M&A: The Year in Review and a Look Ahead; Recent ... · Feb 05, 2013 Dell Inc. Michael Dell and...

M&A: The Year in Review and a Look Ahead; Recent Noteworthy Valuation & Accounting Trends

Alan D. MacEwan, Partner, Verrill Dana, LLP

W.S. (Sandy) Miller, Jr., Partner, Tax Services, CF, Accountants and Consultants

Jeffrey S. Phillips, Managing Director, Stout Risius Ross

Justin A. Wolfort, Director, Western Reserve Partners

M&A: The Year in Review and a Look Ahead

Mergers & Acquisitions Capital Raising Financial Opinions & Valuations Restructuring & Bankruptcy

CLEVELAND ● COLUMBUS ● DALLAS

WSG North American Regional Meeting March 2013


Recap of 2012 – Market Recoveries: They Don’t Make Them Like They Used To

3

U.S. Middle Market M&A Activity

Great Expectations

Deal activity was strong in 2012, particularly in Q4, but overall fell short of expectations

M&A volume as a percent of total U.S. market cap in 2012 was almost 30% below the historical average

A Tale of Two Markets

A closer examination reveals a bifurcation of the “haves” and “have-nots” (companies with healthy margins and strong growth stories versus those with weaker performance or less sophisticated technology)

Middle market LBO targets with above average financial performance accounted for 64% of middle market LBO activity in 2012, compared to only 42% in 20091


1 GF Data, February 2013

M&A Volume as a % of Market Cap

5%

0%

2%

4%

6%

8%

10%

12%

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

U.S. Announced M&A as a % of Market Cap U.S. Average

Source: Dealogic

1995 - 2012 Average: 6.7%

6,203

7,030

7,766 8,428 8,527

6,986

5,639 6,299 6,546

6,208

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Number of Transactions Deal Value

Source: Thomson Financial

(# of transactions) ($ in billions)


Recap of 2012 – Fiscal Cliff Effect: Pennywise and Pound Foolish?

4

2012 Middle Market Private Equity EBITDA Multiples

While Q4 ‘12 deal volumes went up significantly, buyers took advantage of sellers’ tax-driven motivations and drove valuation levels lower

Tax-motivated sellers were met by a buyer universe with lower valuation and faster deal cycles in 2012


2012 Middle Market Private Equity M&A Volume by Quarter

52

3730

89

0

20

40

60

80

100

Q1'12 Q2'12 Q3'12 Q4'12

* Middle Market = transaction enterprise value between $10 and $250 millionSource: GF Data

6.2x 6.1x

6.9x

5.9x

3.0x

4.0x

5.0x

6.0x

7.0x

Q1'12 Q2'12 Q3'12 Q4'12

* Middle Market = transaction enterprise value between $10 and $250millionSource: GF Data


Recap of 2012 – Valuation Trends: Synergy and Size Still Matter!

5

Middle Market Private Equity EBITDA Multiples

Strategic valuation premiums lessened as corporations pulled back and private equity firms continued to aggressively deploy their long-committed capital on quality businesses

However, a longer-term perspective and synergy creation allow strategic buyers to afford premium valuations


Middle Market EBITDA Multiples

5.5x

6.1x

6.8x

7.5x

4.0x

4.5x

5.0x

5.5x

6.0x

6.5x

7.0x

7.5x

8.0x

2007 2008 2009 2010 2011 2012

$10 - $25 million $25 - $50 million $50 - $100 million $100 - $250 million

Source: GF Data *Middle Market = transaction enterprise value between $10 and $250 million

(EV / EBITDA)

8.7x 8.3x

6.8x

8.2x 8.4x 7.9x

6.0x 6.0x 6.0x 5.9x 6.1x 6.2x

0.0x

1.0x

2.0x

3.0x

4.0x

5.0x

6.0x

7.0x

8.0x

9.0x

10.0x

2007 2008 2009 2010 2011 2012

Strategic Financial

Source: Capital IQ / GF Data * Middle Market = transaction enterprise value between $10 and $250 million

(EV / EBITDA)


Recap of 2012 – Cross-Border Activity

6

U.S. Acquisitions Abroad

Cross-border M&A activity continued to cool in 2012 as the global financial crisis kept buyers at bay

U.S. companies continue to focus on building domestic capacity versus offshore investing

The compressing exchange rate of the U.S. dollar to key international currencies has cut into the “value” proposition of U.S. targets

Still mired in the Eurozone crisis and sovereign debt issues, coveted European assets present a value opportunity for healthy foreign acquirors


Foreign Acquisitions in the U.S.

