M&A 2012: Interesting Chart -- Confidential Pricing Hides Robust M&A Middle Market

Middle market M&A deals with confidential valuations increased 20% year-over-year in 2011 and in the second half of the year hit record levels, exceeding 70% of announced transactions.

Key takeaways for 2012 deals.

Reading the 2011 M&A Market: Up, Down or Sideways? For lower middle market M&A deals (<$250MM) involving companies in the US or Canada, depending on how you slice it, yes.

Through mid-December there were roughly 2900 middle market deals with announced values totaling $115B – or an average deal size of $40MM. Both of these 2011 market parameters are roughly equal to 2010 – suggesting the market is flat from 2010-2011.

However there have also been approximately 6700 M&A deals with confidential pricing in 2011, versus 5600 in 2010 – a 20% increase. While there are some $250MM+ deals in this dataset, it is safe to assume that most are smaller deals.

It is interesting to note that this trend continued in 2H-2011, despite stock market volatility, and US and Euro-zone economic issues. Since June 2011, there have been roughly 3200 deals with confidential pricing, versus 2600 in 2H-2010 (a 24% increase).

Buyers and sellers in M&A transactions are not obligated to disclose deal values, except in certain public company circumstances, and there are many reasons both sides prefer privacy. For acquirers, valuations give powerful business-related signals to competitors and other 3^rd parties with no direct interest in the transaction. For sellers, M&A liquidity events are major milestones, but privacy with respect to personal financial matters is clearly preferred.

Key takeaways here are: 1) Market and economic issues impact deal announcements with price disclosure requirements more than those that are kept confidential; and 2) over 70% of deals are not disclosing pricing and valuation terms. These are meaningful, requiring “old school” research and relationships to understand what 2011 deals and markets will actually mean for a 2012 transaction.

Data source: Dealogic LLC. M&A deals involving North American companies with undisclosed or <$250MM transaction values. Final ownership stake >50%. Excludes real estate & finance sector.

Transaction Announcement: World Energy Solutions Acquires GSE Consulting

Benning Associates' Greg Benning served as financial advisor to World Energy Solutions, Inc.

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DALLAS, TX and WORCESTER, MA--(Marketwire -11/01/11)- World Energy Solutions, Inc. (NASDAQ: XWES - News), a leading energy management services firm, today announced it has purchased GSE Consulting, LP (GSE), a TX-based energy management and procurement company, for approximately $8.6 million at closing plus a potential earn-out. The acquisition provides World Energy a major foothold in Texas, the largest de-regulated electricity market in the U.S., and a significant presence in the fast-growing small and medium-sized market. World Energy expects the transaction to positively impact top-line revenue, EBITDA and backlog in 2012.

"With GSE, we gain a proven winner in the competitive Texas marketplace with a large pool of customers and a top flight sales team," said Richard Domaleski, CEO of World Energy Solutions. "This transaction caps off a series of strategic acquisitions we have made over the last several weeks that we believe are 'game-changing' for us. Together these moves advance our consolidation of the energy procurement space, broaden our customer target set and geographical reach, and increase our energy management capabilities. Consolidating these companies will accelerate our growth and enhance our EBITDA margins."

Added Brian Dafferner, President, GSE: "We see tremendous upside for our customers and employees in joining forces with a national leader like World Energy. The Company's vision for lowering total energy costs, and its ability to execute that vision, will be well received by the hundreds of businesses we serve. Not only do we see an opportunity to cross-sell new services into our existing customer base, but we believe our knowledge and relationships will help World Energy penetrate additional Texas-based and national accounts."

Formed in 2002 following the inception of electricity deregulation in Texas, GSE has become one of the premier energy consulting and management firms in the country. World Energy will retain the services of more than 20 GSE employees across three offices: Dallas, Fort Worth and Houston.

Today's deal marks the third in seven weeks for World Energy, which recently announced the acquisition of Co-eXprise's energy procurement business and energy efficiency firm Northeast Energy Solutions.

Greg Benning of Benning Associates served as investment banker to World Energy Solutions in the transaction. Benning is licensed as and acted in the capacity of a General Securities Principal through Burch & Company, Inc.

