M&A professionals expect the dealmaking market to remain healthy in 2019.
That’s one of the conclusions from a panel of executives MiBiz assembled to talk about West Michigan’s mergers and acquisitions sector.
Roundtable participants expect to see greater due diligence on deals this year as economic growth eases. They’re also beginning to see more deals involving distressed companies and signs of pressure on high valuations.
Participating in the executive roundtable with this reporter and MiBiz Editor Joe Boomgaard were:
- Mike Brown, partner and managing director at Charter Capital Partners, a Grand Rapids-based investment banking firm
- Jeff Helminski, managing partner at Auxo Investment Partners, a Grand Rapids-based private equity firm
- John Pollock, managing partner at Ada-based private equity firm LV2 Equity Partners LLC
- Peter Roth, partner at Grand Rapids-based law firm Varnum LLP, which sponsored the roundtable
- Randy Rua, managing partner at NuVescor Group LLC in Grand Rapids and president of Rua Associates LLC in Zeeland
- Eric Seifert, founder of Muskegon-based advisory firm Left Coast Capital Resources LLC
- Jimmy TenBrink, director of business development at Grand Rapids-based Waseyabek Development Co. LLC, the non-gaming arm of the Nottawaseppi Huron Band of the Potawatomi
- Don VanDine, regional vice president at Wells Fargo Bank in Grand Rapids
Here are some highlights from the conversation.
How has the M&A landscape held up in 2018 and what do you see going on in 2019?
Rua: 018 has been a very good year for us, probably one of our best years. I think deal flow for (2019) is going to be stronger because we usually take in about one to two clients a month, and in the last two months, we had 10 new clients engage with us. We have quite a few (deals) in the pipeline, so we’re seeing a lot of sellers. Now, we’ll see what the buyer side is going to look like next year, but the seller side is going to look strong.
Helminski: It's been really, really busy for us. We’re on track to see about 600 qualified deals (in 2018), if the last couple of weeks hold up about right. For the size of our team, that’s a lot. Our goal is 1,000 a year. We’re not hitting that, but for what we’ve got dedicated to it, we feel good about that outcome. We’re closing another deal here before the end of the year, so that’ll be three this year. That puts us at six inside of 16 months since we closed our first one. I don’t see any signs of it slowing down.
VanDine: In general terms, from a financer’s perspective, it seems like it’s been a very active, robust market (in 2018) and it doesn’t show any signs of letting up in the next year. I think some of the players are changing a bit. There may be different motivations for the sellers, different motivations for the buyers.
Roth: While active, I think we have seen some stress in the market with deals where you might have a seller that has some warts. Those deals will be harder to get done. We are seeing a little more deeper dive in some of the diligence (and) a few auction processes that haven’t had quite the result sellers have wanted. While the market’s still very active and we had great deal flow this year, it’s not quite as easy to get deals done as it was a year or two ago. I kind of expect that to continue.
Pollock: From a deal flow perspective, as a very small firm, our deal flow is as robust as it’s ever been since our inception. I would concur that I think we’re starting to see — and particularly with the type of buyer we are — more pseudo distress or signs of things, which I think increases our type of deal flow. From a portfolio company perspective, we’ve seen very little slowdown. The trajectory’s still pretty sound. I don’t see anything changing that in the near future. There are signs out there and uncertainty out there that are probably going to start affecting valuation and the ability to put certain amounts of leverage on transactions. But as far as deal flow, I think it might actually accelerate because we’re starting to see some of this uncertainty unfold.
TenBrink: We’re definitely the youngest — at 15 months — at really seeing deal flow, so I can’t go back to last year and say we’re seeing more. But I could tell you the last three to four months, we’ve seen a massive increase in our deal flow, and I don’t know if that’s us being out there or this industry. I can see the same (trend) with some turnaround or struggling kind of opportunities. With the sellers I’ve already spoken to, I think we’ll see more because of the fear of what’s the economy doing, what are these tariffs doing, what are the interest rates doing. People realize they’ve had 10 solid years of running their businesses. I think they’re ready to jump ship and get out of there before they start to get any kind of downturn again.
