Key 2014 Considerations for CEOs Considering Private Equity Deals

Traditionally Private Equity buyouts have made money through a handful of value-creating levers:  Buying at a good price; using capital and leverage effectively; operational improvements; and exit management.

A 2014 poll by The Deal showed a significant and increased reliance on operational improvements versus use of leverage, buying low, and selling high.

80% of survey respondents indicated that operational improvements are more important now than before the financial crisis, and 50% indicated they start focusing on operational improvement (and spending due diligence funds) before signing a letter of intent.  Operational improvements could range widely: from product pricing policy, to cost cuts, to add-on acquisitions, to personnel changes/additions.

Most of these funds were also investing from their latest/largest funds, suggesting adequate PE management company cash flows to enable higher levels of pre-LOI research.

One other key insight from the survey was that 75% of respondents found management skills weaker than initial assessments, and a majority of the survey suggested a heavy reliance on operating partners and former CEOs for investment management insights.  Some of this sentiment could be reflection that operational improvement strategy and implementation is hard work.

Many new PE deals in the current market are highly priced at entry.  Given this, deals in 2014 are not just about levering the company and selling at a high price.  Private Equity is increasingly focused on running their portfolio companies differently.


Strong Q3/Q4 Expected in Med-Tech M&A

After record Med Tech M&A activity in Q1/Q2 characterized by bigger but fewer deals, a strong surge in middle market acquisitions and divestitures is predicted for the second half of 2013.  M&A is a key structural component of the medical device industry, where scope and scale are primary competitive advantages.  In many unpredictable economic cycles, healthcare M&A stays relatively constant, driven separately by demographics, new product introductions, and regulatory dynamics.

Active Large Deal Market:  2013 YTD global healthcare M&A totaled $156B, the highest YTD level on record, and more than twice the 2012 YTD volume of $72B. In particular, Abbott’s (ABT) spin-off of AbbVie was the fifth largest healthcare M&A deal on record.  Another notable transaction was the $8.7bn acquisition of Bausch & Lomb by Valeant Pharmaceuticals – 2013’s fourth largest healthcare deal.

Source: Dealogic LLC

Middle market acquirors seemed focused internally in Q1/Q2, addressing internal restructurings in the face of a weak global economy, the implementation of healthcare reform and new medical device taxes.  Offsetting these negatives and leading into the second half of 2013, have been strong and growth-focused acquirer stock performances.  To enhance topline growth, it is expected that companies like Abbott (ABT), Johnson & Johnson (JNJ), Boston Scientific (BSX), Covidien (COV), and Stryker (SYK), will actively pursue acquisition targets with renewed energy.

Large Cap Med Tech Stock ETF Performance (NYSE: IHI)

Source:  Yahoo Finance

Target Considerations:  The medical device and technology sector is already characterized by significant scope and scale advantages, recent regulatory and tax changes are making it even more difficult for smaller device companies to achieve operating scale.  Companies and investors have been united in their characterization of the slated 2.7% medical device tax as a job and innovation killer.  Margin pressures fall out in many ways for companies with successful devices, including more difficult growth funding, and less cash flow to invest in global sales and distribution – Where faster growth in emerging markets is becoming increasingly important.

This combination of acquirer and target dynamics is strongly suggestive that middle market Med Tech M&A will be resurgent sooner than later.


Critiquing NYT Dealbook's Q1 Take on the M&A Market

We are big fans of Dealbook, The New York Times investment and transaction-focused reporting team.  But we thought their recent piece on M&A activity in Q1: Mergers Slowed to Snail's Pace in Q1; Lowest Since '03 missed the forest for the redwoods.

The article expressed disappointment that a combination of improved economic conditions, stock market advances and banker/lawyer predictions had not driven higher volumes.

Sometimes large cap biases miss broader market dynamics.  Economists analyze M&A as a form of corporate investment, and look at M&A dollar volume of deals as a percentage of GDP.  Granted that $10B deals create massive direct and derivative economic impacts, but most CEOs and owners are focused on opportunities under $100MM.

