Multiples Rise Amid Fierce Competition For Good Deals –

With valuations down and LBO firms well capitalized, the competition for deals-especially the “good” ones-is fiercer than ever. That helps to explain why average purchase price multiples in financial sponsor transactions nudged higher in 2002 and are expected to increase further in 2003.

According to S&P’s Leveraged Commentary & Data, LBO purchase price multiples averaged 6.45 times as of Dec. 31, 2002, compared with an average of 6.1 times during the year-ago period. Market pros say several factors are influencing this upward trend, including a shortage of quality companies, seller attitudes, the recession and the shrinking number of senior debt providers. And as we progress into 2003, those factors are expected to continue.

“[While] the numbers can be very industry-specific, it appears there is a full turn higher in price occurring in 2003 over 2002,” said Hugh Wade, senior managing director of Madison Capital Funding LLC. “The price seems to be getting higher. Last year, every deal seemed to have a 5 [times] handle, while lately it seems like there is a 6 or 7 [times] multiple [for the same deal].” However, he stressed that “this may not be a permanent change.”

Multiples were highest for deals between $250 million to $499 million, at an average of 6.77 times, compared with 6.26 times in 2001, according to S&P’s LCD. For deals up to $250 million, the average multiple was 5.8 times, while deals of $500 million and over had an average multiple of 6.7 times.

In select cases, the numbers have even reached double-digits. When RCN Corp. agreed (in August) to sell the subscriptions of 80,000 cable subscribers in Central New Jersey (which was then brought into a company named Patriot Media & Communications LLC) to Spectrum Equity Investors for $245 million, the EBITDA was “in the 11 times range,” according to a source close to the deal (see article, page 5).

On the flip side, in cases where the seller is highly motivated and the deal size is small, sources say the floor is around 4 times – and at times has dropped even lower. Such was the case when the owner of Lexicon Marketing Corp., Jose Luis Nazar, sold his firm to Golden Gate Capital for $40 million. The multiple was 3.5 times EBITDA, while the equity for the deal equaled 50% of the total purchase price.

However, LBO pros complain that the best companies are still asking for-and receiving-high multiples, in large part because of buyer demand.

“There are not that many great companies out there for sale, and there are lots of firms chasing the same deals,” Wade said. “The main reason [for these numbers] is the dearth of quality transactions at a time when money is piling up. Sellers and their advisors know this.”

The increase in multiples is more striking considering how restrictive lending terms have become. Banks and mezzanine lenders that were once willing to pay a debt multiple of 5.8 times (the industry average in 1996) are now offering an average of just 3.75 times, according to data from Standard & Poor’s LCD.

But despite the higher equity portions that LBO firms have to contribute-the average is a little more than 40% nowadays-the chance to buy at bottomed-out prices, as well as their coffers of unspent cash, present a compelling incentive to make purchases now, often regardless of the multiple.

On an industry level, printing/publishing was the most expensive industry to play in, as multiples averaged 8 times, according to PMD (see charts on page 42). Conversely, industrial deals of under $250 million were cheap by comparison, as purchase prices averaged around 5.7 times EBITDA.

“Healthcare and consumer products companies have been generating strong multiples, but the real difference has been company-by-company, with some receiving very aggressive multiples,” said Jeff Rosenkranz, managing director and co-head of the Middle-Market M&A Group of US Bancorp Piper Jaffray. “The most attractive companies are the most stable ones, which were least impacted by the economic cycle, and have the most growth opportunities.”

“The problem is [that] everyone plays in a different market,” added a managing director at a private equity firm. “Cable and broadcasting [are] very different from distressed players. Cash flow is depressed, [and] it is a very misleading indicator. Different sectors have very different multiples.”

How High Can They Go?

Rosenkranz and other private equity pros say they’ve seen multiples higher than 8 times EBITDA for some of the stronger targets. “Competition is so fierce, and the desire to put money to work is so strong, private equity firms are stretching and driving down equity returns,” he said. “If a firm can write a $100 million check for an investment they perceive as less risky – and therefore they can put a big slug of money to work – and sleep at night, then they are happy to do it.”

However, the impact these multiples have had on fund returns isn’t going unnoticed. While many LBO pros can envision a slight uptick in purchase prices in 2003, most don’t believe they can go up much more. Lawrence Golub, president of Golub Associates, said multiples aren’t higher because of “perceptions of limited opportunity for growth and profit and [the] tight financing markets.”

Added Rosenkranz: “Do I see multiples changing dramatically? No. While we expect a continued slight uptick in financing multiples, that won’t be enough to affect multiples dramatically.”

Another source was more optimistic, arguing that multiples should come down in 2003, due to concerns about returns. “We sense that multiples are coming down,” the source said. “The name of the game is leverage. Returns will suffer without leverage.”