40% on average right now.”
Banks and mezzanine lenders that were once willing to pay a debt to Ebitda multiple of almost six times (the average was 5.8 in 1996), are now only promising three times to four times, according to data from Brown, Gibbons, Lang.
“We’ve been successful in getting banks to stretch for companies doing refinancings for ongoing operations further than they will stretch for buyout firms,” Petryk says. “Banks are still being cautious about the unknowns that go with buyout deals. There has been improvement recently, but it’s not material improvement.”
The debt market dynamic plays into many parts of the buyout market, but as it relates to multiples, the difficult debt market is giving strategic buyers the upperhand when it comes to doing deals. Over the past few years, prior to 2001, the lines between financial buyers and strategic buyers had blurred because they were paying about the same prices. But, what a difference a year makes. Sources say strategic and financial buyers aren’t even in the same league right now because the underlying cost of capital for strategic buyers is less. “They can pay one or two times what financial buyers can pay on average,” Callaghan says.
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