Brown: We’re doing a handful of deals a year, seven to 10. We’ve got more active engagements right now than we can handle, so we’re pushing off new clients into first quarter or second quarter kickoffs because it’s so busy. I see no signs that it’s slowing down. We have lenders who aren’t putting as much money in on these deals, so there’s some cushion there for those businesses to maybe underperform a little bit without tripping that covenant. Part of that is they might not be calling us for the distress deals. That’s not the kind of shop we are, but I’m seeing bigger valuations, more robust processes than I’ve ever seen in my 16 years.
Seifert: I’ve had more calls in the last 30 days than I have in the last quarter. What I’m starting to sense is that some of my peers, the aging Baby Boomers, are thinking that there’s a softening coming up and ‘I’ve been riding the wave of prosperity and now it’s time to hit the beach (and) cash in.’ I think there are going be a lot of sellers, which might drive the multiples down. The bankers that I talk to on a daily basis are starting to rate-shock more significantly and apply discounts to the revenues to see what’s going to happen in a 15, 20, 25 percent downturn.
Why are some companies facing distress in this market? Is it a matter of mismanagement or the company not being able to keep up with growth?
VanDine: Just from my perspective, in large portfolio customers, most of the problems that we’re seeing are people that are struggling to keep up with their growth due to a lack of available talent. A lot of these seem to become a people issue because there’s ample business opportunity. There’s been ample business opportunity to grow over the last several years. Sometimes just things grow beyond individual capacities to manage them.
Is that causing financial distress or just limiting growth?
VanDine: If your business is now running incrementally beyond your capacities, your ability to control it, keep your margins where they ought to be, bring in talented people to get your product from order to delivery, it’s just incrementally harder. That will eat away in your margins. We’re seeing a lot of it. It comes from different sources: regulatory stress, increased shocks in terms of input costs — which there’s been a lot of, and just trying to maintain through it. All the while, it’s an intensive, competitive market for anything. It’s really hard to materially improve margins on a company. That’s really where most of the stress that we’re seeing is coming from.
Everybody recognizes we’re long into the economic cycle. How’s that affecting deal flow?
Rua: From the side of the sellers coming to the market, it seems to be increasing, at least for us. It seemed like earlier this year, people were rushing to do something quick and they were shortcutting deals a little bit. But now it’s back to full-on ‘as long as it takes, I’m getting everything looked over really well.’ I think there’s some caution on the buyer side.
Roth: Some buyers think there’s going to be some softening (and are) willing to hold back a little — more (so for) strategics than financial (buyers). But the strategics that I’m talking to that are involved in M&A are sort of thinking, ‘Where are we in the cycle, where’s our core business? Would I be better with some dry powder 18 months from now where I can pick some deals up cheaper?’
TenBrink: It sounds like us in that it increased deal flow. I can be much more aggressive on multiples with lower numbers and longer due diligence. The last three LOIs I put out were a full multiple and a half lower than I probably would have been advised to eight months ago. But just because of that increased deal flow, we are being much more strategic with our situation, saying, ‘In 18 months, will the capital we have sitting in an account be better served to invest then or now?’
Brown: We think of it as barbells. At one end, you’ve got low capex, recurring revenue, a bunch of different customers, management wants to roll — that’s into the double digits. And not just double digits, in the teens double-digit multiples. Then high capex, cyclical end markets, there’s not as high growth or single-digit growth — that’s kind of in the five times, six times ratio (for multiples). It depends on the size.
How big of a concern are trade disputes and tariffs in due diligence, especially if you’re doing a lot in the manufacturing sector? Is that exposure a barrier to doing deals?
Helminski: Something we’re spending a lot of time looking at when we look at deals is how might they be impacted by tariffs. It just really becomes company-specific when you drill down to say, ‘Well, what does that actually mean to this business or its end markets?’
Is it a situation in which these pressures are just more complication you could do without?
Helminski: I think it’s bigger than that. I think it could have a real material impact on a lot of different businesses. It’s a very important issue. It’s just not a peanut butter spread across the board type of an issue. It becomes very specific to a company that’s in markets that are sourcing material and components.
