Despite a lethargic market for mergers and acquisitions, leveraged buyout valuations hit their highest level in more than a year in June. In the 79 U.S. LBO deals tracked by S&P Capital IQ last month, acquirers valued the target company at an average 21.4 times trailing 12-month EBITDA (earnings before interest, taxes, depreciation and amortization). That was more than double May’s number and the highest average multiple since April 2012. (See chart below.)
M&A financiers attribute the rise to multiple factors. There is still plenty of talk about financial sponsors sitting on uninvested committed capital that they raised in 2007 and 2008. But the greater availability of cheap debt to finance deals may be of greater influence. “The market for financing has heated up,” says Ted Aronson, a principal at Monroe Capital. The last few months, lenders have been willing to provide a half-turn to one-turn more leverage on M&A transactions, he says, “and that’s what directly correlates to an increased valuation.”
Banks have cleaned up their balance sheets, says Thomas Angell of Rothstein Kass. In addition, there is a lot of retail money pouring into mutual and other funds that invest in corporate loans, says Angell, who is the principal in charge of the private-equity practice at Rothstein Kass. They do so through collateralized loan obligations (special-purpose vehicles by means of which banks securitize commercial loan portfolios and move the assets off their books).
Financial institutions closed 98 CLOs in the first half of 2013, up from 39 in the same six months in 2012, according to Appleby, a provider of offshore legal and fiduciary services.
Aronson says that as long as a PE firm has an appropriate investment thesis and capital structure for a buyout (meaning sufficient equity in the deal), banks and other financiers will welcome them with open arms. Monroe Capital, which lends for middle-market transactions, requires 30 percent to 40 percent of the capital structure be equity, says Aronson, a number still higher than during the pre-financial-crisis M&A boom.
On the other hand, the multiple that a PE firm pays for an acquisition doesn’t concern the lender as much, Aronson says. “We will underwrite a transaction based on what we feel is the amount of leverage the company can support,” he says. “If we feel five times is the correct leverage and the company sells for 15 times or 20 times, it doesn’t affect us. It just means there is more cash equity that needs to be put into the business.”
Whether the trend continues depends, among other things, on the growth of the U.S. economy. PE firms must be finding a significant upside in future revenue to pay such high multiples, says Angell. “There is not a lot of cost cutting still going on,” he says. “Obviously in going from being a public company to a private one there are dollars to be saved, but not enough to warrant these multiples.”
A report by S&P Capital IQ accompanying the numbers highlighted two recent proposed deals with outsized multiples: Thoma Bravo’s agreement to acquire cloud-services company Keynote Systems, which is valued at $395 million, or 23.1 times its trailing 12-month EBITDA; and David Murdock’s offer to acquire 60 percent of Dole Food Co. The latter deal has a total net transaction value of $2.2 billion, or a 19.6 multiple.
Below the strata of such megadeals, huge multiples just don’t happen, says Aronson, with the value tending to be in the range of 4 times to 10 times trailing 12-month EBITDA.