M&A Special Circumstances

After several years of a strong buyers’ market, fueled in large part by flush private equity firms and readily available credit, the sagging economy and financial sector problems have caught up with the mergers and acquisitions market.

According to Thomson Reuters, which tracks mergers and acquisition data, there were 14,727 deals in the United States in 2007, with a total value just less than $2 trillion. In 2008, that number dropped to 12,225 deals, with a total value of $1.31 trillion. The first quarter of 2009 saw 2,170 deals with a total value of $175 billion, putting the year on track to realize approximately 8,700 deals with a total value of just $700 billion—a big change in two years.

Minnesota deal numbers showed a similar decline. In 2007, there were 461 deals in the state with a total value of just less than $36 billion. Last year, it was 446 deals with a total value of just less than $21 billion. In the first quarter of 2009, 52 deals, with a total value of $1.73 billion put the state on track for approximately 200 deals for the year valued around $7 billion.

Despite the dramatic downturn, however, some industries and market sectors are still seeing deals. The volume isn’t enough to pull the mergers and acquisitions industry out of the doldrums, but the bright spots highlight the sectors that are pushing forward in this economy.

The Plunge

The troubles in the mergers market are largely those that have affected the national financial sector, as well as the U.S. economy in general. “The housing market put consumers on their ears, which caused a collapse in credit, which caused a banking crisis, which caused some big liquidity problems, which caused layoffs, which put houses back at risk,” says Jim D’Aquila, managing director of the Mercanti Group, LLC, a private investment bank in Minneapolis. “No one knows who to believe, and no one believes in anyone’s earnings projections. We’re waiting for the other shoe to drop.”

In the past few years, private equity firms were willing to pay as much as a six to seven times a company’s earnings before interest, taxes, depreciation, and amortization (EBITDA). In the current economy, private equity has much less access to credit. Previously, financial buyers might have put 25 to 33 percent equity into a purchase, accessing capital at a ratio of three, four, or five borrowed dollars for each equity dollar. Now that ratio is one to one “if you can even get it,” says Thomas Lyons, president of Faelon Partners Ltd., a mergers and acquisitions advisory firm based in Golden Valley. As a result, private equity firms can’t match 2007’s total deal value, and are likely forced to cut back on deal volume, too.

Private equity firms are also waiting to see what moves the new Obama administration will make, which may involve changes to disclosure rules and taxation structure. It’s possible that private equity fund principals will be required to pay ordinary income tax rates on profits, rather than lower capital gains tax rates. “People are on hold for a few months to see what’s really going to happen, waiting to see what the Congress and administration will do,” Lyons says. “Private equity is on the sidelines.”