Simply put, the story on multiples is one of good news and bad news. The good news is, after years of Ebenezer Scrooge impersonations by the lending community, debt multiples are rising, a trend that has had a direct impact on deal activity.
Specifically, debt multiples inched up from an average of 4x EBITDA in July 2002 to 4.2x EBITDA in the fourth quarter of 2003, according to Standard and Poor’s Leveraged Commentary & Data. That makes it a full straight year that debt multiples have been climbing.
However, the bad news is, purchase price multiples are rising as well-in some cases, to double-digit levels. For deals worth $500 million or more, purchase price multiples have jumped from 6.7x EBITDA to 6.91x EBITDA, while the jump in deals below the $250 million threshold is more significant, to 6.4x from 5.8x the previous year. While those averages are a far cry from the 8x range we saw five years ago, LBO pros stress that for the best companies, it does feel like 1998.
“We are all paying too much for companies,” says Douglas Newhouse, a managing partner with Sterling Investment Partners. “We are almost always seeing our multiples in the 8x arena.”
To be sure, the high amount of uninvested capital in the private equity market is partly to blame. With buyout firms feeling pressure to put their money to work and to make acquisitions before the strategic buyers return, most recent auctions have been fiercely competitive, thus driving up the price.
“Now everyone is aggressive because there is all this buyout money that has to be put to work,” said Bruce Rauner, a senior principal with GTCR Golder Rauner. “We are back to the wild days of auctions being bid up, money chasing deals and firms paying high prices. Lenders have also become very aggressive.”
Indeed, according to Newhouse and others, the ease in lending terms is an equally important factor. “When times are bad, no one is lending. When it is better they all lend and try to top each other trying to get the money out the door. They all act in the same fashion, they copy each other,” he says. “Ten months ago it didn’t matter who you went to for a loan, most shut their doors on you, [but] now they welcome anyone with open arms.”
Banks Are Good People Too
Of course, the ease in lending terms isn’t all bad. There’s no question that it helped drive volume to record levels in 2003. Moreover, the rising multiples have helped keep the average equity contribution stable or, in some cases, moved it lower. “Prices are higher, but our equity level has been less because lending institutions are giving more,” Newhouse says.
At least one lender agreed that banks would continue to shoulder more of the burden in transactions. “We are definitely going to see purchase prices continue to rise, but with the banks carrying more of the weight it shouldn’t negatively affect the market,” the lender says.
Where the buyers and lenders are most aggressive is in the 0-$250 million range, where purchase multiples have jumped to 6.4 EBITDA, which isn’t much lower than their peak of 7x EBITDA in 1998.
But that rise certainly isn’t taking small market pros by surprise. “For high quality companies the multiples are increasing significantly, but that has a lot to do with debt financing becoming more aggressive. Debt multiples were in the 2.5x EBITDA to 3.5x EBITDA range, but now they are at about 4x EBITDA,” says John McCormack, a co-founder with Sentinel Capital Partners. “As the debt multiple creeps up so does the purchase price multiple, but it is still a buyer’s market.”
But at least one pro, Barron Fletcher, a managing with Saunders Karp & Megrue, didn’t expect it all to happen so quickly. “I would say 6.5x EBITDA is probably accurate, but we have found deals closer to 5.5x or 6x. Either way the multiple moved pretty quickly,” he says. “In a six-month period multiples have gone up a half and a full multiple. That is fast.”
Fletcher adds that if lenders continue to be aggressive multiples will increase even further.
Scarcity Of Good Deals
Other than the lender driving prices up, the lack of good deals also plays a part in all this. “In any size deal, there is certainly a premium for good deals. You have to wonder if this is an overreaction to lack of supply,” said Jeff Rosenkranz, a managing director with Piper Jaffray & Co.
There are certainly plenty of examples of high multiples. Code Hennessy & Simmons paid 8.5x EBITDA to acquire The Hillman Cos. from Allied Capital Corp. for approximately $510 million, which includes repayment of outstanding debt and the value of the company’s outstanding trust preferred shares. Additionally, Warburg Pincus is reportedly paying 8.5x to acquire GTCR Golder Rauner filtration platform Polypore Inc. for $1.15 billion. Polypore, based in Charlotte, N.C., is a global manufacturer of filtration products used in the power storage, healthcare, electronics and specialty technology industries.
Those deals are certainly no anomaly, and buyout pros fear that once strategic buyers return, those multiples could go even higher. The question, of course, is when the game gets too rich for a firm’s blood.