Transaction Announcement: World Energy Solutions Acquires Co-eXprise's Energy Procurement Business

Benning Associates LLC served as investment banker to World Energy Solutions, Inc.
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WEXFORD, PA and WORCESTER, MA--(Marketwire -09/14/11)- World Energy Solutions, Inc. (NASDAQ: XWES - News), a leading energy management services firm, today announced it has purchased the energy procurement business of Co-eXprise, Inc., a privately-held enterprise software firm. The acquisition extends World Energy's leadership in online energy procurement, adding valuable new government, institutional, and commercial & industrial clients to its large and growing customer base. World Energy expects the transaction to be immediately accretive.

"Our acquisition of Co-eXprise's book of business in energy increases our market share, expands our government franchise, and adds to our backlog," said Richard Domaleski, CEO of World Energy Solutions. "Bigger picture, this deal highlights our ability to put the capital we raised earlier this year to smart use in advancing our strategic growth objectives. We have long said that consolidating the energy procurement industry, eliminating competitors and supplementing our strong organic growth is a path we will actively pursue to drive future success, and today we are making good on that promise."

Added William Blair, Founder and CEO of Co-eXprise: "This transaction is a key component of Co-eXprise's strategy to generate working capital to invest in the continued growth of our enterprise software business. We chose to sell the energy procurement business to World Energy, a true leader in the space, to ensure our customers will continue to receive a high level of professional support for their energy management initiatives. This transaction represents a win for all parties."

Today's deal marks World Energy's second in energy management. Its 2007 acquisition of Energy Gateway made World Energy a leader in natural gas procurement and brought with it a blue-chip base of industrial clients that remain a bedrock of the Company's success.

Transaction Announcement: Partners Healthcare Signs LOI to Acquire Neighborhood Health Plan

Benning Associates is serving as investment banker to Neighborhood Health Plan.
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Boston Globe (Aug 11, 2011) - Partners HealthCare System Inc., the state’s largest hospital and physicians network, has signed a letter of intent to acquire Neighborhood Health Plan, a Boston-based nonprofit that insures more than 240,000 mostly low-income residents across Massachusetts.

Under the deal, which would give Partners a foothold in the health insurance business, no money would change hands. But Partners would contribute an unspecified sum to provide grants to more than 50 community health centers affiliated with Neighborhood Health. Partners would also work with the insurer and health centers to provide better medical care more efficiently to the urban poor in Boston and other cities, the parties said.

“We are making a critical long-term commitment to take care of this population,” said Dr. Gary L. Gottlieb, chief executive of Partners, which owns nine hospitals in the Boston area. “As we look at the downward pressures on Medicaid dollars and other subsidized products … we are very concerned and want to make sure there are not barriers to our institutions. We want to make sure care is accessible to everyone.”

Deborah C. Enos, president of Neighborhood Health, said the 25-year-old insurer has been weighing the benefits of an alliance as the health care industry consolidates. It has been talking to potential partners for several months, she said. The majority of Neighborhood Health’s members receive coverage through state programs, such as Medicaid and Commonwealth Care, which provide health insurance for low-income residents.

“This is an opportunity for us to look forward and position Neighborhood Health Plan to be better situated in the future,” Enos said.

It would not be the first time a health care provider and insurer have joined forces. Several hospitals in Massachusetts, including Boston Medical Center, Cambridge Health Alliance, and Baystate Health in Springfield, also have insurance operations. And in Pennsylvania, insurer Highmark Blue Cross Blue Shield plans to affiliate with a local health system.

Enos said Neighborhood Health is working toward negotiating a definitive agreement with Partners by late October. The deal would require approval by state Attorney General Martha Coakley, the state Division of Insurance, and the US Department of Justice.

Cross-Border Buyers Returning to US M&A Market

M&A transactions involving companies with deal values of $100MM or less are considered to be the core of the M&A market. Over the past ten years, the cross-border M&A exits involving US targets and international buyers have increased approximately 50%. This trend peaked in Q3/2008 at 35% of all completed transactions.


The geographic shift in buyers is a function of global economic drivers and the decline of the US$ versus other acquisition currencies. Looking forward, we expect this M&A trend line to continue as the US economic recovery continues, 2011 target company earnings become more visible, and foreign acquirors flex their financial muscle.

