Our Outlook for Middle Market M&A in 2020

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By Russ Warren,
Managing Director

20/20, in optics, means Clarity of Vision.  For 2020, the year, the outlook for business climate and merger and acquisition markets is not so clear but citing current conditions and commentary that will influence middle-market activity over the coming months can provide insight.

First – How to Read the Tea Leaves

In discussing merger and acquisition activity, it’s important to differentiate between mega-mergers like United Technologies/Raytheon (the headline grabbers) and lower middle-market M&A activity (the real world).

  • The middle market (below $500 million) drives the number of transactions reported
  • The largest mergers drive the aggregate value of transactions reported for the year

Unfortunately, aggregate value is often reported as volume, when it really refers to value.  Also consider the source of the information: large institutions – major banks, investment banks, CPA firms and law firms – usually have a large-transaction perspective. 

2019 – It Was A Very Good Year

North American M&A activity was strong from top to bottom with 11,300 reported transactions worth more than $2 trillion, even though numbers and value were down from a record 2018 by 12% and 14% respectively. 

In the chart above, the number of 2019 middle-market M&A transactions reflect in part late-cycle concerns, while the value of large mergers was driven by acquisitions of technology, ‘mergers of equals’ for competitive effectiveness and execution of strategic repositioning.  

The Setting as 2020 Dawns

  • We are enjoying the longest economic expansion in U. S. history, says National Bureau of Economic Research.  Business risk is seen as the likelihood of U. S. economic growth slowing (but not stalling) in 2020 – buoyed by low unemployment, optimistic consumers and strong corporate profits.
  • Uncertainty surrounding the U. S. Presidential election outcome and post-election tax, regulatory and Socialist spending policies, international trade and tariffs, faltering global economic activity and geopolitical unrest concerns business leaders, and is causing accelerated deal timelines. 
  • The pace of technological change continues to accelerate across many industries, driving companies to change their business models and seek new capabilities and skills.
  • There is ample funding for M&A activity: interest rates are low and expected to remain so, debt leverage is strong, corporate balance sheets are cash rich and more than $800 billion of undeployed private equity capital (latest available data from Pitchbook) is in waiting, even if there is a mild downturn ahead.
  • The market continues to be very pricy due to the imbalance between a limited supply of quality sellers and intense buyer demand, with premium prices offered for recession-resistant businesses, desirable technology capabilities and growing, profitable companies.
  • Buyers are being more selective and careful given today’s high valuations and we are seeing them conduct more thorough due diligence, extending the time to closing.

What’s Trending and Why

Because investors have uncertainty concerns mentioned above, an acquisition candidate that can demonstrate its business is recession resistant, not vulnerable to tariffs, a change in government regulations or a disruptive technology should attract multiple suitors and command a premium price. Historically cyclical businesses may receive offers based on profitability over the cycle or offers that include payments contingent on future performance.

Some buyers are motivated in today’s tight labor market and strategic focus to acquire talent or additional needed skill sets in the middle market.

Attractive industries for acquisition are those undergoing consolidation, and those with disruptive new technologies and wind-at-your-back demographic trends.  A few of these attractive sectors include:

  • Healthcare – based on graying demographics and rapid changes in medical technology
  • Food & Beverage – due to market changes in food and food service preferences
  • Industrials/manufacturing 4.0 – experiencing disruptive entry of alternative power sources and electronics into traditional products like automotive and home security
  • Environmental – reflecting concern about problems from ocean-bound plastic waste to ecology 

Accordingly, our outlook for middle market M&A in 2020 is positive, with specific types of businesses and industries generating especially strong buyer interest due to cycle performance or enduring trends.

If you are thinking of selling a or divesting a business, consider whether this is a good time to start the planning process, based on the 2020 market setting, your business’ attributes and shareholder needs.

© Copyrighted by EdgePoint.  Russ Warren can be reached at 216-342-5859, by email at rwarren@edgepoint.com or on the web at www.edgepoint.com

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