Finally, a rebound in the M&A market?

After four consecutive years of decline in the number of announced domestic mergers & acquisitions ("M&A") transactions, we believe the M&A market is finally showing signs of a strong rebound in 2004. Despite a national decrease in domestic M&A activity (approximately 50% since 2000), 2002 and 2003 were record years for Barrington Associates. However, we have recently seen a further significant increase in our deal pipeline, due to a number of factors discussed below.

Recent upturn in private company valuations--Driven by a number of economic factors, acquisition prices in most industries have experienced recent improvement. The most important factors include:

Rebound of the public equity markets--Private market valuations trends often correlate to trends in the public equity markets. Due to recent gains in the public equity markets, strategic and financial buyers are loosening their wallets and often paying premium prices for companies in industries that are performing well in the public markets.

Loosening in the lending market--Buyers have enjoyed a recent improvement in obtainable levels of acquisition financing, with Barrington Associates seeing a significant increase in Total Debt / EBITDA acquisition multiples. The market has been driven by a handful of non-bank lenders specializing in acquisition financing (often focused solely on sponsored equity transactions), who have emerged to fill a void over recent years as the traditional bank lenders have tightened their credit requirements. As a result of this rebound in the acquisition financing market, buyers are able to lever their transactions with a higher amount of debt financing which typically carries a significantly lower cost of capital than that required by equity investors.

Buyers' lower return expectations--Due to the lower return expectations across asset classes, investors are beginning to accept lower returns from acquisitions. As a result, private equity buyers in particular are able to pay higher prices and meet these lower return expectations.

Private equity buyers continuing to drive the M&A market--We estimate that there is currently over $125 billion of uninvested capital in the hands of U.S. private equity groups. The majority of this uninvested capital was raised prior to 2001, and as a result, is under increasing pressure to find a home. Private equity groups (i) only have a limited number of years to invest this capital and (ii) do not generate returns on uninvested capital. Thus, private equity groups are racing to invest this capital in a limited number of quality companies on the market.

Strategic buyers again looking for growth through acquisition--After several years of performing triage on existing operations, we are beginning to see strategic buyers in most industries again become active bidders in M&A transactions. Many of these strategic buyers have significantly improved their operational infrastructures and are in a much better position to successfully integrate acquisitions than they were prior to their internal restructuring. Strategic buyers today appear to be focused only on highly synergistic acquisitions, and are paying premium prices for companies which provide this high level of strategic benefit.

Entrepreneurs beginning to look for liquidity--Entrepreneurs, the lifeblood of the U.S. economy, buckled down and operated their businesses over the past three years while paying little attention to liquidity alternatives. As a result of the sweat poured into entrepreneur-owned businesses over the recent years, many of these businesses are much more attractive acquisition candidates than they were three years ago. With the recent improvement in valuations, the record amounts of capital in the hands of financial buyers and the re-emergence of strategic buyers, we see the near-term as an excellent time for entrepreneurs to explore partial of full liquidity through a well-organized recapitalization or sale process.

Increase in competition driving high closure rates--As a result of (i) the record amounts of uninvested capital in the hands of financial buyers and (ii) the return of strategic buyers, we are seeing a record level of competition for attractive properties. This strong competition is not only driving increased valuation in well-organized sale processes, but is also raising deal closure rates. We have recently completed a number of transactions where the eventual buyer was not the original buyer. A well-organized, competitive process will ensure that (i) buyers are held to tight milestones well-defined in a letter of intent and (ii) backup buyers are kept warm so that a process can be quickly re-ignited with a new buyer in the event that the initial buyer fails to close during their exclusivity period.

Jim Freedman is the Founder and a Managing Director of, and Adam Roseman is an Associate at, Barrington Associates. For additional insight on the current M&A or financing markets, to discuss any of the information contained within this article or to talk about a situation regarding a specific company, please contact Adam Roseman at [phone] or [e-mail].