Participate, Profit & Celebrate:
Q.: What are the latest American mid-market deal trends in light of business uncertainties?
Mr. Bunn: Until recently, there were number of key trends that we were seeing including a strong IPO market for middle market growth companies especially in the broad technology sectors, financial sponsors becoming much more competitive with strategic buyers in pursuing acquisitions, expansion of valuation multiples being realized in both the public and private markets that was approaching but not quite equal to the 2005-2007 levels, and many strategic players focusing on their core business by divesting non-core assets.

There was a continuous strengthening of all of these trends starting from early 2010 through late July of this year, when economic uncertainty started to affect the equity and credit markets. We've now seen strategic and financial buyers hit the “pause” button to see how things shake out and if the recovery that seemed to be underway through most of this year will continue, or if we'll instead experience a double-dip.
Q.: Can you elaborate on how the fear of a double-dip recession will play out especially given the high levels of cash sitting on corporate balance sheets?
Mr. Bunn: Many corporates do have strong cash positions and also have pressure to deploy that cash towards acquisitions that support their growth. I think that the experience of the last recession gave a lot of companies confidence that they can weather the storm of another one, and so will continue to make investments and acquisitions and not just sit on their cash balances. With that being said, I would expect that they would be measured in those investments so as to maintain enough of a cash cushion that they feel like they could survive a longer recession without having to return to the capital markets to raise money. You also are likely to see higher stock components in deals, particularly for larger transactions, because of this desire to maintain a sufficient cash balance.
Q.: In your opinion how is the current level of volatility in the financial markets impacting the M&A activity?
Mr. Bunn: We closely track the relationship between equity market volatility and M&A activity and find these two to be very highly correlated. When volatility is high and/or increasing, we see a slowdown in M&A activity, and vice versa. One of the reasons for this is that valuation multiples for public companies are changing day-to-day and week-to-week in volatile markets – sometimes significantly. Buyers rely heavily on public valuation benchmarks when valuing target companies and when these multiples are changing by 10% or 20% over a relatively short period of time, buyers have a hard time feeling confident in their valuations of target companies. We look closely at the VIX index to take the temperature of market volatility and generally find that the M&A market is healthy when the VIX is roughly below 25. The VIX was under 25 for most of 2010-2011 except for a spike in the spring of 2010 that was tied to concerns about the European debt, and until very recently when the VIX index had jumped up in the 30 to 40 range. It's declined in the last week to 10 days, so we're optimistic that that's a sign of smoother markets ahead.
Q.: So, how will M&A shape up from those sponsors that are facing the pressure to invest?
Mr. Bunn: Whereas you didn't see much activity from the sponsors in the last recession, I think that it will be different this time and that you'll see sponsors continue to be active buyers and investors because of the need to put their capital to work before investment periods end. If the recession is accompanied by a weak credit market, this might mean that they need to put more equity into deals than they would ideally like to, but that could be somewhat offset by lower valuations if the markets are down.
Q.: Who are buyers of the private equity backed companies lately?
Mr. Bunn: We've seen about a 50/50 split between the buyers being other financial sponsors and strategic buyers. Among our recent transactions, for example, we've seen our PE-backed clients Evolution Benefits (formerly owned by CCP Equity and the Sprout Group) acquired by Genstar Capital, Plimus (formerly owned by Susquehanna Growth Equity) acquired by Great Hill Partners. On the strategic buyer side, our clients PayFlex Systems (owned by Oak Investment Partners) has announced its sale to Aetna, Matrix Financial (owned by Bluff Point Partners) was acquired by Broadridge while GeoLearning (owned by Volition Capital) was acquired by a PE-backed strategic buyer, SumTotal Systems and Vista Equity.
Q.: Broadly speaking, what are the key difference between a strategic versus a financial buyer in pursing an acquisition?
Mr. Bunn: There are a few key differences that are notable here. Depending on their size and acquisition experience, strategic buyers will frequently rely on their internal resources to conduct due diligence and execute a transaction, rather than rely on third parties, and can finance a deal with balance sheet cash or cash available under existing credit facilities. As a result, they can frequently get the finish line more quickly and with fewer contingencies. Financial buyers who rely on third parties to perform much of their diligence and require financing will be more reluctant to spend the money on this third party diligence until they know that the deal is theirs. This can disadvantage sponsors when competing with strategic buyers because a strategic will often be able to present a target company with an acquisition proposal that contemplates a faster path to signing a definitive agreement and with a higher degree of certainty.
Q.: What are the challenges of closing a transactions in the mid-market segment?
Mr. Bunn: A key point related to closing a transaction from a seller's perspective is that sellers will often have stronger purchase/merger agreements with strategic buyers than financial buyers. If a strategic buyer doesn't require financing for the deal, the seller will typically have the right to specific performance such as the legal right to force the buyer to pay the purchase price and close once the closing conditions have been satisfied. On the other hand, the financial buyers need of financing to close, leads them to give themselves more “outs” in the agreement that are undesirable from a seller's perspective.
Q.: So, how do you advice clients on preparing to overcome these challenges?
Mr. Bunn: When advising clients, we frequently advise sellers to insist on the right to specific performance from any buyer because volatility in the markets between signing and closing can introduce significant risk to closing a deal that requires financing. A financial buyer can accommodate this by agreeing to “backstop” the deal and pay the entire purchase price with the equity from their fund. Sponsors have varying appetites for this approach, and some will instead suggest reverse break-up fees that are payable to sellers in the event that they are unable to close. The seller would always prefer a specific performance structure over a reverse break fee approach, but if they do accept the break fee approach, they need to make sure that the figure is large enough to provide appropriate assurance that the buyer will be highly motivated to close.
Q.: What is the secret to winning business in an ever so competitive mid-market segment?
Mr. Bunn: We win business by consistently achieving excellent results for our clients, who then become strong references for future clients. While there's no such thing as true “recurring revenue” in our business, we have been able to complete multiple transactions for companies and private equity firms by delivering superior execution on a consistent basis. We pride ourselves on having senior bankers with deep domain expertise, strong industry relationships and extensive transaction experience in the sectors we cover. Another thing that sets Raymond James apart is that our senior bankers get involved and actually execute transactions vs. many of our competitors.
Q.: On a personal note, are you reading a book currently?
Mr. Bunn: I don't have a lot of time for pleasure reading as most of my reading is of industry or company research or trade rags, but I've just started The Extra 2% by Jonah Keri, which is somewhat similar to Moneyball. I'm attracted to the quantitative and analytic aspects of sports and am fascinated to read about former investment bankers who were put in charge of running the Tampa Bay Rays and turned them into a perennial playoff contender against the more deep-pocketed Yankees and Red Sox.

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