As the global economy traces a delicate trajectory back on to a path to growth, dealmakers are reporting a surge in interest in mergers and acquisitions. The mid-market is typically a fertile source of deals, and the beginning of this M&A cycle is no different, with a resurgence in acquisitions already apparent.
In the UK last year, eight FTSE 250 stocks fell to buyers, a volume typical of the early stages of an M&A cycle. On average, about 17 UK mid-cap stocks are taken over in the middle to late stages of an M&A cycle, according to analysts at Citi, the financial services group, suggesting more activity to come.
According to Dealogic, the data provider, mid-market M&A as a percentage of total global activity has reached 24 per cent, a level not seen since 2004.
“We are seeing significant M&A activity in the mid-market area. It is a fertile ground for deals,” says Cyrus Kapadia, deputy head of UK investment banking at Lazard. “Many corporates have been through a period of difficult cost-cutting and have been careful about their use of cash, but are now in a better position from an M&A financing perspective.”
Global mid-market M&A, for deals of $100m-$1bn, reached $675bn in 2010, a level of dealmaking not surpassed since 2007 and up from $469bn in 2009, according to Dealogic. Nearly half of that total has been reached already this year, with $310.6bn of mid-market deals completed by May 31. For deals of between $250m and $2bn, global volumes reached $789bn last year, according to Mergermarket, the news and data company.
Chief executives are increasingly looking at what their competitors are doing and whether to be proactive on a particular situation,” adds Mr Kapadia. “They want to make sure that any deal will be perceived as a success. A transaction in the mid-market area may well be more appealing than a multibillion-dollar transformational deal that would naturally be higher risk in the current environment.”
A strong recovery in capital markets has supported the revival in dealmaking. As investors search for yield in an environment of low interest rates, bond markets have boomed and opened to a greater range of riskier, smaller borrowers.
“Both debt and equity are available for deals in the mid-market, although access to capital for smaller companies is generally more volatile,” says Tom Willett, chairman of corporate finance for Europe, the Middle East and Africa at Royal Bank of Scotland. He adds that macroeconomic uncertainty continues to complicate dealmaking even in the mid-market.
The oil and gas, property and healthcare sectors have been the busiest for mid-market M&A so far this year, with an 89 per cent increase in activity in healthcare on the same period last year, according to Dealogic. The US has seen the most activity, followed by China and the UK.
However, shareholders are not always supportive of M&A, and some bankers highlight the uncertainty some boards have about getting the necessary support for dealmaking.
“While the mid-market is generally in reasonable financial health, shareholders in the UK tend to look to companies to manage efficient balance sheets and return any excess cash to shareholders,” says Mr Willett. “US investors seem to be better disposed towards M&A as an acceptable use of surplus cash.”
The depth of demand for high-yield bonds has helped finance a resurgence in leveraged buy-outs by companies backed by private equity, which has boosted M&A volumes. In the first quarter of 2011, junk bond issuance has continued apace, with global issuance up 28 per cent at $103bn, a record start to the year.
Bankers and investors say a large source of deal activity has been companies backed by private equity. In the first quarter of 2011, private equity buy-outs were up 71 per cent from the same period last year, accounting for a higher proportion of M&A activity, reports Mergermarket.
“We have done £170m [$278m] in the year to date in six new deals, which is in line with our strategy of investing through the cycle, and what we would do in an average year,” says Darryl Eales, chief executive of LDC, the UK mid-market private equity house that is part of Lloyds Banking Group. “Our plan is to do £300m-£350m in 2011. I’m confident we will do that because the pipeline is strong. In a typical year, we would do £250m- to £300m-worth of deals.”
But competition for assets is intensifying. “We have been trying to originate more deals urselves as a way of dealing with this more competitive environment, and our regional network is a great strength here,” adds Mr Eales. “Trade buyers are back in the market very aggressively.”
However, lending has not returned to pre-crisis levels, and dealmakers say activity has been limited by restrictions on the provision of finance for M&A with smaller companies.
“For businesses with an ebitda [earnings before interest, tax, depreciation and amortisation] of €25m [$36m] or more, you can attract a more international group of lenders, but if earnings are below that, then companies are restricted to a narrower set of local lenders. That can make deals more difficult to finance on attractive terms,” says Neil MacDougall, managing partner at Silverfleet Capital, the private equity company.
Not all shareholders are keen to sell out of their companies yet, presenting opportunities for new investors to provide capital.
“We have recently seen opportunities to invest alongside existing owners who don’t want to sell their companies but want capital to invest,” says Stephen Welton, chief executive of the Business Growth Fund, which has £2.5bn to invest in UK companies. The fund was launched by banks last month in response to government pressure to lend more to small and medium-sized enterprises.
Mr MacDougall says Silverfleet is the busiest it has been for several years. “France and the UK continue to be active for us, and Germany has picked up again in the past few months,” he says.
Opportunities could be more attractive in continental Europe. “There is on average a definite gap between the growth prospects of deals in the UK and, say, Germany,” says Mr MacDougall. “Would you find it easier to believe the same forecasts from a UK company or a similar German company given the difference in the strength of their domestic economies? You have to take into account the impact of reductions in government expenditure and the levels of personal spending, which in Germany are much less of an issue.”
The rise in dealmaking is expected to continue through 2011. KPMG, the professional services firm, predicts UK companies will have comparatively larger war chests this year, but bankers note nervousness about the economic outlook as a barrier to deals. Earlier this year, KPMG noted a fall in forward price/earnings ratios, which some see as an indicator of confidence to do deals.
As the recovery in capital markets strengthens and confidence about the economic recovery improves among corporate leaders, the shift could be towards bigger deals.
In April, the global M&A deal count was 3.8 per cent below the same period last year, but announced dollar volume grew 21.4 per cent, driven by an increase of more than 40 per cent for the number of deals valued above $500m, according to RW Baird, the mid-market investment bank.
In the global middle market, the first four months of the year saw a 7.2 per cent decrease in the deal total and 24.1 per cent growth in dollar volume. In April, the monthly total of transactions dropped 22.6 per cent to 2,095, the lowest since August 2009. However, reported dollar volume increased 38.5 per cent to $195.8bn. In the mid-market, the transaction total was down 21.5 per cent, whereas dollar value climbed 21.6 per cent.