Between Rocks & Hard Places: Managing Low M&A Bids

One of the toughest situations for founder/CEOs and venture capital investors is a “good but not great” M&A offer: A bona fide proposal, but one that is below seller price expectations.

These are difficult for several reasons. The buyer is usually a strategic acquiror, who knows the target’s markets and customers quite well. They may not know the target’s full value, but think they know what it is worth, and what it will take to acquire it. Typically these are one-on-one negotiations, not multi-bidder sale processes. Information imbalances create conservative M&A bids. Conservative bids in turn can create problematic "agency conflicts."

Agency Conflict is a financial economics term for a conflict of interest between parties with different interests in the same asset (for example, different % shares in sale proceeds at different deal prices). Individual circumstances and incentives can put one party at odds with their partners. And below-expectations pricing exposes agency conflicts like nothing else.

In a typical venture-backed capital structure, management is at the bottom of the deal proceeds water-fall: That is to say, VCs usually get paid first. Depending on the terms of options imbedded in different classes of stock (preferred dividends, participation rights, vesting rights, etc.), there can be significant differences in net proceeds to the junior parties in a deal.

The graph below shows a sample transaction, illustrating how increasing (decreasing) deal proceeds get divided up between common, participating preferred and non-participating preferred.



Lower-priced deals can be very difficult negotiations. VCs have a fiduciary duty to maximize portfolio returns to their investors. Management however, has all their economic interests in the company’s common stock and options. If management proceeds are less than hoped for, the deal could be at risk. The deal may make sense overall, but not for key employee decision-makers.

Counter-Strategies for Targets: There a number of steps VC-backed companies can take. Here are two general pieces of advice.

First, before acquisition interest turns into a written bid, have appropriate management/VC discussions about key employees, market compensation and retention packages, unallocated stock/options and other issues with economic ramifications. Have some level of internal agreement (or at least shared awareness), and be in a position to manage these views early in any M&A discussions.

Second, get a 2nd bid. Work quickly to evaluate other actionable options, whether staying independent, or trying to stimulate additional buyer interest. Nothing changes negotiating leverage (and pricing) like multiple bidders.

More Upside for New England M&A Market

In September 2006, I spoke at the ACG Boston Breakfast Series. There were over 300 people in the room, and my message was simple: “Tell your clients if they are thinking about doing a strategic deal or financing, do it now.” The transaction market had been rallying for several years, multiples were full, and confidence was high. It was also clear conditions weren’t going to last.

Today I work with a team of M&A bankers at Benning Associates (http://benningLLC.com), based in Kendall Square. Our Firm’s current market view is more tempered, but optimistic: There is more upside for the New England M&A market.

The New England M&A market has recently seen 25-30 deals announced deals each month – roughly 2/3 of long-term averages. There have been a number of VC-backed exits and divestitures, but relatively few high-quality private company sales. Simply put, demand significantly exceeds supply.

The graph below shows indexed M&A announcements between 2006-2011, for New England and the United States as a whole.

The lower middle market (sub-$100MM) held up into 2008, well after the sub-prime crisis and shutdown of leveraged finance. Also, in 2009-2010 New England had more relative transaction activity, due to regional industry mix, large healthcare and software/services sectors, and a solid base of VC-backed companies.

Healthcare will continue to be an area of interest for acquirors for simple reasons: Sheer market size, trends in demographics and chronic disease, regulatory change and cost control mandates. These will drive large, high growth, profitable investment opportunities. Click here for a link to a recent Benning Associates presentation on Med-Tech and Healthcare IT deal drivers.

The leveraged finance market for target companies with $10MM+ of EBITDA is hot again, and term sheets for sponsor-backed $5MM+ target companies are very competitive. There is significant dry powder in PE funds, and they are raising more capital in anticipation of increased opportunities. As PE investors figure out ways to address current owners’ financial goals, we will see a significant uptick in PE deals involving New England private companies.

The lower middle market is still a challenging one to get deals done in. In particular, for smaller companies, with more concentrated risks, the economic recovery is still unpredictable – and potential volatility in operating results is weighing on valuation and structuring discussions. The good news is that most trends are generally “up and to the right” for the foreseeable future – so deals that get sidetracked today, have a good chance of coming back together, if counterparties handle discussions properly.

