M&A in 2013

2012 Review & 2013 OutlookM&A Activity Report

2012 Review & 2013 Outlook

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M&A Activity Report

AxialMarket is the network for qualified deal professionals. Professionals join AxialMarket to source opportunities, manage active deal processes, and build smarter relationships.

Introduction

Data & Methodology

This report analyzes 3 primary data sets:

• In-depth 1:1 interviews with a carefully screened subset of Members from across a variety of industry verticals

• AxialMarket Network activity data

• A survey sent to 14,000 deal professionals

To give insight into the coming year, this report reviews major trends, industries, and events from 2012 and the expected activity for 2013. All real-time snapshots of market activity in the report are as of December 31st, 2012.

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M&A Activity Report

Thanks to Participating MembersEdwin Burke, Managing Partner at Pillsman PartnersPillsman Partners, LLC is a private investment firm that specializes in direct investments in established, small to lower-middle market businesses. We focus on companies with $1 to $10 million in EBITDA, stable cash flows, and strong organic growth potential.

Stephen Connor, Director of Business Development at Hamilton Robinson Capital PartnersHamilton Robinson is a lower middle market PE firm that was founded in 1984. We focus on the Commercial and Industrial sector-specialty/niche manufacturing, industrial services and distribution. We have years of successful investing experience and a strong knowledge base in this sector.

Marek Olszewski, Managing Partner at Catalus CapitalCatalus is an investment firm that partners with US, Canadian, and European middle market companies and private equity funds by providing capital and operational expertise. We facilitate expansion opportunities and strategic initiatives, and also consider asset-backed deals.

Spencer South, Partner and Principal at Lazarus CapitalLazarus Capital Partners is a private equity firm based in Birmingham, Alabama, focused on acquiring controlling equity interests in lower-middle-market operating businesses. LCP’s target investment profile is concentrated in manufacturing, value-add distribution, and business service companies.

Chris Eichmann, Managing Partner at Pillsman PartnersPillsman Partners, LLC is a private investment firm that specializes in direct investments in established, small to lower-middle market businesses. We focus on companies with $1 to $10 million in EBITDA, stable cash flows, and strong organic growth potential.


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M&A Activity Report

2012: A ‘Moderate’ YearFor much of the M&A world, 2012 was a year defined by perennial uncertainty. After a lackluster start, activity never seemed to hit a rhythm. Whether it was the JOBS Act, the presidential election, or the fiscal cliff, deal activity was stalled with uncertainty, waiting for the next major trend.

Moderate

47%

Slow

43%

Strong

10%

2012 M&A Environment:Because of this overarching uncertainty -- and still-recovering economy -- 2012 was a slow-to-moderate year for M&A. When asked about the year, 47% of survey respondents described the environment as “moderate,” with another 43% describing the year as “slow.” Despite these views, 84% of survey respondents reported closing at least one deal in 2012.

Steve Connor of Hamilton Robinson Capital Partners agreed with the ‘moderate’ sentiment. He explained, “While [activity] started off slow, it definitely picked up during mid-year

and the summer months. By the end of October, however, the time for closing deals was narrowing and activity began to taper off. Instead of focusing on new deals, many PE firms and investment banks were working to close the ones in process.”

The focus on closing deals in the late fall left some quality deals on the table for firms -- like

2012 Deal Activity:

Deals Closed No Deals 1-3 Deals 3-5 Deals 5+ Deals% of Respondents 16% 50% 21% 13%

Pillsman Partners -- who remained actively focused on cultivating deal flow. Chris Eichmann, Managing Partner of Pillsman, explained, “Instead of maintaining a warm pipeline, groups pushed to get their deals across the finish line before year-end. Not only did fewer close than


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M&A Activity Report

expected, but many capital providers seemed distracted by the rush. This allocation of time led to several quality assets coming to market that did not get much attention.”

Sent Deals & Pursuits of Deals by Quarter

The inconsistent deal activity -- both in quality and quantity -- hit many firms asymmetrically. Marek Olszewski of Catalus Capital remarked, “2012 was both a great year and a difficult one.” He explained, “From a returns perspective, we are making solid risk adjusted returns for our investors. However, from the new capital invested perspective, 2012 was more difficult. While we did make a few investments, it was fewer in number and smaller in size than desired.”