1,893

1,680 1,538 1,501 1,501 1,454

$0

$100

$200

$300

$400

$500

0

400

800

1,200

1,600

2,000

2007 2008 2009 2010 2011 2012




2,362

1,999

1,440

1,809 1,8771,744

$0

$100

$200

$300

$400

$500

0

500

1,000

1,500

2,000

2,500

2007 2008 2009 2010 2011 2012





Recap of 2012 – Private Equity Sectors in Favor: Who’s Hot and Who’s Not

7

Business Products & Services continues to garner substantial attention, with investors appreciating scalable and capital-light nature of these businesses in the face of macroeconomic uncertainty

□ Business Process Outsourcing

□ Staffing / PEOs

□ Facility Services


Consumer Products & Services has seen a shift from consumer staples to discretionary focused sub-sectors

□ Specialty Retail

□ Consumer Discretionary

□ Specialty Food (Organic, Gourmet, Ethnic)

Information Technology has seen recent investment growth as businesses continue to realize the savings associated with outsourcing information technology and other electronic services

□ SAAS

□ Systems Automation

Financial Sponsor Activity (Percent of Deal Count)

Healthcare investment has remained relatively stable amid uncertainty regarding the Affordable Healthcare Act

□ Pharmaceuticals

□ Healthcare Software

3% 2% 3% 2% 2%

4% 4% 5% 4% 4%

6% 6%6%

6% 5%

8%7%

6% 7% 7%

13%

11%11% 12% 12%

17%21% 19% 18%

16%

17% 17% 16% 18%20%

31% 33% 33% 33% 34%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2008 2009 2010 2011 2012

Information Technology Consumer Products & Services

Healthcare Business Products & Services

Industrial Energy

Financial Services Materials & Resources

Source: Pitchbook


Outlook for 2013 – Confidence Will Be Key Component

8

Q1 ’13 is experiencing a “hangover effect” from the “go-go” market of Q4 ‘12

M&A volume and public equity market performance are correlated

□ Continued improving sentiment supports an outlook for increased deal activity

□ Consumer confidence increased substantially in 2012, but still remains well below the pre-recession peak

The stage is set for a strong M&A year in 2013; however, anxiety surrounding the sequester and debt ceiling looms on the horizon


M&A Volume and Consumer Confidence M&A Volume and S&P 500

0

25

50

75

100

125

150

$0

$100

$200

$300

$400

$500

$600

Q2

'95

Q1

'96

Q4

'96

Q3

'97

Q2

'98

Q1

'99

Q4

'99

Q3

'00

Q2

'01

Q1

'02

Q4

'02

Q3

'03

Q2

'04

Q1

'05

Q4

'05

Q3

'06

Q2

'07

Q1

'08

Q4

'08

Q3

'09

Q2

'10

Q1

'11

Q4

'11

Q3

'12

Deal Volume Consumer ConfidenceSource: Dealogic

(Consumer Confidence)($ in billions)

0

200

400

600

800

1,000

1,200

1,400

1,600

$0

$100

$200

$300

$400

$500

$600

Q2

'95

Q1

'96

Q4

'96

Q3

'97

Q2

'98

Q1

'99

Q4

'99

Q3

'00

Q2

'01

Q1

'02

Q4

'02

Q3

'03

Q2

'04

Q1

'05

Q4

'05

Q3

'06

Q2

'07

Q1

'08

Q4

'08

Q3

'09

Q2

'10

Q1

'11

Q4

'11

Q3

'12

Deal Volume S&P 500 IndexSource: Dealogic

($ in billions) (S&P 500 Index)


Outlook for 2013 – The Return of the Mega Deal?

9

Market capitalizations have recovered from their lows in early 2009 to levels comparable with 2005 and 2006, providing a valuable acquisition currency and boosting CEO confidence levels

The “Wait-and-See” mentality that stemmed from the presidential election and fear of the fiscal cliff is over, and clarity surrounding the Euro crisis has increased

Buoyed by strong balance sheets and an appetite for growth, large strategic buyers have re-entered the market and are looking to put capital to work

Private equity mega funds have reemerged; fundraising efforts produced 32 $1B+ funds in 2012, compared to less than 20 in 2010

With the housing crisis in the rearview mirror, banks are looking to “turn the spigot back on” for high quality corporate loans with historically low interest rates


Mega Deals Announced in 2013 Year to Date

($ in bi l l ions)

Date

Announced Target Acquiror Deal Value

Enterprise

Value EV/EBITDA

Feb 05, 2013 Dell Inc. Michael Dell and Silver Lake Partners $20.5 $22.4 5.0x

Feb 05, 2013 Virgin Media, Inc. Liberty Global $13.2 $23.8 9.3x

Feb 12, 2013 NBCUniversal Media (49% equity stake) Comcast $16.7 $40.1 9.2x

Feb 14, 2013 H. J. Heinz Company Berkshire Hathaway and 3G Capital Management $23.4 $27.5 13.6x

Feb 14, 2013 US Airways Group AMR Corp (American Airlines) $10.6 - -

Feb 20, 2013 OfficeMax Office Depot $1.2 $1.7 8.7x


Outlook for 2013 – What’s Motivating Buyers?