Pollock: If the specific company or industry cannot get that product sourced any place else and it’s subject to the tariff, it has significant valuation effect. If there is an alternative, it doesn’t affect valuation at all. From a more broad perspective, tariffs and trade wars are just lose-lose situations. It’s almost like a war of attrition. Who can last the longest? Who has the most to lose? But along the way, there’s just so much collateral damage that trickles to a bunch of different companies and industries over time. That’s the part that concerns me. If it extends out too long without resolution, it has a dampening effect on everything. As far as immediately what happens, it is very deal specific.
TenBrink: It’s just one more factor that we look at. Obviously, you start adding and all of a sudden if you’re at four to five factors that are pointing in a bad direction for a business, then it does take an impact on the valuation. Now we have to pump the brakes and drop it that full multiple because we have to assume some of the risk there.
Seifert: I think it’s all over the map. I’ve got a couple of metal-bender clients, metal fab shops, and some of their raw materials are up 30-some percent. That hurts. I’ve got a couple foundries I’m working with and they’re getting work back from China because of the tariffs, so it’s kind of a mixed bag. I work with a manufacturer of glass mosaic tiles — a startup that my angel group (invested in) — and they’re very much looking forward to the tariff because China has 90 percent of the production of glass tile. They hope to get a larger piece of that when the tariffs come into play.
Helminski: It cuts that way, too. There are beneficiaries on this side.
Specifically in manufacturing, if talent is becoming more of an issue, are there opportunities to scale up and grow automation companies?
Rua: We actually sold four automation companies last year or this year. It’s been a very busy market and because it kind of self-propels, now we have more coming to us again to sell. It seems like there’s a lot of small players in the automation industry, and (with what’s) going on now there’s bigger players seeing some need. We actually had buyers that are either trying to do a rollup in that area, or strategics that just want to add it on, because they know that they need the automation capability to be able to compete. It’s going to change pace.
Pollock: We’re in the midst of actually the largest investment we’ve ever made as an entity. It’s largely driven by that. We’re not buying a company or adding on. We’re just investing in automating and not only expanding it, but making our plant a lot more efficient because of many factors going into that. It’s not just labor constraints, but one of them is to do more with less people because it’s so hard to find the people.
Helminski: I don’t see the people shortage changing any time soon, even if the economy pulls back a little bit, so I think there’s going to be a much brighter light shined on automation efficiency.
On the talent issue, are you seeing companies specifically wanting to buy talent? Are they specifically targeting a deal because a company has the talent base they need?
Rua: We are seeing that in the automation space. We’ve actually had some of the buyers who were doing a valuation model on the number of controls engineers (a seller) had because there’s such a shortage of that talent.
Brown: I’ve seen it actually in engineering businesses, too, and software and medical systems design — anything where you’ve got a real technical knowledge. Those are a lot of times acquired through acquisition.
Helminski: I don’t see opportunities where there’s open availability of talent or where people are underutilized. You might be buying capabilities, but you’re not buying labor hours in terms of talent that can then take on more because everybody’s kind of maxed out right now.
Roth: What I am seeing in deals is more due diligence on the HR, the employee-retention side.
Aside from economic volatility, political volatility has started to become more of an issue in America these days. Is that causing anybody to pause and wait to see what happens with the new Congress?
Brown: I don’t think it matters. If you look, we’re on 10 years of a good run. That’s with Republicans in office, Democrats in office, Republicans controlling the Senate, Democrats controlling the Senate. The economy and the political noise, to me, need to be decoupled.
VanDine: I would differ in that I think the thing that was undersold over the prior 10 years was the weight and the burden of the regulatory state and its massive expansion on businesses and how that impacted everyone. It’s something that doesn’t get a whole lot of discussion, but that was very real. I think part of the jump we saw since the last presidential election was the notion that there was going to be some easing on a constant barrage (of regulation). Every single business owner I’m talking to has talked about increasing regulations. Just having a neutral stance is a big benefit to American business. If that changes and swings to the other end of the pendulum again, then I think that’s something that should cause a lot of concern, a lot of worry about the future.
