As we have mentioned in previous blogs and in Orion Capital Group’s Northstar Newsletters (www.orioncg.com/mergerslibrary.php), market timing is one of the more crucial factors in determining the price and terms you get for your business. During times of high deal flow, you are likely to get better terms and vice versa. So the question is: what are the factors in the market and economy that affect deal flow? We have detailed each of the major factors and how they effect M&A and what we see happening.
Credit Availability
We all know that availability of credit is low now. The Fed has cut interest rates to an unprecedented low and injected capital into where they think it will have the biggest effects on credit liquidity. The banks and automakers (which have a big hand in the credit market) are going to use their initial help from the government to suture up their critical wounds before they even try to get aggressive again in making some profits. While this will take time, we have seen that in the past few weeks, we have seen banks starting to get more active in trying to get new mortgages and SBA loans. So the process of credit recovery may be in sight.
Target Company Cashflows
Although companies do acquisitions for intellectual property or future blockbusters, the bulk of deal flow is done based on cashflow. We believe M&A will pick up again when most buyers see positive signs of cashflow beginning to return. This will most likely depend on consumer spending and inflation trends. We have yet to see any signs of recovery on that front.
Investor Risk Appetite
In recent years, private equity groups and hedge funds fueled large growth in M&A because of large capital availability from high investor risk appetite and good returns from these types of funds. However, limited partners in these funds require a return premium for keeping their money in illiquid funds. Depending on the types of returns these funds ultimately yield their investors will determine how long it will take for private equity groups, hedge funds, and venture capital firms to successfully raise new funds in the future. Going forward, investors may be leery about locking up their capital and not being able to react to market conditions.
Buyer Company Balance Sheets
With most corporate profits being affected the past couple of quarters and poor outlooks, many company balance sheets will not be where investors and top management want them to be at the end of this recession. That may cause most companies to reduce acquisitions until they improve their balance sheets again.
Capital Gains Tax
If the capital gains tax increases in upcoming years, it will reduce both sellers’ interest in selling and buyers’ interest in buying. Whether the incoming administration and legislators will increase the capital gains tax is anyones’ guess. However, changes will almost definitely have an effect on the future of M&A.
We don’t intend to provide a grim outlook on M&A, but the fact is that overall M&A is down and probably will be down for at least another year or two. However, there are certain areas that haven’t been affected as much. Intellectual property (including patents, brand names, and trade secrets) is doing relatively well because companies are trying to buy them from cash-strapped companies at a steal in anticipation of future profits. Smaller deal sizes (middle-market) under $200 million, has remained relatively intact because there is less of a need for leverage, investors are looking for bargains and some buyers feel that they can incorporate and grow their newly acquired companies during the slow time.
If you have further questions or wish to learn more about Orion Capital Group’s outlook, please go to www.orioncg.com to learn how to contact us.
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