Volatility continues to grip world markets during 2016, whether from the standpoint of mom-and-pop investors or young entrepreneurs.
Symptoms indicating a risk-averse atmosphere include the sharp contraction of venture capital money both in Canada and south of the border during 2015, as well as a drop in mid-market merger and acquisition activity, which during the first five months of 2016 in North America shrank 10% year-over-year to US$56.9 billion, with deal volume dropping from 896 deals to 655.
These findings are outlined in a report, called Mid-Market M&A: Deal Environment for Sellers, prepared by Toronto’s Firmex and Mergermarket, which breaks down the current M&A atmosphere by segment and activity.
Mid-market firms are typically defined as having revenues anywhere between $50 million and $1 billion, with staff sizes between 100 and 499, so it’s really describing anything bigger than a start-up and smaller than IBM.
Mid-market companies make up less than 1% of the number of companies in Canada, according to BDC, but account for 16% of the jobs, generate 12% of GDP and account for 17% of the value of our exports.
In Canada, the story of mid-market enterprise mainly follows the narrative arc of the collapse of the manufacturing sector, which plummeted from 2,807 companies in 2001 to 1,381 in 2010, while the Canadian dollar rose and manufacturing was outsourced to Asia.
But just as the financial crisis of 2008 led to the widespread acceptance of start-up culture as we know it, so the market for M&A has created new opportunities and new ways of creating value.
“I always tell clients: There is no such thing as a general market approach when it comes to achieving the best valuation for your business. It is entirely sector- and geography-driven,” said Cormark Securities vice-chairman Jim Kofman. “Timing is also key – what makes sense today is different than it was six months ago. So it is really about understanding the individual industry and the food chain in that industry – who the buyers are and who needs what at any given time.”
For business owners who might be contemplating a sale, it’s good to know the current environment and which strategies are most likely to lead to a safe exit.
It has, for the past several years, been a seller’s market for the most part, in which sellers were free to dictate terms.
Although the pendulum has swung recently for many sectors in favour of buyers, there are still strong opportunities, depending on circumstances, for sellers.
Technology tops the breakdown for both value and volume of deals made year-to-date (June 15) in 2016.
Deal volume in the “Technology, Media and Telecommunications” sector, at US$13.8 billion and 148 deals, for YTD 2016 surpassed “Energy, Mining and Utilities”, at US$10.57 billion and 114 deals, by over $3 billion.
Looking at the pitfalls and opportunities in other sectors, whether retail, resources, financial services or the medical sector, only underscores the degree to which all companies now are basically technology companies, which is truer still for anything involving a supply chain or the food and beverage industry.
“Influenced by shifting demographics, the increasing impact of technology and social media, changes in food processing and distribution, and a heightened focus on food safety, the entire food and beverage landscape is being reshaped,” says D.A. Davidson managing director Jeff Cleveland. “This backdrop increases the importance of evaluating the impact that changes up and down the entire supply chain could have on a business.”
For sellers, challenges ranging from how to handle activist shareholders, running due diligence, or determining whether an offer from a strategic partner or a private equity buyer is best remain factors in optimizing deal value.
The advantages of a strategic partner are that they may be willing to pay a higher price and that they may not require debt to finance the purchase, while possibly also allowing the seller to remain with the company in some role in order to preserve corporate identity.
Private equity has its advantages, though, if an owner wants to prevent confidential information getting into a competitor’s hands, for example, not to mention that the buyer is more likely to create long-term equity incentives for the previous management team to maximize the business’ value.
“The first difference between selling to a strategic versus a private equity is the type of consideration on offer,” said Kofman. “PE is always going to be paying cash, while strategics may be paying in cash or shares. You have to decide whether shares are attractive and what the tax implications are. Secondly, if you’re selling to a PE, they are not interested in buying a company unless management also comes along and commits to the business. Whereas, if you’re selling to a strategic that’s already in the space, they may want management to come along, but it’s also possible that one of their motivations is synergies, which is a nice word for ‘cutting costs.'”
For buyers, a collapse in the Canadian resource sector has produced both market volatility and anger from activist shareholders, who attend meetings driven by a variety of motives, but that downfall has also been unpredictable in doling out winner status for other companies and sectors.
“Ironically, the sector that was probably most out of favor only six months ago is probably the hottest sector in Canada right now, which is gold and silver companies,” said Kofman. “The average gold company has seen its stock triple since mid-January. They were way down, but the speed at which they’ve recovered has been nothing short of incredible, and no one saw it coming.”
Wynnchurch Capital managing director Michael Teplitsky identifies what he sees as growth sectors in the near future.
“There are three Industrial sectors seeing favorable conditions right now: Building Products, driven by the recovery in U.S. housing starts and construction spending; Aerospace, driven by the increase in air travel and the need to replace aging Boeing and Airbus fleets; and Automotive, driven by the booming demand for new cars by the recovering US consumer,” he says, adding that Wynnchurch has made several recent investments in companies ranging from manufacturing to air cargo services to water pipe infrastructure makers.
According to GE Capital, global GDP growth and low oil prices are set to drive an increase in passenger air traffic, making the aerospace industry a good bet for future growth.
Your mileage may vary. With surprise events like the Brexit throwing a spanner into cross-border M&A activity, among other things, a stiff drink may be as helpful as a crystal ball.