Middle Market M&A Review – Mid Year 2017
Overall deal flow in the US middle-market slowed in 2016. We expect 2017 deal flow to be in line with 2016 levels as various trends remain steady in the market. We expect valuations to remain high, as middle-market private equity firms aggressively compete for quality assets. Roll-up strategies and renewed focus on maximizing EBITDA of existing portfolio companies continue to be a trend in the middle-market. While large assets are sought after and valuations are high, we anticipate buyers further pushing down into the lower middle-market to find relative value.
Middle market M&A activity was expected to increase in velocity following the 2016 election and subsequent inauguration of President Trump. However, the pace of middle market mergers and acquisitions remained sluggish in the first six months of 2017, recording the eighth consecutive quarterly decline in middle market deal volume in Q2 2017. A stable economy, continued low interest rates, and a more business friendly federal government were all expected to lead to more robust M&A activity and a strong deal making environment in 2017. However, continued political uncertainty buoyed by ongoing bipartisan antics in Washington has extended political uncertainty and delayed the implementation of a more business friendly agenda.
Two high profile examples of delayed initiatives in Washington include income tax and health care reform. If passed, income tax reform could potentially roll-back recent changes that increased effective long-term capital gains tax rates, such as the tax rate increase to 20% from 15% on higher incomes and the supplementary 3.8% Medicare tax on net investment income that took effect in 2013. Reduction in the long-term capital gains tax rates is expected to incentivize owners of middle market businesses to seek a sale transaction to take advantage of lower effective tax rates on these transactions.
The number of deals recorded in the first half of 2017 was over 30% lower than the number of deals closed in the same period of 2016. The average middle market deal size of $36 million in in the first half of 2017 was down from the average $39 million deal size closed in the first half of 2016. The decline in deal volume and value can be partially explained by business owners waiting for the Trump Administration to deliver on tax and business regulatory reform before committing to an M&A process. While most deal makers expect major changes in business regulation and taxation, these changes are taking longer than anticipated.
Private equity firms have more than $800 billion in dry powder (unused investable capital) and strategic buyers have abundant cash balances for acquisitions. These dollars are all chasing a finite number of quality deals, which drive valuations to remain near all-time highs. 2016 deal multiples remained at historic levels. We anticipate these valuation levels to be sustained as competition for quality assets remains intense. For 2017, we anticipate multiples to remain high as PE firms aggressively compete for a limited supply of quality assets. Properly prepared, performing companies in attractive market segments are always welcome in the M&A market and will continue to command premium valuations.
Author and Contact
Partner
jtoomay@palominocap.com
214-269-3414
www.palominocap.com
Mr. John Toomay is a Partner with Palomino Capital. He has over 18 years of investment banking and corporate finance experience and has led complex engagements for clients in a variety of industries including manufacturing, healthcare, business services and logistics. Since joining Palomino in 2005, he has led or played a key role in 33 transactions representing $600 million in transaction value.
Palomino Capital is a boutique investment banking and financial advisory firm specializing in middle-market transactions for privately held businesses.
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