If you are like me, you’ve probably seen countless headlines describing a hot 2018 merger and acquisition (M&A) market. While I can confirm that in many regards that this market is very healthy, I must also share a cautionary piece of advice regarding how to interpret many of these headlines. I am doing this because I believe many people rely on mainstream media and national publications to form their opinions of how the U.S. M&A market is performing and what they can expect in the future. However, most mainstream publications focus on broader M&A market trends, which can include global statistics, as well as mammoth-sized transactions, which don’t usually provide an accurate reflection of how most transactions or trends behave within the specific market a reader is interested in or actively participates in. Therefore, statements and questions that people approach me with, like, “The market is really hot” or “How long can it last?” often stem from curiosity fueled by the opining of prognosticators on stats that frankly don’t apply to those people. In reality, a substantial share of the U.S. M&A transaction volume is comprised of middle-market and lower-middle-market transactions (deals of typically less than $250 million). These types of deals receive much less press and attention and are often drowned out within the broader statistics you see and hear, due to lack of dollar volume and scale. This is certainly the case across the region, as most transactions that are announced and/or advised upon are of the lower- or middle-market variety.
2018 in review for the lower and middle market:
By most any measure, regardless of which market segment we look at (in terms of size or geography), 2018 was a strong year for M&A. The market most familiar to many, the U.S. lower- and middle-market, posted total transaction volume of $349 billion, which exceeds last year’s total of $329 billion. This represents a year-over-year increase of $19 billion, or 6.0%. The 2018 total was even more impressive when benchmarked against the prior 10-year period and prior 5-year period annual totals; compared to these statistics, last year demonstrated an increase of 31.8% and 13.6%, respectively. From a dollar-volume perspective, the only other year in the past 10 that was higher than 2018 was 2014.
As you can see, 2018 was a statistically strong year for the lower and middle market. If one is being nitpicky in observing trends and wanting to find signs of a newer and weaker trend, one could point to the fourth quarter of 2018 as showing signs of some deceleration. To be sure, it was the slowest quarter of the year ($82.3 billion), but it still proved to be the third-highest Q4 in the last decade, which is nothing to sneeze at.
Finally, activity was brisk across most all sectors and among all classes of buyers (strategic and private equity), with technology and healthcare representing the largest contributors to total volume in 2018. In general, 2018 was a very strong year for M&A.
2018 was great for lower and middle markets—are we in for an encore or growth in 2019?
My unofficial poll of other U.S.-based M&A service providers as well as various other buyers with whom I have relationships would indicate that 2019 is off to an even faster start than 2018, based on their pipeline of active pursuits and engagements. At VonLehman, we closed a dozen transactions in 2018, making it a strong year by our standards. At this same point last year, we had two active deals with business owners in our pipeline for which we were providing sell-side service. In the first month of 2019, we have three times that amount of active assignments, suggesting we have an extremely active year in store for us. When I talk to others, these general trends (e.g., more activity to start the year) seem to ring true for most everyone, and there seems to be no softness on the near-term horizon. For the naysayers that want to point toward Q4 2018 as a harbinger of things to come, I believe it to be a possible blip that was potentially caused by execution capacity constraints (among those who get deals done) and likely some political uncertainty (e.g., trade, government shutdown).
If you don’t want to take my unofficial polling as gospel, Deloitte recently released its “State of the Deal M&A Trends 2019 Survey,” which asked over 1,000 U.S.-based M&A and private equity professionals about their expectations for 2019. According to Deloitte’s survey, roughly 80% of respondents expect the average number of deals they close on to increase over the next year. Additionally, 70% expect that the size of those transactions will be larger than the ones brokered in 2018. These findings appear consistent with my much smaller, unofficial poll.
What are the catalysts that could continue to accelerate 2019 M&A activity?
Several catalysts that existed in 2018 will continue accelerating M&A activity into 2019. First, companies are thirsty for innovation, disruption, and growth, and these are typically very difficult to grow or initiate organically from within. Most businesses are concerned with disruption in general, seeing a need to be proactive. This would certainly explain why the technology sector did so well in 2018 and will likely continue performing well in 2019. I expect this desire for disruption to persist in 2019. Second, many companies expect that the effects of tax reform and repatriated cash will provide excess cash for strategic buyers, which they will be hungry to deploy in return, generating assets such as acquisitions. In addition to excess cash from these aforementioned items, company earnings will remain strong as well, which only bolsters cash reserves and the desire to deploy. Third, private equity funds continued to possess ample “dry powder” despite deploying considerable capital throughout 2018. Although new fundraising efforts have slowed, these new efforts that have been occurring are trending toward a lower- and middle-market bias, which creates ample new dry powder in these markets. Fourth, the available debt capital for M&A activity is still readily available at a relatively low cost to acquirers. I believe this to be one of the most, if not the most, influential factors that will contribute to continued M&A volume growth. Availability of debt isn’t just a phenomenon occurring with large banking institutions, either. Alternative sources of capital will continue to raise funds at a rapid pace and are primed to put money in deals as well.
What Does VonLehman believe regarding 2019?
Given all the activity we see in our own pipeline and hear about others, in addition to other aforementioned driving factors that persist, VonLehman’s M&A advisory group expects another very robust year of M&A activity that is on par with 2018, if not better. We are cautiously observing macro-economic trends, and barring any sizeable collapse or economic contraction, we anticipate a brisk pace of deals, a high dollar volume of deals, and seller-favorable valuations to persist.