While advisors prepare for an M&A rebound in the back half of this year and into 2024, they can expect longer timelines and tactical twists in sales processes.
According to Alec Dafferner, partner and head of US advisory for GP Bullhound, a lot of private equity-backed companies started revisiting transaction processes toward the end of 1Q23 and into 2Q23 that had been shelved in the back-half of 2022 as interest rates climbed and the deal environment soured.
PE’s dry powder is one of the biggest drivers to the current resurgence, but diligence required to obtain new debt has dramatically increased, Dafferner said. That’s challenging for larger deals in which leverage becomes more important, given where interest rates are, he explained.
Stephen Rossi, Managing Director and Head of Investment Banking for Palm Tree Finance, an M&A advisory for private equity firms, said financing due diligence that once took three to four weeks to process is now more like 10 to 12. The biggest areas of concern for investors, Rossi said, are around large cap-ex projects and those platforms.
‘Tactical deal making’
One method that has proved successful involves not running auction-style sale processes, but rather employing “tactical deal making,” said Dafferner. This involves identifying up to the 10 most likely parties and engaging with them one-on-one to “lay out the synergy case and complementarity of the businesses", he added.
“It's not a rush,” Dafferner said. He explained if there's no need to transact immediately, and flexibility exists to have some conversations over an extended period, firms can optimize timing based on current conditions where swings in the market can be quick in sub sectors.
Allowing for about three to six months for these types of talks has worked well, he noted. Even if no transaction is reached, it warms the market up for a more formal process later that can help create “competitive tension,” which can be helpful to a successful process, he said.
The advisor mentioned a recent deal where it advised Goat on its acquisition by WPP [LSE:WPP], a UK-based communications and public relations firm. Goat is a UK-based global data-driven influencer marketing agency backed by PE firm Inflexion. Dafferner said the deal wasn’t broadly marketed and plans were to go to market later this year, but the firms had some one-offs. WPP was keen on acquiring a business in the influencer marketing space, and the company had a US presence as well, Dafferner explained. WPP acquired it, preventing it from slipping to a competitor later, while Goat received a valuation similar to what it was in 2021 and the first half of 2022, Dafferner said.
Boxing out divestitures
PE firms that can segregate and break-up non-core assets within portfolio companies are doing just that, Rossi said. A chunk of Palm Tree’s current consulting business relates to that practice, which could lead to an increase in corporate divestitures later this year.
“We have clients that have had billions of dollars of incremental debt service cost across their portfolios in a year,” Rossi said. These situations can’t be refinanced and the only way out, he said, is to either bring in equity capital to pay the loan down or find non-core assets to carve out and divest at a higher value than the associated debt, applicable to that division. That’s used to pay down even more debt, he explained.
They find the non-core assets and “put a box around it from a reporting perspective,” he said. When potential buyers appear later, all the data books and everything are ready to go, Rossi said.
Valuation gaps closing
Seller valuation expectations have started to normalize and come down, Dafferner said, and enterprise, software-as-a-service (SaaS) businesses have seen their valuations come back 20% to 25% after having dropped 50% to 60%.
There is still about a “turn to two turns gap” between buyer and seller expectations on the purchase price multiple for many companies, Rossi explained. Sellers usually have six- to nine-month lags to get sensitized to the new purchase price multiple paradigms. “That’s what we’re sitting in right now,” Rossi said.
Dafferner also noted some companies could run out of cash, leading to distressed sales or mergers that are all-stock deals at lower valuations. Those companies that can’t reach profitability and then run out of runway in terms of cash will struggle, Dafferner said. Those firms need to eliminate their reliance on the market to fund their runway going forward, he added.
“If you talk to any board of directors right now, the advice they're giving all of their portfolio companies is get profitable as quickly as you can,” Dafferner said.
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