|At first glance, the story on purchase price multiples looks fairly mundane. Prices for the types of companies most commonly acquired by buyout firms have remained flat over the past 12 months, and industry observers don’t expect conditions to change much in the near future.
Strange as it may sound, though, the fact that prices aren’t going up speaks to a relatively new and exciting trend in the buyout market. Throughout most of the 1990s, according to yearly surveys conducted by BUYOUTS, prices rose gradually and steadily until the year ending in February 1999, when the average multiple of earnings before interest and taxes (EBIT) paid by financial and strategic buyers leveled off. According to this publication’s most recent survey, average purchase price multiples have, for the second year in a row, dramatically gone nowhere.
Industry sources say the stabilization can be attributed to disciplined lenders and higher interest rates. Many observers also point to the wild popularity of technology and telecommunications?sectors which are drawing capital away from the more traditional buyout hunting grounds of manufacturing and basic services. Tech and telecom companies, of course, have seen soaring valuations, despite often having little or no earnings to speak of.
The past year also saw the lines blur between financial and strategic buyers, who paid roughly the same prices for similar properties, a trend which sources attribute to greater specialization within private equity portfolios and more discipline on the part of strategic buyers.
The multiples survey this year is culled from interviews with dozens of investment bankers, lenders and buyout firm general partners, who supplied anonymous multiples information on deals in which they participated over the last 12 months. Where specific deal information was not available, the survey respondents were asked to provide numbers they felt reflected average multiples for various sectors, and the approximate size of the pool of deals upon which these averages were based. The averages were then weighted and blended with the averages calculated from isolated deals. The overall multiples are heavily weighted toward manufacturing and service deals, which make up the lion’s share of buyout transactions, followed by communications, health care and retail.
Those readers who slavishly follow the BUYOUTS multiples survey from year to year should note some changes. In response to the fact that most industry professionals do not consider EBIT to be the best measure of cash flow, BUYOUTS has begun using multiples of earnings before interest, taxes, depreciation and amortization (EBITDA) as the standard measure of prices. In the interest of comparing this year’s numbers with past years’ however, an overall EBIT multiple has been included in this year’s information (see chart), which was culled from the firms who supplied such numbers.
Of course, with buyout firms increasingly investing in unprofitable start-up companies, even EBITDA multiples fail to tell the real story of the prices being paid for many tech and telecom companies. “A multiple of a negative number is not meaningful,” notes Tripp Johnston, a managing director at First Union Securities.
Johnston says that multiples reached their peak before 1998’s late-summer debt crisis. Since then, he says, the markets for senior debt and high-yield financing have been difficult to access, and this has had the effect of holding down multiples.
Dan Marszalek, the group president of corporate finance at Heller Financial, agrees. “Overall, prices are stagnant because interest rates have crept up a bit,” he says. “Lenders are showing discipline in terms of lending multiples.”
Financial Buyers Growl
But with so much capital to invest, private equity firms are not waiting for banks to lose their discipline. Chris Williams, a principal at investment bank Harris Williams & Co., says he has noticed financial buyers ponying up strong equity components to win deals in the face of reticent banks. Michael Rosenberg, a managing director at middle-market specialist Barrington Associates, also notes that financial buyers lately have been even more aggressive than strategic buyers in their bids, particularly when acquiring add-ons.
When making an acquisition through a platform company, financial buyers can afford to make the same bids as traditional strategic buyers. Marszalek notes that past experience in specific industries has given financial buyers increased strength.
In the meantime, many strategic buyers have been less aggressive in their bids. “Strategic buyers have needs and desires to show a return on equity,” Marszalek says. “They’ve become a bit more disciplined.”
As a result, the traditional gap between the prices paid by financial and strategic buyers has closed considerably over the past year. “I see [the two groups] as being about equal these days,” Marszalek says.
The Lure of Tech
Buyout professionals often like to describe themselves as contrarian investors, but you wouldn’t know it from the way many of them have been charging toward tech and telecom of late, leaving prices for the more traditional value plays in the dust. Demand for basic manufacturing companies, for example, pales in comparison to demand for high-growth companies.
And even though prices for basic manufacturing and services companies are attractive relative to the industries favored in the public markets, financial and strategic buyers are not rushing to open their wallets. “I can’t tell you how many CEOs of public companies have come to see us whose share prices have been cut in half,” says a general partner at a major buyout firm, referring to the manufacturing sector. “I’ve got a list of companies on my desk right now in [sectors like] chemicals and packaging with multiples [of EBITDA] between 4.5 and 6. These are the basic meat and potatoes of the buyout industry, but no investors are interested in these kinds of companies. The rush of so many traditional buyout firms into telecom and e-commerce has created a kind of vacuum.”
To be sure, there are some hot industries outside of tech/telecom. Based on survey responses, food-related companies are en vogue, despite food’s inability to be digitized. Within the last 12 months, a food distribution company was sold for a multiple of 12 times EBIT to a strategic buyer, while two food manufacturing concerns sold for 9 and 11.4 times EBIT, respectively. Old media companies, too, are enjoying their day in the sun, thanks mostly to their ability to be incorporated into new media concerns. Harris Williams’ Williams notes that properties as old-fashioned as newsletters are selling for between 9 and 11 times EBITDA, while radio stations are being sold for as much as 40 times EBITDA (see story p. 49).
Health care, too, has its stars. While traditional services like staffing remain moribund, with multiples of EBITDA ranging between four and five, prices for any company with a biotechnology or genomics orientation are soaring. Of course, the more high-flying health-care companies tend to have negative earnings, and thus are often valued on multiples of revenue, which can range from one to five, according to sources.
Negative earnings notwithstanding, buyout firms are migrating to growth and early-stage investing, and this has eased pricing pressure on many mid-cap, basic industrial companies.
Some industry observers think prices for meat-and-potatoes companies will begin to fall once sellers come to grips with true market conditions. “It takes time for sellers to adjust their expectations,” says Tyler Wolfram, a managing director at Cornerstone Equity Partners.