Mid-Market M&A Outlook: Spreading Downturn ?
Being somewhat connected into the mid-market (that's smaller firms) M&A/Buyout market and community it's something I follow and every once in a while something really interesting comes across my desk. Now we've discussed before that the implosion in large deals might be spreading into the mid-market (circa Jan08) based on anecdotal evidence that the deal flow began drying up in late Dec07. Now some much harder data has crossed our desks from OEM Capital. OEM is a specialist in mid-market M&A for the technology space and has an enviable track record, and sterling reputation. They track activity in that space montly and from their data we can begin to see the downturn spreading. If you're interested check out their web site and see if you can subscribe to their monthly newsletter. An excellent if dry information source.
M&A Announcements (OEM Capital) For January 2008, merger and acquisition announcements targeting US information and communication companies totaled 99 compared to 145 for January 2007. In January, the Software sector accounted for 62% of all announced transactions followed by Hardware & Systems (15%), IT Services (14%) and Telecom Services (9%). Not only were the number of transactions down substantially from a year ago, there was only one transaction over US$100 million. The largest two transactions during the month were: NYSE Euronext Inc. announcement to acquire Wombat Financial Software Inc, a developer of data software for financial institution trading, for a total value of US$200 million; and, Universal Electronics Inc. planning to launch an unsolicited tender offer to acquire Zilog Inc, a manufacturer of semiconductors, in a transaction valued at US$77 million. US buyers accounted for 83% of the transactions. Foreign acquirers from countries with two or more announced transactions included Canada (6) and the Philippines and Japan (2).
Below the line though you'll find a bunch of other relevant information, either on technology or the M&A market in general (largely courtesy of the WSJ's Deal Journal which we also recommend following). The first item is an analysts' report which sees Tech spending turning negative ! Gee - wonder if these are correlated datum ? :) For regular readers this shouldn't be any sort of surprise given that we've been arguing for such for several months based on our macro-analysis of capex trends.
The rest of the Deal Journal readings will "read" you into the picture with growing tales of woe and consequences: declining business deal flows, likely downsizings, bring your own debt for deals and, most especially, an increasingly cloudy outlook for corporate debt defaults. Which'll just be another feedback loop to add to the general malaise until it turns into fullblown misery (thank you Pres. Peanut for creating a phrase).
UPDATE 2/22 (this is from an e-brochure alerting/advertising for an upcoming seminar on Mid-Market Finance that, reading between the jargon, tells us a lot about the state of play):
In case the jargon's not entirely clear CLO (Collateralized Loan Obligation) is what banks and LBO's do with the loans they'd like to make to fund buyouts, i.e. the equivalent of the stuff blowing up in the mortgage markets. Mezzanine debt (click thru for a definition/discussion) is higher risk loans with an equity kicker and can/often has 20%+ rates while sr. debt is more like the real deal. In other words normal business finance ("sr. debt") is drying up, the investment banks aren't buying or selling the funny sythnthetic stuff anymore even for this market so the loan-sharks who get a cut of the company are the only guys in the game. So...Paulie...what's the vig ?What a difference just a few months can make!! Last summer, middle-market mezzanine finance was the subservient Cinderella to stepsisters like increased levels of senior debt and second lien loans. Now suddenly, mezzanine once again is the belle of the ball.It’s stunning to me how fast the whole landscape changed.
CLOs struggle with their ability to raise capital. Second lien paper is nowhere to be seen. Senior lenders have pulled back on their lending multiples. Hedge funds are laying off their business development teams. Covenant lite deals are a footnote in Wall Street history. In fact, when you look at all the participants in middle-market finance, mezzanine funds are the biggest beneficiary of the credit turmoil.
