Summer Perspectives: Factors Coalescing to Drive Sales of Private Companies Higher
Private Company M&A has been chunky since the recession began in 2007.We believe that situation is about to change. Supply and Demand in the M&A market for Private Companies has been disjointed for much of this period.
Simply put: Demand exceeds supply. On the Demand side, Private Equity firms are flush with cash, have short time fuses on their funds and want to take advantage of historically low interest rates. Public companies are also flush with cash. Operationally, they have delivered, radically cut costs and become very efficient in taking advantage of technology by swapping human labor for technology/mechanical solutions, reduced office space etc. Financially, public companies have successfully kept shareholders happy with increasing dividends, share buybacks and increasing stock prices-the latter driven as much by, if not mostly, by easy monetary policy by the Federal Reserve Bank. However, all of these countermoves by public companies ( and the Fed) will not continue to offset the real problem companies face to drive increased future profits-that problem is lack of organic revenue growth.
Without organic revenue growth, companies can no longer substantially increase profits because the law of diminishing returns is setting in as they have little room to further cut costs and become efficient.
Therefore, Revenue must be the driver of future growth.How do public companies grow revenue in a slow growth economy? They must use their excess cash to buy accretive private companies. The penalty for not doing so will be their stock prices getting pressured every quarter they report earnings without any real growth in earnings.
Public companies are trading at healthy Price/Earnings ratios with low yielding cash on their balance sheets. It is highly probable that they will make use of both of these currencies to “Buy Growth”.
On the Supply side, although many Private business owners would like to sell and they have been waiting as much as six years to do so, many owners are concerned that low interest rates and perceived high equity prices are not an attractive risk/reward for selling their businesses. Simply put: They don’t think they can replace the yearly income generated from their business via a sale and the investment income from such a sale. Therefore, they prefer to remain undiversified and get the higher return from their business.
Public companies will be forced to buy and to grow and they have plenty of room to pay business owners a price they need to mitigate this concern.