Merger Trends in a Recession
One of the few good things about a recession is that it provides a chance to reconsider basic valuation assumptions affected by the depressed economic environment. Business valuation experts can get a quick update by reviewing some of the popular references in our profession. So when the 2010 edition of Mergerstat Review arrived, it was time to see how things changed in the “Great Recession” of 2009.
Let’s start with the nicely presented “Summary of Charts” section in the preface. The total dollar value of merger announcements was down sharply in 2008 and again in 2009. Looking at the 20 year chart, it appears that merger dollar volume spikes dramatically in the three years before a recession and then falls by approximately 60% in the trough of the recession. The number of deals falls as well, showing a decline in the range of 40%. So we can see that the entire acquisition market slows down significantly in a recession. (Whereas a three year merger boom might be a signal to short the market!)
Of course, business valuation experts want to see the data on privately-held companies. Surprisingly, deals for privately-held companies as a percentage of total M&A transactions experienced changes of much smaller magnitudes. The sale of privately-held companies is still the biggest category of M&A transaction, accounting for 51% of acquisitions in 2009 versus 55% in pre-recession 2007. So it appears that many sellers of privately-held companies are not keeping companies “off the market” waiting for a return to pre-recession valuations. Divestitures, which might be expected to spike in a recession, rose modestly from 30% in 2007 to 36% in 2009.
Of special interest to business valuation experts are the control premiums offered for the acquisition of public companies, as this data can be considered in the calculation for the discount for lack of control. Control premiums in this recession have risen to approximately 40%, the level also seen in the 2000-2001 recession. This is up from approximately 24% in the boom years of 2005-2007. What does this mean for valuation experts? I think this supports the view taken by many valuation professionals of considering several years of historical results in their capitalization of income approach, especially if they are adjusting net cash flows to determine control values. Since the control premium rises when earnings are depressed and drops in boom years, considering several years of results when adjusting cash flows to control values will recognize that business value can be less volatile than annual cash flows. This multiyear approach to valuation might also explain why sales of privately-held companies continue to be strong, as sellers can expect a price that reflects long-term performance of the business.
My favorite statistical time series are the data on “Going Private” deals, which are transactions where sellers are public companies, and the buyers are private equity groups or private companies. In the 1990s, these transactions were generally under 10% of all public company acquisitions, but they have risen gradually over the first decade of the 21st century, hitting a peak of over 40% in 2006 and only declining slightly since then. They are proof that private equity is a major force in the markets and a determinant of business value. Since private equity firms are winning a larger percentage of deals, it may also be evidence that the prices paid by so-called “financial” buyers are converging with those paid by “strategic” buyers already in the industry. Of course, many private equity firms are strategic buyers in the sense that they often consolidate an industry through acquisitions. The data show that in normal years this is true, the average P/Es paid in "going private" transactions are very similar (and sometimes higher) than those of the acquistion market as a whole. However, the P/Es paid in two recession years of the last decade were only 70-75% of the P/Es paid by the acquisition market as a whole. Perhaps the higher returns earned by private equity are rooted in these recessionary periods.
Raymond J. ("RJ") Dragon MBA, MS, ASA, CFFA is a Principal in Citrin Cooperman's Valuation & Forensic Services practice in the New Jersey / New York City area. His work encompasses valuations for litigation support, marital dissolution, shareholder disputes, estate and gift tax, intangible asset valuation, purchase price allocation and financial reporting.