Coal miners once brought caged canaries into the mines to warn them of pending trouble. If dangerous gas were present in a mine, the canaries would die first, serving as a warning for miners to get out fast.
I thought about those canaries when I recently sat on a regional business economics association panel along with another investment banker and partners from two private equity firms. In discussing the global M&A outlook, the group agreed we are looking at an unprecedented marketplace in which valuations in all industries are incredibly aggressive.
One panelist noted that in the short term we could expect only blue skies ahead. There are many reasons to believe this. Since 2013, the number of private equity funds created to focus on the lower middle market (defined as firms between $100 million and $500 million in revenues) has increased significantly. More funds mean more available capital. Even in a market with high-priced assets, private equity groups are in the business of deploying capital. They need to continue to invest. Capital deployment in today’s market comes with a smaller margin of error, partially because of the high valuations required to get a deal done.
A recent report by GF Data says middle market valuations achieved a peak in 2016, so fund creation and valuations are at a high watermark. These market characteristics help make this a good time to be a seller. Buyers are often forced to be aggressive on good investment opportunities because they need to put their capital to work. It does not appear there are fewer sellers as in past cycles, but there are definitely more buyers. This strong demand is partially responsible for the valuation increase.
While one panelist’s “blue skies ahead” optimism for the short term M&A market feels good, we certainly need to watch and see what happens to the canaries. Government regulation is a big question mark. New regulations concerning tariffs and trade could have a lasting effect on the economy. Tax reform may affect corporations and individuals, but to what end? We expect interest rates will continue to slowly rise, but the general consensus is the slight uptick will not affect lending capacity. Obviously, the threat of global instability—or U.S. conflicts with Russia, Korea or in the Middle East—would have a negative impact.
No one could pinpoint anything specific. It was more a sense that the euphoric times we are seeing today are unprecedented. The days ahead seem bright, but all good things come to an end.
M&A has a cyclical nature. At this point, no one seems able to figure out when the canary will draw its last breath.
The Latest Deals
There were just 21 deals reported in February, down from 40 in January. There were 74 deals completed in the first two months of 2016—61 fewer deals than in the same period a year ago.
Private-equity backed independent agencies have been the most active buyers this year. They account for 24 of the 61 deals—nearly 40%. P-C agencies have been acquired most often. They make up nearly 50% of all the announced deals in January and February (30 of 61).
Arthur J. Gallagher & Co. has been the most active buyer with seven acquisitions through February. Notably this year, Baldwin Risk Partners and its affiliated company, Baldwin Krystyn Sherman Partners, have announced several transactions. They have been the second-most active buyer this year, behind Gallagher. Baldwin has announced three p-c agency acquisitions in the Florida market, where the parent company is based.
Trem is SVP at MarshBerry. Phil.Trem@MarshBerry.com.
Securities offered through MarshBerry Capital, member FINRA and SIPC. Deal counts are inclusive of completed deals with U.S. targets only. Please send M&A announcements to M&A@MarshBerry.com.
Sources: SNL Financial, MarshBerry.