10

Despite recent increased earnings following recession-era cost cutting measures, companies have been increasingly challenged to grow revenue organically given the limits of a slowly improving economy

Acquisitions have been tapped to accelerate market share expansion and improve distribution efficiencies

S&P 500 cash balances have reached a ten-year high at over $2.0 trillion, while near zero interest rates and higher dividend taxation provide incentive for corporate reinvestment

Low leverage and wide availability of capital from financial sponsors and commercial lenders are conducive to increased M&A activity


S&P 500 Cash Balances Uninvested PE Capital

$989 $999

$1,497 $1,601

$1,703

$2,060

7%

10%

13% 12% 13%14%

0%

5%

10%

15%

20%

25%

$0

$500

$1,000

$1,500

$2,000

$2,500

2007 2008 2009 2010 2011 2012

Cash on Hand Cash as % of Enterprise Value

Source: Capital IQ

($ in billions )

$428

$501$481

$433

$373$348

$0

$100

$200

$300

$400

$500

$600

2007 2008 2009 2010 2011 2012

Source: Pitchbook

($ in billions)


Outlook for 2013 – Strengthening Lending Environment

11

Middle Market Debt / EBITDA Multiples

Lenders remain hungry to put money to work, and competition can be fierce for high quality credits

Overall debt multiples (senior and sub) have held steady above 3.0x EBITDA in the middle market

A premium of nearly 1.0x EBITDA for deal values above $100 million has emerged

Despite more favorable lending conditions, middle market loan volume was down significantly below 2011 levels

A significant maturity wall in 2013 exists which, if coupled with an uptick in M&A activity, could support an increase in loan volume


$9.5

$26.9

$35.4 $36.4

$31.8

$9.2

$5.4

$11.5$14.3

$9.9

$0

$5

$10

$15

$20

$25

$30

$35

$40

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: S&P

($ in billions)

* Middle Market = issuers with EBITDA of ≤ $50 million

Middle Market Loan Volume

2.2x 2.1x 2.4x 2.3x 2.4x 2.3x 2.2x

2.5x 2.2x 2.2x 2.4x 2.5x

0.7x 0.4x

0.9x 0.8x

0.9x 0.9x 0.9x 0.8x 1.2x

0.9x 0.9x 0.9x

2.9x

2.5x

3.3x 3.1x

3.3x 3.2x 3.1x 3.3x 3.4x

3.2x 3.4x 3.4x

0.0x

0.5x

1.0x

1.5x

2.0x

2.5x

3.0x

3.5x

4.0x

Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Q2'11 Q3'11 Q4'11 Q1'12 Q2'12 Q3'12 Q4'12

Sub Debt Senior Debt

Source: GF Data *Middle Market = transaction enterprise value between $10 and $250 million

(Debt / EBITDA)


Outlook for 2013 – Private Equity: “A Bit Long in the Tooth”

12


Corporate and secondary sales comprised the majority of portfolio exits in the middle market in 2012, as the IPO market remained weak

With 641 deals, 2012 was a record year for exit volume, compared to the historical average of 395

More than 6,500 companies are currently held in financial sponsor portfolios, many of which are ready to harvest

□ The recession increased average hold times from 3.4 years in 2007 to 5.4 years in 2012

□ Nearly 70% of companies currently owned by financial sponsors have been held for three years or longer

Sponsors are eager to return capital to LPs in order to showcase returns and focus on raising next generation funds

Financial Sponsor Inventory Financial Sponsor Exits by Type

177219

370

436

525573

381

235

503533

641

0

100

200

300

400

500

600

700

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Secondary Buyout Initial Public Offering ("IPO") Corporate Acquisition

Source: Pitchbook

(# companies exited)

4,703

5,342 5,637

6,020 6,344 6,538

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

2007 2008 2009 2010 2011 2012*

Source: Pitchbook

(# companies held)

