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.