Business Owners Not Coming to MarketFor the past several months, there has been a general hypothesis that business owners would come to market to sell before new taxes went into effect in 2013. While there was a minor surge towards the end of the year, “at the end of the day, tax uncertainty failed to act as a strong impetus to convince sellers that now was the best time to sell,” explained Edwin Burke of Pillsman Partners. “Seller valuation expectations [exceeded] that which the market was willing to ascribe to their businesses. This proved somewhat frustrating -- to compete with sellers choosing not to sell.”

One of the major motivations for business owners to endure the potential tax hikes is the

0

50

100

150

200

250

12-Q1 12-Q2 12-Q3 12-Q40

200

400

600

800

1000Deals Sent Pursuits

As the year came to a close, many firms found themselves with meager pipelines for 2013. This realization could have spurred the relative spike in pursuits seen in Q4.

Data: AxialMarket


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M&A Activity Report

overall lackluster economic and investment environment. Connor explained, “One contributing factor to the decreased lower middle market deal flow is the current interest rate environment. If an owner were to sell his business today, he would have limited options to invest his proceeds on decent yielding investments. Rather than parking their money in low-yielding CDs, many owners are deciding to hold on to their businesses.”

Spencer South of Lazarus Capital confirmed Connor’s read on business owner temperature. “In speaking with business owners, I have found that many who were contemplating going to market have reassessed due to the lack of investment options for the proceeds of a sale.” As a possible solution, South suggested pursuing partial sales. “One way we aim to combat the issue is a partial sale of the business where the owner takes chips off the table, but stays in for 20-30%.”

The low-yield interest environment has affected business owners and deal professionals alike. As a lender, the compressed rates have created unique challenges in 2012. Olszewski explained, “Interest rates have continued to come down throughout the year. While this is good for borrowers, it is bad for lenders.” He added, “Debt has been performing well -- it is a very competitive environment.”

Dry Powder, Valuations, and LBOsThe challenges of thin deal flow were supplemented by the enormous amount of dry powder sitting in private equity funds. With the clock ticking on the more than $1 trillion in capital overhang, many private equity firms began expanding the parameters of their investment theses.

“In terms of purchase price, we try and stay disciplined in the 4x - 6.5x valuation range.” - Spencer South, Lazarus Capital

“We see a fair amount of deals in the 5x - 7x EBITDA range in the lower-middle market.” - Marek Olszewski, Catalus Capital

“We really focus on deals where the acquisition multiple falls somewhere between 3x and 6x.” - Chris Eichmann, Pillsman Partners


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M&A Activity Report

As Connor explained, “We saw some larger private equity firms coming down market and pursuing smaller companies. Their presence continues to create an imbalance between the supply and demand for quality companies, which has created highly competitive auctions.” The movement of larger firms into the middle market has not only driven valuations up, it has

also impacted deal financing strategies. The combination of the capital overhang and interest rates has created a buyout-friendly environment. As Olszewski explained, “The amount of equity going into LBOs is definitely on the rise. PE firms are using less debt and relying on senior debt or unitranche facilities, and less on mezz or subordinated debt.” He added, “In order to get that type of capital structure, firms are relying on high-yield and loan markets.”

Industry Total Deals AveragePursuits/Deal

Active Interested Investors

Industrials 1,571 6.65 529Manufacturing 1,458 7.39 622

Technology 936 6.79 586Energy & Utilities 701 8.18 310

Healthcare 659 6.36 471

2012 Industries with Highest Average Pursuits

Northeast 759

South 1931

West 1274

Midwest 843

2012 Deal Breakdown by Geography

In 2012, the largest number of deals originated in the Southern United States.


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M&A Activity Report

2013 OutlookAlthough the fiscal cliff is resolved -- for now -- the uncertainty that stifled activity in 2012 has set a weak stage for 2013. According to Connor, “Because of slow pitching activity and weak deal flow the past few months, it is unlikely we will see a torrent of deals early in 2013.”

