Are there opportunities to acquire in today’s marketplace? Two-thirds say they’re very likely or somewhat likely to acquire a target in the same line of business in 2020, according to DirectorCorps’ 2019 Corporate M&A Survey, sponsored by Crowe LLP. Overall, almost half are open to acquisitions but prefer to focus on organic growth; 43% of respondents aspire to be active acquirers over the next five years.
The survey features insights from independent directors, CEOs and senior executives who represent a broad array of industries, particularly from the healthcare, technology and banking sectors. The group represents experienced acquirers: 71% say they’ve served on a board or the executive team of a company that has acquired or merged within the past three years. Responses were collected in August, September and October of 2019.
Of those who completed an acquisition within the last three years, almost half featured private equity investors on at least one side of the transaction, revealing the prevalence of private equity in recent deal-making.
Private equity groups can typically pay more for a target, but as acquirers, public companies “offer other intangibles, like taking care of [the seller’s] employees [and] integrating the culture into a bigger company,” says Archie Leynes, a partner at Crowe LLP. “Obviously, from the public company side, you have to provide input to your investors on why you’re deciding to pay a higher multiple on a deal, versus private equity which has more limited folks to [persuade] to buy a company.”
And these differing viewpoints often impact how the buyer values the management team at the target company, adds Crowe Partner Brian Kerby. “Private equity making an investment in a platform company relies heavily on acquiring a strong management team, whereas a corporate acquirer may not need to as their existing management team can mostly like run the platform,” he says. “That creates cost synergy to the deal, [because] those costs go away.”
Respondents from two sectors — healthcare and technology — reveal themselves to be more acquisitive. But deal rationale differs a bit by industry. Overall, public companies primarily seek to increase earnings per share (54%), supplement or replace organic growth (51%) or expand into new markets (38%).
However, healthcare companies, at 78%, are particularly apt to seek additional organic growth. And 43% percent of healthcare respondents say their company is likely to acquire a new business line in 2020, compared to 32% of respondents overall.
Medicare and Medicaid are driving the change in healthcare’s complicated payment models and that’s fueling healthcare acquisitions. “Payment models are being devised where there’s going to be a composite, or bundled, payment for a group of services,” explains Kerby. A company that provides a narrow range of services in the future will most likely have to share a portion of its payment with an unrelated provider attached to the service. “It’s all driven [by] where the payment model is headed in the future, [toward] bundled payment services.”
The survey findings underscore one truism across all industries: Pricing is a major roadblock to getting deals done. Overall, 88% of respondents cite pricing expectations on the part of potential targets as a top-three barrier to making an acquisition in today’s environment, followed by a lack of suitable targets, at 43%.
Respondents are split in regard to whether pricing for targets is fair and reasonable for their industry. Almost half believe deal pricing is too high; 43% believe it’s fair.
On the technology side, 67% of respondents believe deal pricing is too high. “It’s the hot market, and there’s a lot of money being thrown at it,” says Leynes. However, he believes companies are getting more selective on pricing. “Shareholders are realizing [that] anything you acquire has to provide [a] quicker return on their investment,” he says. “They’re a bit more careful.”
Concerns about pricing impact deal structures and indicate yet another challenge in coming to terms on valuation. Most respondents favor a combination of cash and stock in a transaction, both as a potential buyer or seller. But more than one-quarter favor a combination that includes debentures (an unsecured long-term loan) in a prospective purchase. This is more deeply favored by healthcare respondents, half of whom would favor that type of structure.
“The high multiples that these healthcare businesses are trading for require debt to support the transaction,” says Kerby. “There are a lot of lenders providing credit to fund these high-priced transactions.”
Earnout provisions promise additional compensation to the seller upon the achievement of certain financial goals within a set time period, and can be used to bridge the gap between the seller’s asking price and the acquirer’s offer. Overall, 61% of respondents favor earnouts as a prospective buyer. However, if the situation were reversed and they were the seller, 56% would not agree to an earnout position.
Earnouts shouldn’t be used by acquirers to overpay in a transaction, warns Leynes. “I always talk to my clients about their use of earnouts, and it’s a matter of making sure that they stay disciplined in their investment approach.”
Tracking whether the targets are met to trigger the earnout also create a headache for the buyer, adds Kerby.
The acquisition structure can reveal a lot about the future of the entity and the seller’s continued influence on the combined company, says Leynes. A purchase that incorporates stock will retain the interests of the seller’s owners and management team.
Despite the challenge posed by pricing, a little more than half of respondents believe it would be easy to find a buyer for their company at a fair price. Almost one-third don’t think they would easily find a buyer, and 15% indicate they’re unsure.
The size of the target can influence how easy it is to sell. Forty-one percent favor a target no more than 25% of their company’s size; 34% would be willing to acquire a company at least half their size.
Smaller firms can be difficult to buy because they lack the infrastructure, data and management team needed to handle the due diligence process. “It’s the same amount of problems at a $10 million revenue company as a $30 million revenue company, but at least the $30 million company has more earnings and will grow a lot faster,” says Leynes. “The small companies are usually more of a headache [in terms of due diligence] than the larger companies.”
To view the full results of the survey, click here.