US-Based Software M&A: 2011 - Not what we’ve been expecting

Software is one of those classic scope:scale M&A sectors, where big players with tons of cash buy up little guys to address known customer demand (product scope), or increase efficiencies for existing offerings (cost cuts and economies of scale).

Surprisingly, after a big volume quarter in Spring 2010 ($16B)… the number of software deals has actually declined for three successive quarters… back down to 2008-2009 levels of about 200 deals/quarter.

Usually, a big M&A quarter with big deals, instigates shake-out and re-alignment within competitive product markets… deals drive deals. It hasn’t happened this time, even in the context of an economic recovery, strong acquiror earnings, and a rising equity market.

Our view is that paradoxically, these same factors are keeping a lid on deal-making.

Priority number #1 for the large software acquirors is delivering on earnings. They have aggressively cut headcount and discretionary spending… lessons learned in 2001-2002 bursting of the Internet bubble. M&A transactions have restructuring charges and front end-loaded investments. Good deals are accretive in year 1, but unless there are immediate sales synergies or cost cuts, even for single product line acquisitions, most deals hit stride in year 2.

M&A is often considered to be another form investment, like CAPX or R&D. It is external versus internal, but at experienced acquirors, it is analyzed with similar capital budgeting tools. Absent strong champions within acquiror sales organizations, CEOs and their corporate development staffs are being cautious about deal-making, as with any discretionary spending. This situation obviously creates a growing backlog of good deals waiting to happen.

Our prediction for the back half of the year is that growth in M&A will rebound strongly with pressure on acquirors for top-line growth, and increased customer IT spending. We expect particular emphasis on enterprise productivity-oriented cloud, SAAS and mobile offerings.

Two Very Interesting Charts, re Q4-10 Buyout Activity

In leveraged finance, stripping away all romance, there are two primary deal drivers: 1) valuations that matter to sellers; and 2) debt capital that allows buyers to afford these prices.

Aside from first-tier strategic buyers, financial sponsors (private equity/LBO funds) are the key players in the middle market. As regulation, technology and trading economics have driven the market value threshold for public companies to $500MM+, investors like foundations and endowments have decided to skip the public markets, and invest in sub-$500MM companies through private funds.

During the M&A market peak of 2006-2007, PE/LBO investors were approximately 1/3 of all announced deal volume in the $100-500MM size range. In Q4 2010, transaction activity surged and equaled those peak years.

The first chart below, tracks private equity portfolio exits since 2006. Exits matter because they generate real returns for investors and re-investment in new funds. Exit activity in Q4 signals an improvement in valuation, but more visibly – looking at the green bar, it shows an increase in secondary buyouts – sales from one private investor to another. These sales are usually fully valued and very dependent on the availability of bank debt.

Chart Source: Pitchbook

This point is important for private company owners: The debt markets for lower middle market deals are opening up again.

Our view of the economic cycle, bank balance sheets and lending spreads/fees, sees this accelerating in 2011. In addition to the increasing availability of funds, low interest rates are helping make transactions more appealing to buyers.

The second chart below shows lending to financial sponsors by type of deal.

Chart Source: Thomson Reuters LPC

Dividend recaps are simply new lending facilities for existing investments, allowing PE/LBO investors to take chips off the table. The more meaningful Q4-10 data, in our opinion, are the two blue bars “LBO and other deals.” These are again close to peak year statistics, and show that the banks are willing to lend into new deals as well.

During 2011, the banks will see a string of positive announcements, as problem assets shrink, and regulators approve dividend payments to shareholders. This in turn will generate pressure to grow, and put money to work in new loans. These changes within the banks are going to greatly improve the abilities of middle market companies and investors to get deals done.

2011 Med-Tech M&A: Deal Drivers for Middle Market Targets

2010 turned out to be a strong year for Med-Tech M&A – a healthy rebound from 2009 levels – with a string of deal announcements with total disclosed valuations of greater than $500 million. Pausing briefly during the economic turmoil, Med-Tech consolidators have resumed external corporate development, employing “best defense is good offense” tactics; and paying full M&A prices to enter or accelerate penetration of targeted new market segments.