Source: NYTimes

From a different perspective, looking at number of quarterly deals involving US non-financial targets between 2003-2013, the momentum over the past few years is clear.  And in 2011-2012 deal flow involving US targets averaged 2,000 deals/quarter, varying 5-10%.  December was clearly a big month, driven amongst other things by tax-related timing.

Source:  Benning Associates LLC, Dealogic; excludes Finance and Real Estate

In the graph above upticks are frequently followed by pauses.  In our opinion, that is a key take-away from Q1 activity: Q4/12's boom stole Q1/13's thunder.  We would also point out two other considerations:  First, that corporate earnngs are better, but not great -- just 10 companies in the S&P500 were 90% of the earnings growth.  CEOs are very concerned about acquisitions being immediately accretive.  Similarly, many sellers that we work with are forecasting meaningful earnings improvement in 2013, suggesting that exits in the second half of the year will increase, as those budgets bear themselves out one way or another.


Key M&A Insights Looking Into 2013: Record Number of Deals, Fragile Markets

The end of 2012 saw a surge in deal flow that left M&A markets at levels equaling 1998/1999 and 2005/2006 market peaks – approximately 11,000 M&A deals involving US companies.

2012, however, was different from these previous highs:  1999 was fueled by a tech stock bubble, and 2006 by structured debt markets.  Our sense is that 2012 was driven by buyers with excess cash and needs for external growth, and sellers with macroeconomic, concentrated wealth and risk management concerns.

Source:  Dealogic LLC.  M&A involving US companies, 50%+ final stakes, ex-Finance/Real Estate

Within the 2012 aggregate numbers, several long-term averages held true for M&A involving US-based companies:
  • The large majority of deals were small and private – 75% of deals had no disclosed value
  • Divestitures were 40% of the market – 1/3 of previous deals were re-sold within 5 years
  • Cross-border acquirors were 20% of deals – Europe was 50% of these, mostly <$100MM
  • Private equity made 1,100 entries and 400 exits, with deal size trending towards $100-500MM

Looking into 2013 we believe activity for the full twelve months will continue at current levels, albeit with challenges and turbulence.  Acquiror balance sheets are at their strongest in many years, internal growth is hard to come by, and cash assets are earning negative real returns.  The downside risks for M&A are also clear:  The US economic recovery is weak, even with aggressive government stimulus, and global political/financial problems are not going away.

Deals that get done in 2013 will have compelling straight-forward rationales.  This suggests for acquirors these deals will also be more successful than long term averages.



Serves as Exclusive Financial Advisor to Neighborhood Health Plan

Boston – October 1, 2012—Benning Associates LLC, a boutique investment bank, today announced the closing of the affiliation of Neighborhood Health Plan (NHP) and Partners HealthCare (Partners).  Benning Associates served as the exclusive financial advisor to NHP and assisted in structuring and negotiating the transaction on its behalf.  Through this affiliation, these organizations will have the ability to address the growing need for care coordination and management and the flexibility to develop innovative patient- and family-centered models of care.
“We are excited to have advised NHP on this transformational business affiliation, assisting with the evaluation of potential counterparties and executing an appropriate strategy for the company,” said Greg Benning, Managing Director of Benning Associates.  
“Today marks the beginning of an exciting new chapter for NHP,” said Jay Remington, Managing Director of Benning Associates. “Together with Partners, NHP will be better able to continue to deliver high quality care to underserved populations now and into the future”
The transaction closed on October 1, 2012.  Hemenway & Barnes LLP served as legal advisor to NHP.
For inquiries, contact Benning Associates at 617-261-3999
About Neighborhood Health Plan
Headquartered in Boston, MA, NHP is a not-for-profit corporation, fully licensed by the Massachusetts Division of Insurance as a health maintenance organization.  It has provided comprehensive health services since 1986.  An NCQA-accredited managed care organization, NHP serves MassHealth, Commonwealth Care, Commonwealth Choice, and fully insured commercial members across the Commonwealth.  By working closely with the MassHealth program and commercial purchasers, and by partnering with community health centers and other providers, NHP grew rapidly from a few thousand members in the late 1980s to approximately 250,000 members today throughout Massachusetts.  NHP serves members who have access to a provider network of more than 4,000 primary care practitioners, over 13,400 specialists, and 65 teaching, community, and specialty hospitals.  For more information, visit nhp.org.
About Partners HealthCare
 Partners HealthCare is an integrated health care system, founded by Brigham and Women’s Hospital and Massachusetts General Hospital, that offers patients a continuum of coordinated and high-quality care.  In addition to its two academic medical centers, the Partners system includes community and specialty hospitals, a managed care organization, a physician network, community health centers, home health and long-term care services, and other health care entities.  Partners HealthCare is committed to patient care, research, teaching, and service to the community.  Partners is one of the nation’s leading biomedical research organizations and is a principal teaching affiliate of Harvard Medical School. Partners HealthCare is a non-profit organization.


