In the current market, due to the corona effect, we see a decline in the number of merger and acquisition transactions. Unjustified because conditions and prices are excellent. Here’s why:
Rising prices in the stock market
It will not have escaped anyone’s notice that the stock market has developed very well in recent months. Despite the corona perils, expectations are very positive. Prices in the stock market have skyrocketed. The price-to-earnings ratios of many companies, i.e. valuations, are high. A big chunk of a positive outlook for the future is being drawn. The question here is whether this development is also reflected in a positive merger and acquisition market?
The positive price development in the merger and acquisition market
In the merger and acquisition market, we also see the price increases of the stock market. Transactions involving listed companies as buyers or sellers have high valuations, i.e. high multiples. But this is as yet only for transactions involving listed companies, the so-called public sphere. For transactions in the “private sphere,” i.e. unlisted companies, multiples have always been at lower levels. What is the trend in the value of these private transactions?
Stable development for SMEs
It is difficult to find reliable data for this specific market because the acquisition price of many transactions is not disclosed. In the Netherlands, for example, we have the Brookz Acquisition Barometer, which is based on a survey of merger and acquisition advisors. This is a fairly large group but it is not objective and complete data. This shows a decline in so-called multiples in the first half of 2020 and a slight recovery in the second half of that year. The US data show a more stable picture for the smaller transactions, valuations remain at the same level for 2020 as well. It could just be that the recovery in America is our foreland in the Netherlands.
In theory, valuations should rise
So there is a difference in valuations and associated multiples depending on both the nature of the transaction (public/private) and the size of a deal. This difference is not only in the absolute level of the price, but also whether this price shows a downward or upward trend. This is actually not justifiable when looking at the factors of a valuation. In theory, valuations of SMEs should also rise. After all, the same basic rules apply to both large and small companies.
Falling interest rates could drive up prices
The main reason for the increase in the valuation of larger companies is falling interest rates.
After all, interest rates are historically low and have fallen even further in 2020. This interest rate factor is reflected in companies’ stock valuations. An equity valuation is nothing more than a valuation of a company’s earning power in the future. Here, future cash flows are mapped out and calculated to today’s value. This calculation of the value is done with a so-called discount rate. This includes, among other elements, the interest rate. And the lower the interest rate, the higher the valuation.
A multiple such as a P/E ratio or an EBITDA factor is actually a derivative of a more complex equity valuation. The higher the valuation, the higher the multiple.
High competition due to insufficient supply and high demand
But the price is also ultimately determined by supply and demand. Our daily practice shows that there is relatively little supply of good companies of sufficient size. However, there is a lot of demand, both from companies looking to grow in their market through acquisitions and from financial investors looking to buy nice companies.
And financial investors in particular are ubiquitous in the M&A market. With almost unlimited amounts of (pension) money in their investment funds, they are diligently looking for suitable investments. In almost every sales process, you come across financial investors as potential buyers. These investors graze the market for good candidates to buy. They do so directly through their own network and contacts and through corporate finance advisors. This leads to more demand for entrepreneurs looking to sell their businesses in 2021.
Competitive market drives up price but also process becomes more difficult
So because the market is highly competitive, sales processes are also highly competitive. This ultimately drives up not only the price but the various bidders often have to bid against the competitor until the last moment in the process. Where previously only one or two parties did the due diligence, we now often see many more parties doing due diligence simultaneously. This is in the hope of then making the winning bid. And where in the past a due diligence could sometimes lead to a downward adjustment of the price, in this competitive field it will not happen easily. Hardly surprising for a selling party. All the more important to choose a good (process) advisor in this process. This is to manage the multitude of buyers well and make the best use of the negotiating power. See also our blog ‘Setting up a data room when selling a business’: http://bit.ly/3pml7MI
We can help you
Are you considering selling the business and waiting for the right time? Are you perhaps considering transferring the business to management or the next generation in the family? We can advise you on the marketability of your business. Especially in these market conditions, as the market seems favorable to sell the company in 2021. We will advise you on the possible valuation or what you can do to make your business sale-ready.
Call Clifton Finance:
Gonneke van der Lee +31 6 52466518 or Maarten Vijverberg +31 6 55853074.