This heightened deal activity has also included acquisitions where the buyer had made a previous investment to achieve an exclusive "first mover" option, while the asset advances through clinical, regulatory or commercial milestones. This has been a prominent strategy of St. Jude, Boston Scientific and Medtronic (MDT portfolio has 60 minority positions valued at $360 million).

With the capital markets reaching their highest levels since 2007, banks more willing to lend and an increasing number of companies seeking exits at acceptable valuations, we are optimistic this trend will continue in 2011.

For a list of 2010 Med-Tech acquisitions with total disclosed deal values greater than $500 million, click HERE.

Like many transactional markets, the “top-line” of the Med-Tech M&A market has exhibited volatility over the last few years, with total number of deals and disclosed value fluctuating significantly year-to-year. However, these fluctuations are largely driven by large cap transactions. As shown below, the number of large acquisitions can spike under the right circumstances and go dormant under others.

Conversely over a 10-year period, the sub-$100 million deal market has experienced more consistent volume. While economic conditions may periodically shut down the market for acquisitions greater than $100 million, “lower middle market” deals and those with undisclosed values (largely sub-$100 million in value), continue to get done with established transaction volume support levels. Note to reader: Compare 2008-2009 volumes in the graphs immediately above and below this paragraph.

Acquirors will not always be willing or able to effect larger strategic transactions (particularly public companies when their stock prices are under pressure), but smaller build-on/tuck-in acquisitions are simply considered an integral part of existing product/market strategies. This segment of the M&A market is less cyclical for a number of practical reasons:

• Straightforward deal rationales – Acquisitions are accretive in the near-term due to sales and marketing synergies, or the acquired technology enhances current product offerings and drives greater market penetration.
• Small bets = manageable downside – Even for larger acquirors, because smaller deals have a greater percentage of success, so not every acquisition needs to be a billion dollar opportunity to be an attractive M&A candidate.
• More efficient R&D strategy – Rather than bear high costs and uncertainties of early stage internal R&D projects, small acquisitions allow acquirors to outsource this role to entrepreneurs and venture capitalists, and pay for proven assets.
• Less integration risk – Relative to larger, more complex businesses, small acquisitions can be added without a large allocation of company resources.
• Larger universe of potential acquirors – For smaller targets, there is a greater number of suitors with a strategic rationale AND the required financial wherewithal.

For the owners/decision-makers of Med-Tech companies being groomed for eventual exits, there are several key thoughts we would offer as relevant for achieving a successful liquidity event:

• Know the buyer universe, big and small – While a target may fit well with large, diversified Med-Tech consolidators, it is important to investigate smaller, lesser known companies who would view an acquisition as a transformational event. This includes sponsor-backed buyers, who are opportunistic and have good access to capital.
• Strategic touch points establish credibility – Early and ongoing discussions with potential strategic buyers create a more receptive audience when a sale process is actually undertaken.
• No substitute for commercial proof points – Whether a product is sold into the hospital, physician’s office or homecare market, its competitive advantages, reimbursement strategy and potential market ultimately prove out with compelling sales and growth.
• Business model is critical to making the acquisition case – Valuation hinges on demonstrating that a product will be accretive given assumptions for manufacturing costs, scalability and reimbursement.
• IP position is where deals often fall apart – A strong and focused IP portfolio is a must-have and will be highly scrutinized in the course of buyer due diligence.
• Go-it-alone strategy and funding provide leverage – M&A cannot be "PLAN A". It is important to have a strategy that credibly finances build-out of the business infrastructure. Even in a competitive M&A process, a strategy of staying independent is an important source of negotiating leverage.

While markets will continue to fluctuate, we can be confident that the sub-$100 million Med-Tech M&A market will continue to provide exit opportunities for smaller companies.

Competition will continue to drive acquirors to seek growth and innovation through external M&A initiatives.

2011 Private Company M&A: Market-Related Considerations

A current McKinsey & Company study articulates Four Core Principles of Corporate Finance for CEOs. We see relevant M&A-related insights for private company owners.

Four Core Principles: 1) Core-of-Value: Value equals return on invested capital and growth; 2) Conservation-of-Value: Only increasing cash flow increases value; 3) Expectations Treadmill: Demands for performance and growth are compounding; and 4) Best Owner: Businesses do not have inherent value – they have different values to different owners and investors.

