Slee on the ‘new math’ of M&A

BVWireIssue #69-1
June 4, 2008

“An ex-partner of mine used to say that M&A is more of a sport than a business,” says I-banker Rob Slee (Robertson & Foley) in a new article posted at his Midas Managers blog.  “Sometimes you bag big game—but more often than not the target runs away unharmed.  Like real hunting, there are certain quantitative elements to M&A.  And right now the math doesn’t look good.”  According to Slee’s research, one variable correlates well to lower middle market acquisition multiples: senior lending multiples.  “In broader terms, availability of capital determines private business valuation (at least for ‘market’ purposes)—and senior lenders provide most of the capital structure.”  When times are good, senior lenders get aggressive, lending up to 5-6 times EBITDA.  But when the economy ultimately cools, creditors retreat to asset-based lending. 

“In the current market,” Slee says, “senior lenders have moved down to about ‘3x’ run rate EBITDA on total debt.”  This combination of debt and equity has caused acquisition multiples to fall below five—and “owners just hate selling for less than 5-6 acquisition multiples.”  But this is what they’re now facing.  “Obviously sellers have a big math problem.  Crafty advisors are starting to rely more on economic bridges (earn-outs, seller notes) to boost purchase prices.  Assuming that lenders continue to retrench, which is highly likely, acquisition multiples will continue to fall—as will the total number of deals completed in the lower middle market,” Slee predicts.  “It appears to me that our sport is about to become a most dangerous game.”

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