Market watch: Buyers have more choices in M&A market
- By Jerry Grossman
- Aug 22, 2002
Notwithstanding the growth in government spending for defense, intelligence and homeland security purposes ? effectively an expansion of the government information technology market ? the economic logic supporting continued consolidation within the industry is still valid. That's because the growth rates required to support current valuations are not achievable for most companies from organic growth alone.
In addition, expanding a company's resource and customer base is essential to competing in many market segments. Contract bundling continues in many areas, while increased targets for small and disadvantaged business set-asides have been established in other market sectors.
Many midtier companies ? sales of $25 million to $500 million ? believe they're in no man's land between the large primes and the "preferred" small businesses.
Pricing, transaction volume, financing cost and execution times within the merger and acquisition market are best understood through a stratification of buyers and sellers. For buyers, the most significant issue is public vs. privately owned status. Recent initial public offerings have expanded the population of publicly traded government IT companies. Most of these are committed to using acquisitions as a part of their growth strategy.
These companies have strong balance sheets and modest levels of debt, while interest rates for additional debt capital are at their lowest rates in 50 years. Twelve acquisitive public government IT companies, with aggregate revenue of about $9 billion, have incremental senior debt capacity of more than $2.2 billion. Without raising additional equity or over-leveraging their capital structures, these companies could collectively buy $3 billion of government services revenue.
Assuming acquisitions at multiples of 65 percent to 70 percent of revenue, or eight to nine times earnings before interest, taxes, depreciation and amortization (EBITDA), these deals would be substantially accretive to the buyers' earnings per share. These pricing multiples are at significant discounts to the trading multiples of the public companies, providing them with strong buying power in transactions where buyer stock is the form of consideration.
Generally, privately held firms have much less buying capacity because of their smaller equity base, smaller average size and inability to use their non-traded stock in a deal. Accordingly, in some instances these buyers are unable to mobilize enough capital to match the prices paid by public buyers.
Industry buyers, both public and private, frequently have limited resources dedicated to evaluating, processing, closing and integrating acquired companies. This factor is slowing the pace of consolidation relative to the substantial capital available to finance the deals.
For sellers, activity is strong as scores of companies have decided the market is ripe for a successful sale. The strong flow of product into the market is exceeding the capacity of many active buyers to properly digest and assess all the opportunities in front of them.
Thoughtful sellers are examining their liquidity alternatives carefully. In many instances, certain strategic or operational issues and changes are necessary before the seller's business can be presented well to the market. Optimal preparation, strategy and timing can expand value potential by 30 percent to 40 percent or more.
The sell side has more momentum than the buy side. The typical public buyer has $300 million to $500 million in revenue and is acquiring businesses with $50 million to $100 million in sales. Integrating these large acquisitions will require considerable time and effort, further impeding the pace of additional deals.
What seemed to be a clear sellers market in the spring is now an environment where the best buyers have more alternatives than ever.Jerry Grossman is managing director at Houlihan Lokey Howard & Zukin in McLean, Va.
Jerry Grossman is managing director at Houlihan Lokey Howard and Zukin.