The Economy's Impact on M&A in 2011

Five core constraints served to inhibit economic growth over the past two-and-a-half years.  Today there are five signs of improvements in the economy.  As conditions continue to improve, M&A activity is sure to follow.  2011 should be a relatively good year for M&A. 

The Harsh Realities of the Past

The five major economic constraints are fairly obvious in hindsight.  The five are all related.  And they all seem to stem directly or indirectly from the mortgage fiasco.  Housing price increases no longer generate cash for investors and home owners.  In fact, the values of real estate have declined precipitously (to more rational levels) and created upside down mortgages and foreclosures, and generally made it more difficult for homeowners to reap the benefits of home ownership. 

A secondary, though related, factor has been the financial/banking crisis and related credit availability.  The banking and credit crisis indirectly or directly led to other constraints.

Third is the unemployment level, which has hovered at around ten percent.  However, when one factors in the “under-employed” and those that have simply ceased looking for work, the figures are actually closer to twenty percent. 

A fourth constraint on economic growth is a side-effect of unemployment – consumer confidence. 

In addition to consumer confidence, business confidence, in the form of capital investment in equipment and structures used to produce goods and services, declined rapidly.

By no means a comprehensive list, these factors serve as the top five inhibitors of economic growth over the past couple of years.

The Positive Signs of the Present

As of September, 2010, there are some positive signs of recovery.  GDP growth has averaged 3.5% since mid-2009.

There has been the creation of more than half a million private sector jobs.  Granted, unemployment still stands at roughly ten percent, but we are creating some new jobs.  New jobless claims have declined.  Some companies are tapping temporary workers to help meet increasing demand.

Third, the Fed seems likely to allow interest rates to remain near zero in the foreseeable future.  Low interest rates are helping to stabilize the economy by keeping credit card interest rates, mortgages and other loan rates low.

Fourth, credit appears to be thawing.  The availability of consumer and business credit again serves as a major driver of economic growth. 

In addition to more supply of credit, there is substantial pent-up demand for credit capital at this time.  There is a backlog of refinancing requests, there are increases in corporate borrowing due to increasing business confidence and interest in capital expenditures, and there is a significant amount of “dry powder” – equity investments in private equity funds that are yet to be deployed.  When this equity is employed, private equity groups almost always borrow capital to complete the transaction (they invest only a percentage of equity in the deal and borrow the rest in much the same way that consumers put equity downpayments on a new house and pay for the balance with a loan).

Middle Market M&A Potential in 2011

The middle market has finally started to benefit from increased confidence of the credit markets.  Lower borrowing costs, more available credit, less stringent covenants – these are all facilitating increased access to capital for acquisitions.  And experts expect that a significant level of demand for asset-based lending will spark an increase in supply of this form of credit by 2011.  Moreover, both second-lien and mezzanine financing are also expected to be strong performers in 2011. 

Both troubled and performing companies alike are now more open to the concept of an M&A solution, as they recognize that there is a stronger possibility of actually getting a deal closed. 

Economic stability has enabled business owners to improve upon the reliability of their forecasts, which helps buyers become more comfortable with the businesses, and ultimately, gives them greater confidence to pay higher multiples of earnings. 

Both deal volume and deal value are demonstrating strong growth in the year-over-year trailing twelve month periods.   And the trend is likely to continue.

Private equity firms may have as much as $450 billion in cash sitting on the sidelines.  They raised this cash during the boom years and now have only a short period of time before they must spend it, or give it back to investors.   Through the first half of 2010, there have been 672 acquisitions by private equity firms with a deal value totaling about $50 billion. In 2009, there were 508 transactions, totaling about $35 billion.

And strategic buyers have cash reserves, and are putting that cash to work. 

The right ingredients are in place to create a strong year in 2011 for M&A activity.

Conclusion

As we analyze the harsh realities of the past, and compare those trends to today’s market realities, it becomes evident that we are on track to see expanding economies and ultimately, increased M&A activity.  The big question marks concern unemployment levels and related consumer confidence.

Christopher “Kit” Lisle is the Managing Partner with Acclaro Growth Partners, a research-based management advisory firm located in the Washington, DC area.  Acclaro supports private equity groups and corporations with market research and strategy consulting activities.  For more information about Acclaro, click here.

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