GF Data Report: Q3 Shows Valuations Rebounding
Bob Dunn of GF Data shares the signs hinting at an M&A rebound in Q3
Those who remember the dark tone of the numbers from the second quarter may be happy to hear that there are signs that the M&A market is starting to revive as we closed the third quarter. Bob Dunn, the managing director of GF Data, an ACG company, joins Middle Market Growth Conversation podcast for the third installment in an ongoing series where we review timely data on mid-market, private equity-backed M&A.
Listen to the full podcast above, and read a transcript of the conversation below:
Middle Market Growth: Welcome to the Middle Market Growth Conversations podcast, I’m Carolyn Vallejo. Those who remember the dark tone of the numbers from the second quarter may be happy to hear that there are signs that the M&A market is starting to revive as we close the third quarter. Joining us on the podcast once again to review the latest data is Bob Dunn, managing director of GF Data, an ACG company. Bob, welcome back.
Bob Dunn: Thanks for having me back, Carolyn.
MMG: So after the bad news of Q2, you predicted we would see an improving market in the second half of the year. Have we seen the rebound in mid-market PE-backed M&A that you had hoped?
BD: Yeah, it’s sort of two sides of the same coin on that. We have seen improvement in multiples with purchase prices that folks are paying. That’s up markedly in the third quarter and for full year 2023, it’s starting to look closer to what we saw in 2022 though it’s still definitely off. The big challenge though is deal volume is still well off. We tracked 56 transactions last quarter. That’s well below the normal tally. You’re generally tracking around 70 to 80, so it’s definitely still a strained marketplace, but there is some improvement in pricing, which is the good news.
Transcript continues below
Watch: Bob Dunn on Q3’s M&A Rebound
MMG: For those 56 transactions that you noted that were completed in Q3 that GF Data analyzed, did you notice any trends within those transactions?
BD: Yeah, so I mean, I think again, looking at purchase prices across all the size tiers that we track, multiples were up in the third quarter, which is a good sign, particularly when you look at the smaller transactions and the $10 million to $25 million enterprise value range. We saw some good improvements there and that’s definitely a more challenging part of the market. It’s being hit more by some of the debt issues that we’re facing. But overall I think the multiples being up across all size tiers is a step in the right direction for an improved market.
MMG: You mentioned that purchase prices multiples are up across the board. What kind of multiples have you seen so far for buyout transactions?
BD: So right now we’re at 7.3 times trailing 12 month EBITDA for the first nine months of the year. That compares to 7.4 times trailing 12-month EBITDA for 2022. So even though it’s still off in terms of volume, we’re starting to see valuations rebound and begin approaching what we saw in 2022, which, again, I think is a sign we’re getting some more stability in the marketplaces.
MMG: When you look at the data, what share of the companies that transacted this year have been above-average performers, and how is that shaping expectations for deal volume in coming quarters?
BD: Sure. Let me recap how we calculate above average performers. So, we take out and pull out companies that have greater than 10% trailing 12-month revenue growth and those with greater than 10% margin. We classify them as above-average performers. The trend through the third quarter of 2022, we were seeing a high percentage of above-average companies completing transactions. It peaked at the end of the third quarter at 70% and we were seeing a drop in the premium that were paid for those companies.
What we’re seeing now is that above-average companies represented just 49% of the market in the third quarter, so well below what we saw in the third quarter of last year. And it’s a market change which tells us that more companies that are more average are actually coming to market and completing deals now, which, again, I think points to an improving market where sellers are likely to take the risk of a transaction versus the last couple quarters when they were really standing on the sidelines and only the best companies were making it through.
MMG: What kind of premium are buyers will to pay for these above-average performers?
BD: Interestingly, the premium was way down in the third quarter of 2022 as well. That was kind of the inflection point on it. We were seeing just an 8% premium for above-average versus everyone else. It’s now gone up to a 28% premium, so it’s been a good rebound there. The companies that are above average are definitely attracting a higher premium, but I think as importantly, companies that don’t make that mark are still going through processes and completing transactions.
MMG: Turning our attention to debt, debt pricing still appears to be a problem for M&A right now. How did that continuing challenge impact the deals that we saw last quarter?
BD: Yeah, so it’s an interesting market from the debt side of it. So overall, we tracked about a one percentage point increase in senior debt rates across all transactions, actually reaching to 10.5%. It was 9.5% last quarter. Obviously there’s dislocations in the debt market. I think that’s impacting deal flow, though there are some improvements in terms of coverage that we’re seeing, but the big question is cost of capital and what that’s pulling out in terms of structure for people. There’s been some interesting changes on that as well.
MMG: We have a column coming up in our Middle Market Growth magazine’s multiples report and it’s going to look at how creative deal structuring has helped move some of these deals forward in a tough environment. What types of structures are experiencing an uptick, and why is that happening?
BD: We’re seeing a lot more use of seller financing and earnouts, which makes sense given a kind of relatively risky market environment. We’re seeing also great opportunities for seller rollover equity, which I think is an exciting opportunity that’s normally not there. I mean, generally the GP wants to try and get all the equity for themselves and there’s a limited amount to go out to sellers to keep them on board, but we’re seeing that ratchet up. I believe it’s about 18% average now for seller rollover equity into transactions. And in many cases that could be sweeter than the original deal for people if they get in there and the company succeeds on it, and it’s going to be a relatively quick time horizon in terms of exit given that private equity just holds deals early for three to five years. So, the debt market has sort of created this situation, but it’s one that I think sellers can take advantage of and get a little more skin in the game in terms of their rollover equity.
MMG: Excellent, love the optimism. Looks like deals are getting done and hopefully we have a positive forecast moving forward, and we will of course check in again in the next quarter. Bob, thank you so much for joining us.
BD: Thanks so much for having me. Take care, Carolyn.
This transcript has been edited and condensed for clarity.
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