*through 11/30/12



13

Motivations and Factors

Confidence will continue to guide the level of M&A activity

Strategic buyers will acquire growth in the absence of organic opportunities

Large deals could cause industry participants to reevaluate growth strategies and spur additional M&A activity

Banks continue an aggressive push for strong credit opportunities

Financial sponsors will continue to eagerly pursue exit strategies for well-aged portfolio investments

Acquirors continue to compete for “trophy” properties and take advantage of improving financing markets

Transactional Characteristics

Scarcity value of well performing companies will perpetuate a market of “haves” and “have-nots”

Technology, healthcare, business services and consumer discretionary sectors will continue to garner attention over that of their commodity-based peers

Cross-border M&A activity will remain at relatively low levels in light of abundance of domestic acquisition and investment opportunities

Going Forward – Please Bate Your Breath

Could 2013 be the year we all expected in 2012?

Investment Banking Valuation & Financial Opinions Dispute Advisory & Forensic Services

M&A Valuation Methodologies

Jeffrey S. Phillips

Managing Director

Stout Risius Ross, Inc.

Traditional Valuation Methodologies

Discounted Cash Flow Method

Guideline Public Company Method

Precedent Transaction Method

15

16

Discounted Cash Flow Method

17

Discounted Cash Flow (DCF)

Projected cash flows are typically based on management projections

Free cash flows (FCF) are discounted to present value at the company’s weighted average cost of capital (WACC)

Courts have tended to place greater weight on the DCF methodology

18

Simplified FCF Calculation (One Year)

Year 1

Sales 556.19

EBITDA 194.67

Depreciation (18.00)

Amortization (10.00)

EBIT 166.67

Taxes (@ 40%) (66.67)

EBIT (1-T) or NOPAT 100.00

Adjustments

Add: Depreciation and Amortization 28.00

Less: Capital Expenditures (25.00)

Less: Investment in Working Capital (15.00)

Free Cash Flow 88.00

19

Sample DCF Output (Abbreviated)

Year 1 Year 2 Year 3 Year 4 Year 5 Residual

Free Cash Flow 88.0 96.8 106.5 115.0 123.0 129.20

Present Value (@15%) 76.52 73.19 70.01 65.75 61.18

Total PV of Cash Flows Capitalization Rate 10%

(Years 1 - 5) 346.7 Gross Residual Value 1,292

(Plus: Residual Cash Flows) 642.4

PV of Residual 642

Business Enterprise Value $989.0

20

Discounted Cash Flow: Projections

The two most contested issues tend to be projections and WACC

Board members should understand projections in the context of how the company is performing and relative to industry outlook and expectations

21

Sensitivity of Enterprise Value to WACC

Decreasing WACC from 15% to 13% = 25% increase in value

Sensitivity is greater for equity value (BEV – net debt)

Increasing or decreasing long-term growth rate also has a material impact

WACC 2.5% 5.0% 7.5%

13% 1,033 1,241 1,640

14% 939 1,101 1,388

15% 861 989 1,203

16% 794 897 1,062

17% 736 821 950

Long-Term Growth Rate

22

Current Issues Impacting DCF Method

Low interest rate environment

Expected return relative to historical returns

Uncertainty in overall market

Derivation of discount rate

Selection of terminal mulitple or long-term growth rate

23

Guideline Public Company Method

24

Guideline Public Company Method (GPCM)

Steps:

1) Identify publicly-traded companies that are meaningfully comparable to the subject company

2) Determine valuation multiples that are most relevant (e.g., EV / EBITDA)

3) Determine appropriate range of multiples for subject company

4) Apply selected multiple range to subject company financial results

Projected financial results are typically based on the same projections as used for DCF

25

Considerations for GPCM

Criteria for selection of guideline companies – Bankers should be able to articulate specific criteria for selection

– Board should query as to specific exclusions

Perfect comps can be hard to find . . .

– Most direct: Companies that also make widgets and sell to same customers

– Less direct, companies that:

Make widgets but sell to different customers

Sell widget components to widget manufacturers

Sell near-widgets to same customers

Sell not-widgets, but using same business model

26

Considerations for GPCM (cont’d)

For “less direct” comparables, likely differences in profitability and/or growth

Criteria for selection of multiple for subject company

– Bankers should be able to articulate criteria, usually in terms of average, maximum and minimum for guideline group

– Selection typically depends on factors including, but not limited to:

