After a banner year for deal flow, the merger and acquisition market seems to have tempered slightly in 2016.
Still, mergers and acquisitions have continued at a solid pace, particularly among West Michigan private equity firms that are courting manufacturing companies. However, private equity fund managers and industry experts point to concerns over when the next downturn in the business cycle may occur and other uncertainties as drivers for the market taking a bit of a pause in recent months.
“The thing I think about today maybe more than I thought about 12 months ago is what are the revenue drivers for this business and where’s the risk associated with those,” said Jeff Helminski, managing director of Grand Rapids-based Blackford Capital. “Many of the macroeconomic projections are suggesting that we may see some sort of economic downturn — I don’t know if it will reach recession-type status — in the 2017 to 2019 timeframe.”
With that information in mind, Blackford Capital has avoided businesses with a heavy international presence and exposure to currency fluctuations. Instead, the firm has opted to focus on companies tied to the homebuilding market, which Blackford Capital expects to remain strong even in the face of a downturn.
That strategy played out in the firm’s two most recent acquisitions, for Hudsonville-based Grand Equipment Co. in December 2015 and for Hastings-based Quality Aluminum Products Inc. last January. Both companies are heavily tied to the construction and homebuilding markets, Helminski said.
Grand Equipment serves as a distributor of heavy construction equipment, while Quality Aluminum Products directly supplies aluminum siding and other products to the residential homebuilding market.
“We’re bullish on both long-term and short-term homebuilding,” Helminski said. “We think there is a strong tailwind behind homebuilding, and even if there is a macroeconomic pullback or recession, the demographics are driving growth in household formation and new construction.”
Both companies were acquired under Blackford Capital’s Michigan Prosperity Fund, which targets mature manufacturing companies based in Michigan with annual revenues between $20 million and $100 million.
Additionally, the firm plans to close its first deal in the automotive industry this month, Helminski added.
A COOLING MARKET?
Most experts interpreted the decline in deal flow in the first quarter of 2016 as private equity firms and other buyers taking a break after the fury of M&A activity last year.
“The market seems to be taking a breath to see if there’s going to be any correction in the economy,” said Tracy Larsen, managing partner at Barnes & Thornburg LLP, who leads the law firm’s corporate department from Grand Rapids. “There’s a feeling that, particularly for some industries, maybe we’re at the tail end of the ride and there will be a correction. Private equity guys are just a little bit more cautious right now. It feels to me like it’s going to be a softer year.”
Deal volume and deal values in the first quarter of 2016 reached the lowest levels since the second quarter of 2013, according to the recent report on private equity activity in the U.S. middle market published by PitchBook.
Private equity firms closed 388 middle market deals valued at a total of $71 billion in the first quarter of 2016, according to PitchBook data. That represents a 17-percent decline in volume and 20-percent decline in deal value over the same period a year ago. Likewise, deal volume fell 22 percent and deal value declined 21 percent from the fourth quarter of 2015.
Larsen acknowledged that the cautionary M&A environment has slowed deal volume so far in 2016, but added that it would have been hard for the market to repeat the robust activity it experienced last year.
Owners who typically would have waited to go to market in 2016 instead chose to sell their businesses last year to take advantage of elevated valuations, he said.
However, some private equity executives view the present slowdown as nothing more than a small anomaly in the deal market. The upcoming presidential election, commodity prices, layoffs from automotive manufacturers and rising interest rates have all caused uncertainty in the market, said John Pollock, managing director of LV2 Equity Partners LLC, a private equity firm with offices in Grand Rapids.
“I think that’s kind of a hiccup,” Pollock said of first quarter deal flow. “Our thoughts are that manufacturing and the economy as a whole is still on a path of steady, controlled growth and absent something very strange happening, I don’t see that changing. I expect we’ll still have a really solid 2016 for M&A activity.”
Most manufacturing sectors, particularly companies in the automotive, medical device, and food processing industries, will remain hot for M&A in 2016, according to deal watchers. However, private equity firms and advisers told MiBiz that they forecast a substantial volume of distressed deals in the energy exploration sector as a result of falling oil prices.
PUSHING DOWN MARKET
While deal volumes so far in 2016 have softened compared to last year, activity in the lower middle market surged, showing the most capital investment since the first quarter of 2008.
Private equity firms closed 189 lower middle market deals valued at a total of $12 billion in the first quarter of 2016, up from 156 deals for $7 billion in the same period a year ago, according to PitchBook. Deal flow and deal value also increased compared to the fourth quarter, when private equity firms closed 166 lower middle market transactions valued at $7 billion.
Deal activity among West Michigan companies in the lower middle market echoes the national activity, as more private equity firms look to similar manufacturers to pursue transactions.
Since most private equity funds have already established their portfolio companies, firms more often are seeking add-on acquisitions these days, said Peter Roth, a partner focusing on M&A at Grand Rapids-based Varnum LLP.
“I’ve had several clients with businesses that … get some serious private equity looks and they were add-ons,” Roth said. “A year ago, I would have thought would have been too small for some of the private equity players.”
Pollock of LV2 said his firm is currently looking for add-on acquisitions to augment two of its portfolio companies, Martin Yale Industries Inc. of Wabash, Ind. and Batavia, Ill.-based Cast Aluminum Solutions LLC.
For Martin Yale, LV2 wants to acquire companies that would add new items to the manufacturer’s line of print-finishing products. Likewise, the PE firm is also scouting for a machine shop in California to boost Cast Aluminum Solutions’ semiconductor business, Pollock said.
“I think (add-on acquisitions) are more prevalent right now and (it) is moving PE and strategic buyers down into looking at smaller companies than they may have in the past,” Pollock said. “It’s making the lower middle market very vibrant, not necessarily as a platform investment but as an add-on to something they have.”
DRIVING DOWN VALUATIONS
After a period in which companies fetched high multiples, valuations are also beginning to stabilize as the market takes a slight pause, sources in the M&A industry said.
“My sense is that pricing probably peaked at year end of 2015 and some of the funds that have been paying above historical average pricing have started to realize they maybe were overpaying a bit and are taking a breather,” said Helminski of Blackford Capital.
While some data suggest a slight pullback in valuations from an average of 10 times earnings before interest, taxes, depreciation and amortization (EBITDA) in 2015, strong companies can still fetch double-digit multiples, according to PitchBook.
However, companies with even a few concerns over profitability will “garner significantly lower prices,” according to the firm’s first quarter PE Breakdown.
West Michigan private equity firms maintain that the current climate is still very much geared toward sellers. Valuations for manufacturing companies around West Michigan have mostly ranged between five and 10 times EBITDA, said Roth of Varnum.
“The market has been really hot for a long time,” he said. “For two years, people have been saying that multiples have been crazy and private equity is just throwing around silly money. Maybe after two years of that, people are like, ‘Well, that can’t last forever.’ All of those factors have people a little more cautious, but people are still out there doing deals.”