Insights & News
The first quarter of 2015 saw higher deal volumes relative to previous years, increased valuations, and noticeably higher levels of debt. By all measures, the year got off to a positive start and was favorable to sellers.
GF Data® reported that 196 participating private equity firms completed 54 transactions in the $10–$250 million value range in the first quarter versus 39 transactions during the same period last year. According to GF Data, the increase in deal volume is likely the result of more firms (both small and large) taking advantage of accommodating market conditions.
For 1Q15, valuation multiples moved noticeably higher, averaging 6.8x Trailing Twelve Months (TTM) adjusted EBITDA, the highest average valuation since 2Q12.
Here are the summary transaction data for the previous five quarters:
|All Transactions||1Q 14||2Q 14||3Q 14||4Q 14||1Q 15|
|# of Deals||39||46||45||53||54|
|Source: GF Data®|
- According to GF Data, the increase in the overall average EBITDA multiple was driven in large part by a surge in total debt to 4.0x compared to 3.6x in 2014. Increased debt levels were most prevalent in the smallest company size group (TEV under $50 million).
- With the utilization of debt expanding faster than valuations, equity contributions have decreased accordingly from 49.1% in 2013 to 43.4% in 1Q15.
- Valuations for health care services (8.1x in 1Q15 versus 6.9x historically) and distribution (7.3x versus 6.2x) recorded the greatest increase in value. Only technology and retail companies experienced a decline in 1Q15. The retail sector continues to suffer from headwinds associated with falling sales, shrinking margins, and fickle customers.
Pitchbook® M&A Multiples
- According to Pitchbook, average EV/EBITDA multiples increased slightly in 1Q15 to 7.9x versus 7.8x in 4Q14. Although values were similar, deal flow increased for the first time since 2Q14. The total value spent on deals in 1Q15 ($492 billion) increased 12% versus 4Q14 and 74% versus 1Q14. Overall, deal values are trending higher. For example, deals valued at $5 billion and over accounted for approximately 57% of total transaction value in the most recent quarter. If this trend continues, 2015 will likely be known as the year of the “Mega Deal.” By industry sector, healthcare contributed $200.3 billion or 41% of the 1Q’s total value. The healthcare sector continues to consolidate across niches to capture more market share. The following graph presents the quarterly breakout of EV/EBITDA and total debt/EBITDA multiples since 2013:
Debt Level Trends
- According to GF Data, senior debt increased significantly from 2.6x in 2014 to 3.4x in 1Q15 while sub debt levels decreased slightly. It appears that senior lenders and equity sponsors are aggressively increasing their piece of the capital pie at the expense of sub debt lenders.
- Pitchbook data indicates that the average debt/EBITDA multiple decreased from approximately 4.1x in 4Q14 to 3.7x in 1Q15.
One of the main themes in 2014, and so far in 2015, has been increased leverage driving higher valuations. A few years ago, this trend emerged in the larger deal group but has since taken root within smaller transactions as well. For years, private equity firms have successfully utilized debt to leverage their return on equity. However, financial buyers know that achieving high overall returns is very dependent on identifying solid companies and buying them at bargain prices. Going forward, with so much capital chasing deals, it will be interesting to see if we encounter a valuation “ceiling” soon or continue an upward trend driven by leverage.
Key Valuation Drivers
Over the years, I have often been asked what factors drive business value. Regardless of the status of the private equity or public stock markets, in my experience, with few exceptions, businesses with certain key attributes attract higher valuations than businesses that lack these attributes. I have summarized a few of these key attributes below:
- Cash Flow Generation — This may seem obvious, but it is surprising to me how many business owners do not focus on this. Cash flow is king because, without it, there would be no funds available for future capital investments, research and development, working capital, debt payments, or distributions to owners. In general, businesses that generate significant cash flow without significant capital investment are more attractive. Demonstrating historical and prospective cash flow growth is directly and positively correlated with higher valuation multiples.
- Management — Business owners need to be constantly grooming their successor managers. A company that has a cadre of senior-level managers sitting on the bench is much more attractive than a company with a thin management team. It is important to identify and develop managers with entrepreneurial talent early, motivate them properly, and keep them aligned with your goals. Otherwise, the risk of losing a key executive or two will tank the valuation.
- Intellectual Property — Companies that hold intellectual property assets (patents, software, trademarks, etc.) are generally more valuable than those that don’t. This is because properly protected IP assets allow companies to leverage employee know-how and ramp-up revenue and profits quickly. Although investments in R&D is required, once developed, IP-related products can be repeatedly sold with very little incremental costs. This is basically how Apple has made (and continues to make) millions for many of its investors.
By focusing on these attributes over time, business owners can enhance and control their valuations and ultimately be in the driver’s seat when it comes time to sell.
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