Analyzing the 2010-2011 M&A market, Benning Associates sees these principles applying directly to transaction decisions for private company CEO/owners.

Most M&A transactions are in the $10MM-$100MM segment of the market, and on the sell-side are driven by “Best Owner” considerations of valuation and up-front liquidity – “It is worth more to me than you, and I’ll pay cash.” For private company owners contemplating liquidity, 2010 has been a significant improvement over 2009, and 2011 looks to be even better. Target companies in 2010 demonstrated core earnings and growth plans, and acquirors re-assessed investment needs and financial resources.

The charts below highlight sales of US-based private companies to either strategic acquirors or private equity investors. The first chart highlights the last 10yrs (2001-2010), and the second covers the 15 years beginning 1995 -- providing some interesting visual context for 2009-2010, inclusive of the 1999-2000 tech/internet spike.



70% of exits in this size range are in the consolidation-intensive technology, healthcare and business services sectors, where acquirors look for straightforward top-line or cost-cutting synergies – tying back to McKinsey’s value concepts. “If we buy this asset we can sell a lot of it.” “We can use this to sell a lot more of our core product.” Or “if we buy this, we can reduce manufacturing costs, cut duplicative SG&A, etc.”

On the buy-side, we expect these cash flow-oriented SCOPE and SCALE deal drivers to assert themselves strongly in 2011, where acquirors with cash reserves and funding resources seek to meet performance expectations.

In 2011 there will be continued upside momentum in valuations. Mean transaction size in the $10-100MM range in 2010 was $29MM, versus $32MM over a ten year period. Indexed dollar volume and number of deals usually track each other tightly, but there was divergence in 2008, as deal sizes dropped sharply. In 2011 with stabilized earnings and multiples, we expect these indices to re-converge, due to more quality sellers at higher prices.

So what’s the takeaway? For owner/CEOs contemplating M&A exits or liquidity, the bottom line is that valuation and cash gets deals done. In 2011, we expect acquiror fair value to more often exceed seller target prices – making acquirors the new “Best Owner” of many corporate assets. This valuation shift, plus improved acquiror financial resources and a relatively stable macroeconomic environment will enable a robust 2011 M&A market.

Transaction data source: Dealogic LLC
McKinsey Quarterly: http://www.mckinseyquarterly.com

Advanced Materials M&A: Strong Demand for Better Mousetraps

Advancements in materials and manufacturing science continue to drive growth and investment opportunities across a wide variety of industry verticals. While exciting advances are often topics of media coverage, the real opportunity lies with those companies that are able to convert an often less than headline grabbing advancement into something that can be commercially produced and sold. In today’s economic environment, that generally means providing something that clearly works better, faster, cheaper than the existing alternative.

It also means these opportunities can be difficult to spot as they are often incremental improvements on current processes, not immediately obvious to casual observers. The appeal of these business models, and subsequently the opportunity to invest in them, is that they generally provide the end-user with increased efficiencies and/or higher cost-performance ratios without dramatic changes to their way of doing business. This enables end-users to lower their costs or offer superior products at the same price points. Only a small minority attempt to create new markets based on previously unavailable technologies.

Another common theme among successful materials-based businesses is a rapid valuation ramp as they gain market acceptance and prove commercial viability. This generally is preceded by a sometimes protracted proof of concept and validation period marked by lower valuations reflecting the increased risk of commercialization.



There are a number of common themes among those advanced materials companies that have successfully attracted investment dollars:

• Well-established product market – to be penetrated through reduced cost and/or improved performance;
• Proven reliability / ability to meet industry standards – penetrating established markets not only requires performance validation of the product itself but often regulatory and quality (ISO) accreditation as well;
• Direct path to high volume production – savvy investors are aware of the dangers of assuming bench-scale quantities can be quickly and easily scaled up to production volumes;
• Clear end market value proposition – for any potential buyer to assume switching costs and the associated risks there needs to be a simple, credible and quantifiable value to the end user; and
• Focused target market and commercialization plan – it is not unusual for multiple applications or markets to benefit from materials science advancements, but a focused initial approach lends credibility to an ability to penetrate wider markets later.

Understanding these issues and positioning an investment opportunity to potential buyers are critical for attracting interest and maximizing value.