If you have been waiting for a recovery in the Merger & Acquisition environment in the defense and government services industries, we have bad news: you will most likely have to wait until well into 2014. By almost all accounts, the M&A market has yet to snap out of the doldrums.
Back in 2008 and 2009, we could blame the problem on a dearth of available financing; however, today there is plenty of cash on corporate balance sheets. Lenders are more than willing to finance good deals. So, what gives? The reasons are diverse, including concerns over declining federal budgets, uncertain government programs, questions about the sustainability of global growth, and the increasing cost of business resulting from the vast array and complexity of government regulations, to name just a few.
With M&A volume meandering sideways, the fact that valuations are stagnant should also come as no surprise. Middle market M&A multiples continue to remain in the 4X to 6X EBITDA range, and sometimes higher in the case of acquisitions by strategic buyers.
While this all might sound depressing, it should not be. For companies with an interest in growing through M&A, conditions could not be much better. Between cash balances and available credit, there is plenty of financing available to fund good deals. Next, the Federal Reserve and other central banks have indicated a commitment to maintain low interest rate environments. Additionally, Baby Boomer retirements and generational transitions in family-owned businesses should continue to result in buying opportunities. Finally, the absence of frothy valuations typically present at this stage of a recovery have not yet materialized, increasing the likelihood of M&A success (when measured in terms of return on investment). This last point is particularly important, because M&A failure rates tend to increase dramatically as asset prices increase. Additionally, many larger companies are opting to divest non-core business units.
Despite the favorable environment, it is important to remember that M&A is fraught with risk. To maximize your probability of success, keep the following points in mind:
- Make sure you have an M&A strategy. Clearly defining business objectives you intend to accomplish through M&A can help identify a broad pool of targets, sift through those targets to identify the best fit, and minimize merger premiums.
- Start small. Successful acquirers tend to grow through a large number of small acquisitions, rather than “betting the farm” on a single transaction.
- Set a walk-away price. The best acquirers set a maximum price early on and stick to it.
- No stone unturned. Make sure you and your advisors do as much due diligence as possible before an acquisition, so you can make an informed investment decision and arrive at a proper valuation. In addition to thoroughly understanding the business and the financial aspects of the transaction (the target’s assets, revenue streams, liabilities, cost analyses and projections), also make sure you have a firm grasp on the risks involved in the transaction, and mitigate them to the best of your ability.
- Do not fall in love with the deal. Negotiating a deal is exciting, but walking away is not. Call it what you want—pride, hubris, delirium—but the sheer desire to close the deal often leads incredibly brilliant people to do incredibly stupid things. Hit the pause button from time to time and ask the advice of those you trust.
