While we have extensively discussed the emergence of the M&A bubble in recent months, with merger and acquisition activity in 2014 set to match or surpass the previous, 2007, record…
… driven exclusively by the record high stock prices of acquiring companies, which, together with the overabundance of cheap debt, has made the purchasing decision virtually a no-brainer, manifesting itself in the lowest purchasing cash consideration since 2001…
… one thing that has stood out is that while M&A has exploded, LBO transactions by volume, remain in the doldrums:
Why this glaring discrepancy?
Simple. Recall that while for M&A resulting cash flow is a secondary concern, primary being fooling equity analysts over the impact of potential “pro forma” synergies many years down the line (and just repeating “accretive, accretive, accretive” over and over), LBOs are and always have been about cash flows (and, of course, debt-funded dividend recaps). And in the new normal where it is all about Non-GAAP numbers, it is legitimate cash flow that has solidly refused to rise (why? hint: lack of capex).
Not only that, but since the acquiror has to fund the non-debt portion with cash, P/E shops don’t have the benefit of irrational exuberance pushing the acquiring currency to berserk levels.
But the biggest reason LBOs – which after all are a product of the “smartest guys in the room” spotting value which they want to then take private – is the following:
According to just released data by Murray Devine, the Median Ebitda multiple for buyouts has exploded to nosebleed levels, rising by over one full turn of EBITDA since 2013 alone, and at 11.5x in the first half of 2014 is nearly 2x higher than during the last LBO bubble peak in 2008, when the average company was taken private at a conservative 9.6x EV/EBITDA.
Further from the report:
Cheap credit is having a significant impact on the deal-making environment. As mentioned previously, the median debt percentage for 2014 deals has hit 72%, a six percentage-point jump from 2013’s 66%. Leverage use has skyrocketed since 2011, when the median debt percentage for PE deals was around 55%. Median debt percentages in 2013 and the first half of 2014 both outpaced the percentages seen during the buyout boom; for context, the median only reached 63% in 2007.
Analysts have noted recently that PE firms, armed with cheap debt financing, have been pushing purchase price multiples beyond what many strategic acquirers are willing to pay. Danaher (NYSE: DHR), for instance, came up short twice against PE bidders in 1Q, first with Ashland’s water technologies business, which CD&R agreed to carve out for $1.8 billion in February, and later with Johnson & Johnson’s diagnostics unit, which Carlyle agreed to buy for $4 billion in March.
To win those deals, PE investors have pushed valuations (11.5x) to historically high levels and have added an extra turn of debt to their transactions. Last year’s median debt-to-EBITDA multiple ballooned to 6.9x, a big jump from the 4.9x median in 2012. Through the first two quarters of 2014, debt multiples are even higher at 8.2x. Part of those high debt multiples, according to some, is tied to a resurgence in cash-flow lending in the industry. Equity-to-EBITDA multiples, on the other hand, have been muted. This year the median has shrunk to 3.3x, down from 3.6x in 2013 and way down from the 3.9x median in 2011.
And here is where the crying will begin once the Fed’s latest, and at this point last, credit bubble finally bursts.
So yes, there is a bubble, pure and simple. In fact, it’s the biggest bubble ever. Anyone claiming otherwise is an idiot and/or an economist.
Let’s move on.