It’s difficult to get dealmakers to agree on anything: company valuations, management fees, CEOs, steak or sushi, it’s all up for debate once battle lines are drawn in the board room. With that said, the most recent bi-annual M&A Outlook survey from Thomson Financial (publisher of Buyouts) and the Association for Corporate Growth (ACG), indicates that for the most part, dealmakers today are in agreement that this is one of the best environments in which to find, finance and finalize transactions.
The survey, released today, points to a bullishness among all the groups in the food chain. Ninety one percent of investment bankers called the M&A environment good or excellent, while greater than 80% of all the lenders, private equity pros, corporate executives and service providers characterized the environment in the same way. Only 1% of the 1,577 people surveyed felt it is a poor environment in which to get deals done.
Daniel Varroney, the newly installed head of ACG, depicted the M&A environment as “white hot,” adding that based on the survey, “It’s likely going to be that way for the foreseeable future.” He says, “Even though the Fed keeps raising interest rates, the cost of money remains relatively low… and that should continue to facilitate M&A growth for at least the next six months.”
Even as ardor prevails, there are some burdens that come with it. The continued encroachment of the hedge funds into the private equity space is one oft-cited impediment, and the majority of respondents believe that there is actually too much capital sloshing around the marketplace.
To be sure, the hedge funds have added some mystery to the market, with few pros certain about their long-term intentions in the asset class and their potential impact going forward. The most popular gripe, according to the survey, concerns purchase prices and whether the hedge funds are driving valuations higher, although almost 20% of the respondents take a contrarian stance and feel the hedge funds actually bring liquidity to the market. Then there’s the indifferent crowd, which represents almost a third of those surveyed that do not see the hedge fund presence as having any significance.
“The hedge fund involvement in private equity is talked much more than it is actually a real factor in terms of people paying more or influencing actual deal activity,” TA Associates Managing Director Brian Conway says. “More than anything, the biggest factor is the amount of capital in the marketplace-the overhang in the market and the record fundraising totals-that is a much bigger factor than just the hedge funds.”
Indeed, as more funds enter the marketplace and successive vehicles gain in size, the middle and large markets have become increasingly crowded. This escalation, though, has opened up the window of opportunity in the small market, at least according to the majority of private equity pros surveyed. Twenty-nine percent view the opportunity in the small market as the most attractive, while 16% give that designation to the mid market, and 13% anticipate early stage venture capital will be the most advantageous place to invest.
One interesting aside is that even with increased competition in the middle market, a smaller percentage of respondents said they used investment banks to source their deals than at the end of 2004. Six months ago, 54% of those surveyed primarily went through intermediaries, and this year only 44% will first look to buy through auctions. Conversely, the number of respondents that use the phone to approach targets directly has grown to 36% this year, versus 32% in 2004.
TA’s Conway, though, whose firm wrote the book on the cold call, notes that the two sourcing methods aren’t necessarily mutually exclusive. “We’re finding that even if we call [a company] ahead of time, there may be a banker that gets involved further down the line. It’s still better than waiting around passively until a blue book shows up, but it seems like every company is represented by a broker or banker these days.”
The survey also touched on what PE groups consider to be the difference maker in an auction that enables them to walk away with the prize. The answers were split pretty evenly between a lack of competition, specific industry expertise, a reputation within the marketplace and a pre-existing relationship. Surprisingly, at the bottom, only 10% of the respondents felt comfortable admitting they win deals by paying the highest price.
A closer truth though would be that all factors are considered before a bidder is even invited to an auction. With the competition what it is in the marketplace, a bad rep, no operational know-how, and, yes, an unwillingness to compete in the bidding, would likely be a nonstarter for most potential targets.
In terms of losing deals, the greatest stumbling block, not surprisingly is a difference of opinion on valuation, according to the survey. Lack of chemistry between the buyer and the target and economic uncertainty also plague potential deals, but overwhelmingly valuation disagreements remain the largest barrier.
How Good is Too Good?
There haven’t been many eras in private equity when there has been this much enthusiasm surrounding the marketplace. Record funds are being raised, new, high profile, deals are streaming in, and the mainstream media has embraced the asset class once again. (The most recent edition of Fortune featured Michael Douglas on the cover, reviving his role from Wall Street when he made popular Ivan Boesky’s sentiment that greed is good.)
However, for all the applause, it is not lost on the participants that returns are slowly sinking, which is ironically the end result of all the hoopla.
“There’s been a lot of fundraising and a lot of deals, but returns are coming down dramatically and that will continue,” Conway says, adding, perhaps tongue in cheek, “The contrarian in me says that we might be better off investing in venture, and five years from now we’ll be saying that it’s the golden age of VC.”