Profitability

Growth

Idiosyncratic company risk factors

Level of comparability

27

Sample Guideline Public Company Output

Guideline Public Company Method - Selected Multiples

In Thousands of U.S. Dollars Range of Indicated Multiples

Lower Upper

Measure of Performance Minimum Quartile Median Quartile Maximum

Near Comps 1

EV / LTM EBITDA 3.9x 5.4x 6.8x 8.7x 16.7x

EV / NFY EBITDA 4.2x 5.4x 6.3x 8.0x 14.0x

EV / NFY+1 EBITDA 3.8x 5.0x 6.0x 7.4x 10.8x

Near Comps 2

EV / LTM EBITDA 3.3x 3.8x 4.2x 4.6x 5.4x

EV / NFY EBITDA 3.3x 3.4x 3.4x 3.5x 5.2x

EV / NFY+1 EBITDA 3.1x 3.2x 3.4x 3.5x 4.3x

Company

Measure of Performance Low High Results Low High

EV / LTM EBITDA 4.5x 5.5x 195$ 900$ 1,100$

EV / NFY EBITDA 4.0x 5.0x 214 900 1,100

EV / NFY+1 EBITDA 3.5x 4.5x 236 800 1,100

Concluded Range of Enterprise Value (Rounded) 867$ 1,100$

Selected Multiples Indicated Enterprise Value

28

Current Issues Impacting GPC Method

Market multiples outside of long-term averages

Volatility in the marketplace

“Market Shock” of 2008-2009 continuing to skew metrics

Variances between public company multiples and transaction multiples

Multiple and EBITDA normalization

Correlation between projected growth and market multiples

29

Precedent Transaction Method

30

Precedent Transactions

Steps:

1) Identify change-of-control transactions with target companies that are meaningfully comparable to the subject company

2) Determine (available) valuation multiples that are most applicable to relevant industry (e.g., EV/EBITDA)

3) Analyze the transaction multiples to determine appropriate range for subject company

4) Apply selected multiple range to subject company financial results

Valuation multiple may reflect transaction-specific synergies

31

Considerations for Precedent Transactions

Precision of multiples impacted by:

– Lesser information available for private target companies

– Transaction structures may differ, for example:

Stock versus cash consideration

Tax / NOL implications

Distressed versus healthy target

True “comparable” transactions may be limited in number

32

Current Issues Impacting Precedent Transactions Method

Minimal Recent deal activity

Older transactions at higher muliples

Transaction selection bias

“Valuation Gap” between buyers and sellers

Changing tax laws

33

Summary and Other Considerations

34

Summary and Other Considerations

Three primary methodologies to determine Fair Market Value

– All methodologies incorporate more “Art” than “Science”

– All methodologies have inherent “Pros” and “Cons”

– Methodologies work best when they are used together to “triangulate” value

Accurate valuations must incorporate the current landscape

Best indication of value is a “market clearing” transaction

Dallas Office

Northpark Central Building

8750 N. Central Expressway, Suite 300

Dallas, TX 75231

(972) 387-4300

(800) 834-8586

New York Office

Rockefeller Plaza

30 Rockefeller Plaza, 26th Floor

New York, NY 10112

http://www.CFLLP.com

http://www.cfllp.com/

One of the larger locally owned firms in Dallas/Fort Worth

DFW is 4th largest MSA in the United States

Client base consists of:

- Service Industries

- Energy

- High Tech

- Healthcare

- Real Estate

- Distribution

- Light Manufacturing

Small to Mid-Size Companies



Impact of new tax law:

- Rates

• Capital gains increased to 20% from 15%

• Maximum ordinary rates increased to 39.6%

- Surtax

• 3.8% on investment income

• 0.9% on earned income

- Nothing yet on carried interests but substantial discussion

as new source of revenue



Medical Practice Acquisitions

Software Companies

Oil and Gas

Real Estate as alternative to financial investments to increase

yield for Class A properties




Analysis of Structure

- Sale of Assets vs Entity Ownership

- Consideration of Sellers retaining an interest

- Treatment of target financing

• Distributions not qualified to use installment treatment

- Consideration of tax free exchanges

- Assistance with Allocation of Purchase Price

• Covenant Not To Compete

• “Hot Assets”

• Seller wants capital gain; Buyer wants depreciable assets



Financial Modeling

- Valuation

- Cash Requirements



Due Diligence – Pre Close

- Audit

- Quality of Earnings Studies



Accounting – Post-Close

- Audit

- “True Up” Working Capital Targets

• Earnings Targets

- Assistance in recording transaction

• Push down accounting goodwill


M&A: The Year in Review and a Look Ahead; Recent ... · Feb 05, 2013 Dell Inc. Michael Dell and...

Documents

Transcript of M&A: The Year in Review and a Look Ahead; Recent ... · Feb 05, 2013 Dell Inc. Michael Dell and...