Merger, acquisition deals follow moderate growth trends

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Steve Blumreich is president of BKD Financial LLC and has 20 years' experience helping middle market companies with acquisitions and divestitures.|ret||ret||tab|

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The 1990s will surely be known as the decade of mergers and acquisitions, as well as the strongest bull stock market in U.S. history. In the 1990s, the economy was strong, capital was readily available for buyers and many business owners took advantage of historically high valuations. |ret||ret||tab|

As we are discovering, however, the "irrational exuberance" of the 1990s was fueled in part by a combination of excesses and misplaced optimism. What the current decade will look like is anyone's guess. |ret||ret||tab|

I believe, however, the first 18 months of the current decade may not be indicative of the decade as a whole. The merger and acquisition growth pendulum, which reached unprecedented heights in the late 1990s, has overcorrected in the first two years of this decade. I believe the true picture for merger and acquisition activity for the decade will be somewhere in between.|ret||ret||tab|

One of the unstoppable factors influencing the number of mergers and acquisitions of small and medium size companies is the aging of the baby boomers and the desire or need of business owners to sell and enjoy the benefits of their efforts. This demographic factor will influence the number of future transactions and general economic and capital market conditions will impact the values of those transactions.|ret||ret||tab|

In addition, many of the acquisition binges of the 1990s are now turning into divestiture purges. Acquisitions that appeared to make sense based on 1990 growth models now are like hangovers from a party that lasted well past midnight. The largest bankruptcies in U.S. history, combined with accounting and insider-trading scandals, are all examples of these excesses.|ret||ret||tab|

The graphic on page 11 shows the number and dollar value of merger and acquisition transactions in the United States from 1992 through 2001, compared to the S&P 500 Index. The merger and acquisition activity followed the trend of the S&P 500, which tracked the increase and decline in both the Dow and NASDAQ. Based on information from BKD Financial LLC regarding the number of transactions currently being managed, 2002 is tracking similar to 2001 with the exception that more transactions are now being contemplated by clients.|ret||ret||tab|

We are seeing renewed optimism in certain industries, such as health care technology, biotechnology, banking and some manufacturing sectors. |ret||ret||tab|

We are also seeing renewed activity in the oil and gas service industries, as well as businesses that service the real estate and construction sectors. |ret||ret||tab|

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On the hunt|ret||ret||tab|

Many companies are looking for acquisitions, and I believe market valuations have brought prudent buyers back into the market, realizing that the current values are realistic.|ret||ret||tab|

The trend shows a steady increase in the Earning Before Interest Taxes Depreciation and Amortization multiples from 1992 through 2000, and then a drop off in 2001. BDK Financial began seeing a decline in multiples in the second half of 2000 and continues to see lower multiples. |ret||ret||tab|

The decline in multiples and company values was the result of several factors. The downturn in several industries starting with dot coms, technology, telecoms and then spreading to the general economy were major factors which impacted middle-market values. The dramatic drop in the stock market and initial public offering activity also impacted the middle market values.|ret||ret||tab|

Many middle-market acquisitions were driven by industry consolidations and "roll-ups" financed by "easy money" coming from the public equity markets, and when the stock market contracted, that source of funding dried up. The public company multiples dropped, which resulted in declines in private company values as well.|ret||ret||tab|

The availability of private equity funds also was affected. Commercial banks reduced the amount of money loaned for acquisitions based on the company's cash flow, which made it more difficult for private equity groups to achieve the rates of return they required. |ret||ret||tab|

These factors all contributed to driving company values down from the historic highs of the 1990s.|ret||ret||tab|

The market has become more efficient in pricing middle-market transactions, and current multiples we believe reflect a more supportable and sustainable level for middle-market companies. The current valuations make sense compared to those of the late 1990s. |ret||ret||tab|

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Diversity|ret||ret||tab|

BKD Financial is using more diversity in structuring transactions, including leases with options to purchase plant facilities rather than outright sales of the property, more seller financing and "earnouts" where the seller is willing to accept some of the sale proceeds in the form of future profits from the company. These strategies provide buyers with opportunities to better manage risks incurred in acquisitions and also provide sellers with opportunities to share in future increases in business profits and values. |ret||ret||tab|

We are also seeing more company owners exploring the use of Employee Stock Ownership Plans as an exit strategy. The ESOP is a vehicle that allows a company's employees to purchase the company. The tax law was changed several years ago to allow ESOPs to elect "Sub S" status for tax purposes. |ret||ret||tab|

An ESOP is a qualified retirement plan, meaning they do not pay federal income taxes. This allows Sub S ESOP companies to use the amount they would have paid in income taxes for repayment of the purchase price, internal growth or for making acquisitions. |ret||ret||tab|

If the seller is an individual, there can also be attractive opportunities to defer the tax on the gain. The ESOP has become a very useful and viable vehicle to be used in appropriate circumstances. |ret||ret||tab|

The trends in the middle market are the result of various conditions and it takes a prudent business person to determine when the time is right to make an acquisition or execute a sale. |ret||ret||tab|

The recent trends have demonstrated very clearly that there exist "windows of opportunity." There may not be another economic and market boom similar to the 1990s. |ret||ret||tab|

However, I believe the economy overall was hurt by the excesses of the 1990s and more moderate, realistic growth will be the theme of this decade.|ret||ret||tab|

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