Citing issues like the credit crunch and competition from strategic buyers, dealmakers today have the same glass-half-empty attitude toward the M&A market that they had immediately after the market’s collapse in 2008.
According to the latest twice-yearly survey by the Association for Corporate Growth (ACG) and Thomson Reuters (publisher of Buyouts), 87 percent of the survey’s private equity respondents say the current M&A environment is fair or poor, compared to 88 percent at mid-year 2009 and 86 percent in December 2008. Only 12 percent of respondents to the most recent survey characterized the market as good, while 1 percent described it as excellent.
“The overwhelming sentiment is that we still have a long way to go,” Dennis White, ACG chairman and senior counsel at law firm McDermott, Will & Emery LLP, told Buyouts. “I don’t think there’s any sense that we’re going to experience a surge…but rather it’s going to be a long slog to normalcy; and there are even questions as to what the new normal is going to be.”
Of the survey’s 191 private equity respondents, 88 percent were buyout professionals, while the remaining 12 percent are venture capitalists. Seventy-six percent of the total pool had $500 million or less under management.
Despite the dreary outlook, more than three quarters (76 percent) of the private equity respondents believe we’re in a buyers market. That said, when asked if the current market favors private equity or strategic buyers, 75 percent said the scale is tipped toward strategics, which tend to rely more on cash on-hand and existing lines of credit to buy companies rather than having to raise new financing on a deal-by-deal basis. Looking forward, 94 percent of respondents believe strategic investments will pick up in 2010.
The credit crunch loomed large among respondents pondering the greatest threats to private equity firms today. Fifty-five 55 percent of respondents listed the credit crunch as one of the greatest threats to their assets class while 42 percent chose the overall economy (respondents could choose multiple selections for this question.) The lack of fundraising and exit opportunities were cited by 32 percent and 30 percent of respondents, respectively.
There was, however, a thin blanket of guarded optimism among respondents, with a majority (68 percent) of them saying they believe the debt markets will be “a little better” six months from now and none expecting the credit situation to be “much worse.” Twenty-three percent said they think the financing markets will be the same in the next half year. Among the outliers, 5 percent believe the debt markets will be “much better” in six month’s time while 4 percent think they will be “a little worse.”
Meantime, respondents believe one way to make up for the lack of leverage is to put more skin in the game. Forty percent of respondents said they expect to fund their deals over the next six months with 41 percent to 50 percent equity, while 30 percent said they expect to put north of 50 percent equity in their new deals.
Fifty-two percent of respondents said their expected contributions in the next six months are expected to be higher than they were this same time last year, while 43 percent expect them to remain the same. Only 6 percent expect to put less equity in new deals than they were a year ago.
For buyers, more equity exposure means more risk of generating mediocre returns. Therefore it’s likely that firms will spend more time placing their bets in companies with a proven sustainability of earnings and growth potential, according to Mark Jones, a partner at lower mid-market buyout shop
“If the financial engineering component of a transaction is muted in terms of leverage, private equity groups have to have growth to make these equity contributions work and to achieve some multiple arbitrage down the road when they sell the business,” Jones said.
As for their current portfolios, 57 percent of private equity respondents said they have written down portfolio company values in the last 12 months, with only 7 percent reporting mark-ups. The remainder held their portfolio values steady over the past year.
Indeed, asked when they plan to start to raise a new investment vehicle, 19 percent (almost one of every five) respondents said they simply do not plan to raise another fund. Nearly a third (29 percent) of private equity respondents said they expect to raise a new fund in 2010, while another 22 percent will enter the market in 2011, according to the survey.