When to play the Trump card in today's M&A market
- By Bob Kipps, Marc Marlin
- Mar 14, 2017
With government services and defense public company valuations near record highs, low interest rates, and a polarizing new administration agenda taking form 140 characters at a time, how should company owners think about the timing of selling their business or raising capital?
While there isn’t a universal answer for the government contractor community, there are relevant markers that owners, acquirers and investors alike should be mindful of and monitor. As they say, “timing is everything”, but how should one balance the trade-off between doing something sooner vs. later in the current environment.
Strong Capital Markets
While public pricing has slightly come-off post-election highs, sector valuations remain strong. There is correlation between public prices and M&A transaction valuation trends, as larger public buyers tend to set the M&A market tempo.
With a lower cost of capital relative to private companies or private equity, public strategics have shown the ability to push the envelope on valuation and still deliver acquisitions accretive to earnings. More so, strong public pricing facilitates longer-term strategic decision making, such as M&A.
It’s tough to foresee public company valuations continuing to climb with Wall Street estimates already reflecting low single digit forward earnings growth. Thus, the full value public valuations suggest a limited time to consider alternatives.
We saw a significant run-up in deal activity in 2012 and a significant drop-off in 2013 given the anticipated increase in capital gains rates. Similarly, an expectation going into election night given the flush of M&A activity in 2017 before Clinton tax hikes in 2018 was expected.
The Trump Administration has prioritized other topics to date. That said, with the general belief that there will be favorable tax reform in terms of income tax and capital gains (in 2017 or 2018), patience may benefit the prospective seller.
It’s been nearly 10 years since the Small Business Administration implemented new regulations around re-certification post-change of control. This change was a major shock to the deal-making system, and a foreshadow of a rocky enterprise value creation environment for many mid-market entrepreneurs.
The past eight years have been very pro-small business, with an increasing focus on agencies achieving set-aside goals and as a result increasing numbers of programs being moved into respective preference programs. The shrinking number of full and open new business opportunities has both challenged the emergence of mid-sized “saleable” companies and heightened the competitive dynamics for those scarce targets.
While the Trump Administrations’ stance has been generally pro-small business and entrepreneur, nuances of their policy around preference programs and M&A value creation are yet to be seen.
While a reversal of the 2007 recertification regulation would be a watershed catalyst for mid-market M&A, any improvement in opportunities for mid-sized companies and a halt of pulling larger programs into the small business preference programs would favorably impact business opportunities for the mid-tier and their exit alternatives going forward.
Big Government / Little Government
The federal employee hiring freeze out of the gate was the first tangible signal of a pro-outsourcing pendulum swing for the GovCon community. The 2007-2009 insourcing trend was devastating for many firms.
A more pro-private sector, commercial off the shelf business environment could release budget dollars for the contractor community, notwithstanding pressures for cost efficiencies and reduction of waste. In practice, this expectation should encourage company performance in the near term.
In addition to contract profile (prime, F&O award type), business performance is the primary driver of value. Even before election night, industry had experienced an up-tick in company performance, and expected of a sustainable return to organic growth.
Increased defense budgets, changes to Obamacare and continued IT modernization all consistent with jobs creation and a pro-business/outsourcing climate will likely take some time to fully work their way through what remains a challenged government procurement system.
We’d anticipate company financials to show recurring positive results by 2018, affording a proven business case for sellers and buyers alike.
That said, at some point barring major reform, entitlement programs and interest on the national debt could at some point start to crowd out the discretionary spending, which very well may create budget pressures like the industry experienced during the Obama Administration. The question is how soon.
In the end, timing is about trade-offs, and more specifically, whether the positive business performance (and continued broader economic growth) will compensate for an eventual pull-back in the market and valuation momentum.
An honest self-assessment should clarify the timing dilemma on a company-by-company (opportunity-by-opportunity) basis. Further, much of the above remains speculation--at some point, market optimism requires tangible actions/results with respect to policy, company performance, etc.
These aforementioned business markers also don’t take into account the impact -- economic, national security or otherwise – of the administrations’ controversial political agenda.
That said, we see an 18-36-month window for attractive and robust deal activity, with the longer term outlook less clear.
Bob Kipps is managing director of KippsDeSanto & Co.
Mark Marlin is a managing director with the investment banking firm KippsDeSanto.