Q1 M&A: Pendulum swings toward sellers amid frothy valuations

First-quarter sponsor-led deal flow illustrated that differentiation is more important than ever, as the pool of buyers chasing quality assets continues to expand and valuations remain at record levels.

“In this expensive market, being able to go up in size gives you an advantage,” Prakash Melwani, chief investment officer of the private equity group at Blackstone Group, said in an interview with Buyouts. “We are one of the handful of firms that can backstop a $1-billion-plus equity check. This is in contrast to 2007 and 2008, when firms were doing club deals to be able to go up in size.”

Blackstone was the most active sponsor through March 14 with 14 completed transactions, followed by HIG Capital and Carlyle Group, which each closed nine deals.

Blackstone also was behind four of the largest 10 U.S. sponsor deals that closed in Q1, according to Thomson Reuters data. Those include the largest, when Blackstone in February agreed to fork out $4.8 billion for Aon’s technology-enabled benefits and HR unit.  

While the consumer, technology and healthcare industries produced 78, 61 and 42 completed transactions through March 17, respectively, Blackstone took a more contrarian approach.

Three of its completed billion-dollar-plus deals were in energy and power — an industry that produced only 18 completed deals over the period and was largely out of favor when Blackstone began deploying capital in the space.

In fact, about half of Blackstone’s total investments during 2016 were in the oil-and-gas sector, as it took advantage of the dislocation in the energy markets, Melwani said. Blackstone doesn’t have such a dominant sector theme this year, he said, but believes its structural advantages from a size standpoint will enable the firm to remain opportunistic across industries.

“The firms that will win have deep industry expertise, the ability to improve businesses post-closing or some other form of differentiation, such as the ability to underwrite large deals themselves,” he said.

Blackstone, for its part, has a lot of fresh capital, having raised three PE pools totaling about $28 billion during 2015 and 2016.

After Blackstone, the top sponsor deals for U.S. companies included Vista Equity Partners’ $4.8 billion purchase of financial technology provider DH Corp and American Securities’ $2.5 billion deal for medical-helicopter company Air Methods.

More competition, higher valuations  

In large part, it’s the supply-and-demand imbalance that has set the stage for expensive price tags.  

“The buyer universe has grown materially over the last few years, broadening beyond traditional LPs, as an increasing number of family offices set up shop and as European funds continue to plant offices in the U.S.,” said Jeff Greenip, who as a managing director at Jefferies serves as the global head of financial sponsors investment banking.

According to a February report by Bain & Co, purchase-price multiples in U.S. buyout deals climbed to 10.9x EBITDA on average in third-quarter 2016 from 10.3x and 9.7x in 2015 and 2014, respectively. Dry powder also reached a record $1.5 trillion across all PE funds on a global basis, according to Bain.

At the same time, today’s sponsors aren’t showing the lack of discipline more prevalent in 2007 and 2008, when interest rates were higher and leverage multiples climbed to more than 9x, compared with about 6 to 6.5 times currently, Blackstone’s Melwani said. Instead, investors are being prudent in how much they’re borrowing, he said: “Deals are expensive, but not being financed in a reckless way.”

“We’re at a point in the market where leverage multiples have moved up modestly,” added John Martin, managing partner and co-CEO of middle-market lender Antares Capital. “To some level, consistent with [M&A] valuation multiples, they continue to be at or near historic highs.”

Contributing to that, Martin explained, is increasing fund flow into the private debt space, particularly from institutional investors in recent months.

“If you look at the early part of 2016, we saw a lot of unitranche financing,” Martin said. “As the year progressed there was significant liquidity and unitranche financing took a little bit of a backseat as the financing of choice. As liquidity continued to build in the private credit space and institutional investors flocked to the private credit space, we saw more broader-base institutional execution.”  

Interestingly, an abundance of capital to deploy didn’t lead to more deals. Pending and closed deals dipped to 454 through March 17 from 506 in the year-earlier period.

Perhaps it’s high price multiples, which some investors believe are unjustifiable, that offset increasing supply.

“There’s a two-turn multiple premium that’s been put on these companies,” Tenex Capital Management managing director Scott Galletti said on a panel discussion at BuyoutsPartnerConnect East conference in Boston on March 22. “There’s been no real economic impact that is driving that.”

“You have to be very cautious,” Galletti said. “You have to have an edge. You can’t just go out and try to deploy capital.”

Competitive edge

One way sponsors are seeking an edge is by avoiding participation in formal auctions.

“This larger buyer universe has caused sponsors to become more aggressive,” Jefferies’ Greenip said. “Firms are increasingly looking to preempt the auction process, and sponsors are showing an ability to sign and close deals quickly, to have aggressive financing in place and, in some cases, an ability to backstop an entire acquisition with their fund.”

Not surprisingly, add-on deals also remain routine for PE firms as they look to produce higher results.

Two-thirds, or 253, of the 379 closed deals were add-ons as opposed to platform investments through March 17, according to Thomson Reuters data.

“Synergistic add-on acquisitions are something we pursue in as many companies as we can,” Blackstone’s Melwani said. “It’s a terrific way to buy down the multiple. Frankly, our highest returns over the years have been from platforms.”         

In the low-to-mid-market, “going shopping” for add-ons at trade shows is commonplace, said Headwaters managing director Stephen Lewis on a panel at PartnerConnect East.

“If you’re not thinking about [add-ons] from the first moment when you make an acquisition, you’re late,” Lewis said.

Looking Ahead

Despite an arguably sluggish start to the year, there remain pockets of opportunity in an environment that experts expect to stay highly competitive. 

Melwani said he expects current conditions — high prices and relatively sensible financing — to continue for the foreseeable future. Under the Donald Trump administration, Melwani said, the notion that there will be more fiscal stimulus seems to have taken recession risk off the table, while the perceived move toward deregulation is also viewed positively by investors.  

In the consumer segment, several factors continue to fuel activity, explained Jim Walsh, who as a managing director at Jefferies serves as the global head of leveraged finance and chairman of consumer and retail investment banking.

“Among other things, a slower IPO market has contributed to increased M&A activity among sponsors on the consumer front,” Walsh said. 

“Traditional retail brands are trying to figure out what they can do to stay relevant, and they are under attack from so many e-commerce disrupters,” Walsh said. “At the same time, e-commerce is creating a vast number of new technology-driven companies across all facets of retail, and that is creating a whole new opportunity for us.”

Antares’s Martin said his firm continues to see significant lending opportunities in sectors including software and healthcare, the latter of which his firm reentered in August 2015 following its sale from GE Capital.

Prakash Melwani, chief investment officer of the PE group at Blackstone. Photo courtesy of the firm.


Additional Data

10 largest announced and pending deals by U.S. Sponsors, Q1 2017

2006-2017 pending and closed deal number and disclosed deal volume


Q1 2017 deals by industry Q1 2017 deals by type

The most active LBO dealmakers of Q1 2017

Top 10 U.S. sponsor deals closed in Q1 2017

U.S.-based disclosed deal value for closed deals by quarter, in billions