READINGS
Corporate IT Spending Goes Negative Overview: ChangeWave’s latest corporate IT spending survey points to a negative growth rate for 2nd Quarter 2008 – and confirms U.S. business spending has already entered into a recession. A total of 2,013 respondents involved with IT spending in their organization participated in the survey, conducted February 11-15, 2008. 2Q 2008 IT Spending: Nearly one-in-four respondents (23%) say their company’s IT spending will decrease (or there will be no spending at all) in the 2nd Quarter – 3-pts worse than the previous ChangeWave survey in November 2007. Only 15% say spending will increase – an unprecedented 9-pt drop from previously. A Picture of Negative Growth: As seen below, the percentage projecting decreased IT spending for 2nd Quarter 2008 is far greater than the percentage projecting an increase. You have to go all the way back to August 2001 to find the last time a ChangeWave corporate IT spending survey projected negative spending growth.
How Bad Is It? The Hillary Clinton Edition Consider the dismal fortunes of the deal business. Leveraged finance is down 82% this year, while announced M&A is down 64% and fee income from private-equity firms is down 74%, according to data from Dealogic and Banc of America Securities analyst Michael Hecht. The M&A backlog of deals that were announced and not completed is a massive $1.5 trillion–which means that one-quarter of all the deals announced in 2007 haven’t closed yet. And the fees, the fees. Mr. Hecht provides some terrifying numbers. In 2007, investment banks missed out on $4.4 billion of revenue as a result of withdrawn M&A deals, up 56% from 2006. This year, the banks already have watched $126 million of fees escape their grasp because of withdrawn M&A deals that never paid their success fees. The investment banks didn’t do much better on equity offerings. Withdrawn equity offerings cost the banks $980 million of revenue in 2007. In the first six weeks of the year, banks already have forgone $200 million in revenue because of pulled deals. So this we know: lower revenue means fewer jobs and, if things don’t pick up, the stage could be set for layoffs on Wall Street. The Street already is staffed pretty fatly, with more than 211,000 working in the deal-making parts of investment banks in 2007, lumped together under “institutional securities.” In 2006, that head count was a little more than 189,000. And productivity at the investment banks already was down in 2007, a year that ended with layoffs. Average revenue per employee at the big investment banks fell 16% to $714,572 last year from 2006. In fact, the last year with lower productivity by headcount was all the way back in 2004, a year in which each investment-bank employee brought in $685,651. As Bette Davis said in “All About Eve”: “Fasten your seatbelts. It’s going to be a bumpy night.”
Gathering the Kindling for the Bankruptcy Pyres Is it time for the bankruptcy funeral rites to start? Here is evidence more companies may be nearing defaulting on their debt, particularly those with the lowest-rated, riskiest debt. Even though years of ever-weaker covenant agreements means such companies may not have officially defaulted on their debt, they still are burning through cash and that is cutting off their access to more funding. According to a Moody’s report today, companies with low-rated or junk debt have the weakest levels of liquidity since November 2004, with more than 90% of companies with C-rated debt having low or only “adequate” access to the cash and revolving credit lines needed to keep them functioning. Of course, many have foreseen an increase in the number of corporate defaults from the record lows of recent past. Still, the number of high-yield, or junk, bond issuers with the thinest of cushions before violating covenants on their debt is at a record, according to Moody’s. Forty-one companies have Moody’s lowest, speculative-grade rating of “4,” up from 25 only eight months ago.
For Private-Equity Buyers Now, the Party Is BYOD In a world of uncertain credit, private-equity deals are still getting done, but increasingly the prize isn’t going to firms with the highest offer. Rather fortune is favoring those who can get the deal to the finish line (or at least can show that they can). Often that means buyers who bring their own debt to the negotiating table, instead of turning to outside lenders. Executives at such firms as Carlyle Group, TPG Capital and Silver Lake Partners all say they have had to spend extra time recently lining up debt before heading to the bargaining table.
Leveraged Loans: The Hangover Wasn’t Worth the Buzz Investment banks now face around $197 billion in exposure to leveraged loans used to back big buyouts in 2007, adding inestimable stress to their efforts to extricate themselves from the credit crunch. Was it worth it? Not really, no.