M&A Market Divergence – Interpreting an Active Middle Market vs. Declines in Large Deals

Over the past 12 months there has been a significant divergence between Middle Market M&A and the $1B+ “Large Deal” Market.  Middle market deals have continued to increase, and are at levels equal to 1999 and 2007 peaks.  On the other hand, large deals have dropped 30% year-over-year.  This divergence in indices of total deals (a good proxy for the middle market) and total value of deals (which is very driven by $1B+ deals) has reached levels equal to the 2009 Financial Meltdown and the 2002 Internet Bubble collapse.

For CEOs contemplating deals in 2H/2012 and 2013, this is critical to understand.  Is Middle Market M&A about to slow down?  Or are geo-economic and global capital market concerns creating so much planning uncertainty for large company CEOs, boards and investors that they are simply knocking down the big deal market?

Source:  Dealogic LLC.  North American targets, acquired stakes >50%.  Excludes real estate and financial institution transactions.  Data reflects trailing 12mo averages.

In Q2/2012 there were 2400 announced M&A transactions in North America and $267B of disclosed deal activity.  This number of deals is close to 1999 and 2007 highs.  However, for large deals, 2011-2012 dollar volume reflected a sharp reversal of their recovery since 2009.  We believe this decline is a function of very short term planning visibility, and a low level of corporate confidence in politicians and monetary authorities.  We believe the planning environment for larger global business models is difficult, and going to stay that way into 2013.

Our silver lining takeaway is for smaller companies.  The North American economy is slowly improving.  Lots of industry sectors have undergone fundamental changes, which should drive competitive restructurings.  Acquirors have cash on their balance sheets for investments.  There is a significant amount of private investor and lender dry powder.

Barring international market crises, our view for 2H/2012 and 2013, is that corporate and private equity acquirors will continue to be active in the lower middle market.  Large acquirors may not be doing big deals, but as they focus on their core businesses, acquiring smaller businesses with clear value, and divesting those that do not fit, will be key strategies.

Middle market deals will be do-able, but also harder to close.  Large company CEO/investor caution mentioned above will be very evident, and will show up indirectly in M&A transactions.  Due diligence will be exhaustive and longer.  Negotiations will be aggressive.  Financial forecasts will need to be very carefully prepared, and it will be important to have multiple transaction options, bidders and lenders.  This suggests an increased importance for pre-transaction M&A preparedness by would-be sellers.


Full Rebound for Machinery-Related M&A

# of Deals in Q2-2012 Equals 2006 – 2007 Peak

Capital equipment-related M&A is much more cyclical than other industry sectors.  Tied to corporate investment and capacity planning, it is a tangible indicator of acquiror economic confidence, and 2012 – 2013 revenue and profit forecasts.  Looking at the 2012 slowdown in large M&A deals, middle market machinery/equipment M&A transactions provides evidence supporting increased domestic manufacturing activity.

In Q2-2012 North American-based machinery/equipment deals should exceed 80 announced transactions, equaling all-time peaks.  From our perspective, approximately half of this is related to technology acquisitions, and half is tied to forecasted infrastructure and capacity-related capital spending.  We are optimistic this end-market focus will enable an M&A deal window similar to 2006-2007, even while geo-economic issues are impacting Europe.

Source:  Dealogic LLC


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 3rd 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.

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.

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.

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.