MoreDeals

53%

FewerDeals

26%

Volume willPlateau

21%

2013 Expected Activity:However, a slow start does not necessarily mean a slow year. Connor speculated that a few variables could jumpstart activity. “One variable that may spur M&A activity is if private equity firms start selling their portfolio companies. Since many funds are reaching the end of their investment horizons, they will need to sell their portfolio companies to show realizations in order to raise the next fund.”

Eichmann identified a different backlog of deals that could come to market in the second half of 2013. “In the past couple of months, many business owners have been deferring their sale until 2013. They have told us they wanted to wait until Q1 or Q2 of 2013 -- or even 2014 -- because they are either hoping for better visibility or validating their current growth plans.” If these business owners do decide to sell, it could mean stronger activity in 2H 2013. Not everyone agrees, however.

Greatest Concerns for 2013:

Dry Powder

Cap Gains/Carried Interest

Fiscal Cliff

Other*

28%

25%

22%

25%

*Other: JOBS Act, European Affairs


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M&A Activity Report

57% of survey respondents believe that Strategics will be better positioned for acquisitions in 2013.

- AxialMarket Private Capital Survey

Some -- like Olszewski -- believe that activity will spike early in the year, only to then wane thereafter. “I don’t see 2013 as a big turning point for activity. However, I do think January will be very busy. After a significant holiday -- like the one this year -- there tends to be a spike in new activity. I think people will return in January to find many new deals and will be quick to jump on them.”

Major Players: Strategics and Healthcare on the RiseEven if activity remains modest throughout the year, the majority of survey respondents believe that strategics -- not financials -- will be in a better position to drive the growth. Connor believes, “Corporates will be driving the overall activity in 2013. While there will be some sellers who prefer financials -- due to desire to stay involved with the business -- I expect most activity to remain in the realm of corporate acquirers.”

In terms of the most active industries, 35% of survey respondents believe Healthcare will be the most active industry in 2013. This anticipated activity is likely tied to the present implementation of the Affordable Care Act.

750

1,250

1,750

Q4-2012

Q3-2012

Q2-2012

Q1-2012

Technology

Energy

Healthcare

Average

While Technology was visibly impacted by the Facebook IPO in the spring and Energy cooled off in the second half of the year, interest in Healthcare Opportunities mimicked the network average despite supposed impact of Affordable Care Act.

Healthcare Pursuits Unaffected by ACA in 2012

Data: AxialMarket


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M&A Activity Report

Valuations will Stay the Same

50%

Valuations will Fall

28%

Valuations will Rise

22%

Anticipated Valuations in 2013:

• Low interest rates discouraged many owners from selling their businesses, as there were few options for post-sale investment.

• Dry powder helped drive larger PE firms down market, driving subsequent valuations up.

• Despite the excess dry powder, 57% of survey respondents believe that strategics will be more active in 2013.

• Strategics are expected to be the most active investors in 2013, with most activity predicted to occur in the Healthcare, Energy & Utilities, and Technology spaces.

Key Takeaways:

Energy & Utilities is also expected to be a major player in 2013, thanks to the recent focus on fracking and shale. The interest in Technology is not surprising to Olszewski, who described the industry as “perennially a bright spot.” He added, “There are so many innovative companies just beneath the surface that will likely become immensely successful.

2013 ValuationsWith activity levels still uncertain in 2013, exact valuation estimates are hard to ballpark.

Because of this uncertainty, 50% of survey respondents believe that valuations will generally stay the same this year. The remaining 50% are effectively split between believing valuations will rise or will fall.

One subscriber to the rising valuations camp is South. He explained, “The combination of low deal supply with the high demand that is being driven by the fund overhang and private equity being an attractive relative asset class, coupled with cheap, available credit, suggests that multiples will likely rise.”

Olszewski, however, believes that the uncertainty will help drive multiples down. “The most recent data suggests that valuations will actually come down in 2013. That could be a result of the uncertainty in economy and regulatory environment -- if you buy a business, you have to price in that risk.”


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M&A Activity Report

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M&A in 2013