Pollock: I think it’s what comes out of it, and it is policy-specific. Tax cuts, less regulation are good for business. They’re just tangibly good. To the extent that stuff begins to get dialed back and changed, that’s probably bad.
Helminski: If you had to point to one thing from a political standpoint that I think would have a big impact on business, it could be immigration policy. I say that in light of the labor conversation that we had earlier. If you end up with a government that has a softer approach to immigration (and) allows more immigration, that could be a boon for labor availability, particularly at the industrial level. With the entry-level and shop-floor level that we deal with, that could have a material impact, in a good way, on that labor availability that I think is constraining the overall economy right now. Whether or not that happens, that’s anybody’s guess.
What would surprise you in 2019 or what’s something you saw beginning to emerge currently that you didn’t see coming?
Rua: If the number of sellers entering the market continues the way it’s been the last couple months, I’m not sure what that means for M&A, but that will change it for sure.
Brown: I’d be surprised if there was any real meaningful downtick in any activity. I think it’s going to keep going just as strong as it is right now for at least another year.
Roth: I think a radical shift either way (would be surprising). It might go down a little, might go up a little, but I don’t think it’s going to fall off the cliff, and I don’t think it’s going to get matured.
Helminski: A major downturn in the economy would be a surprise to me.
Is it going to stay a seller’s market?
Rua: That’s the question. That’s what I’m wondering. If we’re going to see some turning next year, if this pace continues with deals … I think it’s going to start to change the tide a bit, which would be really interesting.
Brown: I think it’s got a ways to go before it flips. (If you’ve) seen 600 deals (in 2018) and you’re just getting four done, it’s because a lot of them are bad deals. You know, the good deals are getting done still. It’s a seller’s market for those deals. It’s the tough businesses that have growth issues or warts on them, those will be the first to flip.
Helminski: I think you’re going to see a widening of this gap between those high-growth, low capex, low cyclicality, recurring revenue (companies). Those are going to continue to do what they’re doing. They can’t get much higher. That gap going down to the (companies that are) more cyclical, more uncertainty, higher capex requirements, longer investment cycles, I think you’re going to see the valuation that’s on those move more in that buyer’s direction, if you will, than you will on that other type of business.
What sectors of the economy are buyers avoiding right now?
Brown: I hear about automotive the most because it’s got the longest lead cycle for new products coming to market, and it requires a lot of capital to get a new model up and running.
TenBrink: The technology is so quickly evolving, with the self-driving vehicles and things. From our standpoint, we look deeper and harder at auto, and we’re in the Midwest. How do you not look at it? With every acquisition, you get some aspect that’s auto, but it’s so quickly evolving and changing and no one’s really laid out exactly what their plan is.
Give us one prediction for 2019.
Rua: Going along with the theme of more sellers coming to market, I do predict to see more lower size deals (and) more pressure on valuation.
VanDine: I think most deals that get done are going to have a much higher threshold in terms of their due diligence and the examinations of the particulars of those deals. The hurdle is going to be a lot higher this year.
Brown: Record M&A. Probably not value of deals, but number of deals.
Roth: Volatility of the M&A market, much like the stock market. There will be great deals that get done easy at high valuations; there’ll be tougher deals that are harder.
Pollock: Maybe I say this as a hope instead of a prediction, but I feel like I’ve said this a couple different election cycles: We’re ripe for a true, solid, independent candidate to emerge in 2019 to make a run in 2020 to return some stability and normalcy to it.
TenBrink: You’re going to hear more from tribal-owned enterprises. Every tribe in the state has some form of an EDC, and not all of them are taking the family office type approach to what they’re doing, but I think you’ll hear more from them.
Brown: I have almost every company now ask me about going through the tribal route, which they never did two years ago or three years ago.
TenBrink: I think there’s some obvious advantages to it, of course, but I think the tribes are starting to get their arms around what diversification to them really looks like.
Seifert: I’m absolutely certain in my prediction. Interest rates are going to change. I don’t think it’ll be a huge change, but it could easily be a half-point or a point.