Mergers & Acquisitions for Q1 2014 and Outlook through Fall 2014
We are in the second quarter of 2014 and data is now available for deal activity through the end of March, 2014. In this report, we will review ClearRidge’s most active industry sectors and provide an outlook through Fall 2014. These 8 industries are also among the most active sectors that drive M&A Activity in Oklahoma and the Southern Midwest region:
i. Aerospace & Defense
ii. Aircraft Parts, Maintenance, Repair and Overhaul
iv. Construction & Engineering
v. Energy: Oil & Gas
vii. Industrial Manufacturing
viii. Transportation, Logistics, Distribution
Note: In the report, you will see that some of the deal data is for larger public companies. The most reliable and timely data is reported by the larger companies in each industry; however, deal activity of the largest corporations is also a good barometer for M&A activity among midsized companies in the same industry.
I. Aerospace & Defense
Q1 2014 was the best opening quarter for Aerospace M&A since the recession in 2008. The deal flow within the defense sector, however, was anemic at best.
Improved deal value and volume within the Aerospace segment can be attributed to high growth – estimated by IBIS World to continue at an annualized rate of 3.8% through 2018. Commercial airlines will continue to update their fleets, in response to increased passenger travel. This led to a transfer of ownership of aerospace companies serving commercial airlines from Private-equity group (PEG) portfolio companies to strategic owners over the past three quarters. We expect the trend of consolidation to continue.
Conversely, defense continues to be an industry in a down-cycle, despite rare bi-partisan cooperation in Washington. Companies are reluctant to expand operations while demand from their biggest customer, the U.S. government, remains tepid. The U.S. Department of Defense recently reaffirmed their anti-trust policy against consolidation among large players – hoping to control costs and the supply chain for the sake of national defense. This policy creates opportunity for smaller players within the industry and may shape the future of American defense contracting going forward.
II. Aircraft Parts, Maintenance, Repair and Overhaul
2012 and 2013 were tough years for MRO companies, an industry that is dominated by the largest ten or so firms. Despite their large stature, many of the dominant companies have lower margins than their smaller competitors. Similar to the broader aerospace industry, MRO will benefit from growth in air travel. The projected 5% annual growth rate in airline travel and 3.8% annual growth rate in the industry at large will help fuel the growth of MRO companies. This increasing level of demand for passenger travel coupled with global inability to produce aircraft quickly enough to satiate increased demand should indicate a positive future for MRO.
Deal activity in chemicals decreased after a solid Q4 2013. Q1 2014 deal value exceeded the previous quarter, while deal volume slightly underperformed three-year moving averages. PEGs are influencing the market to a larger degree than in previous years, as nearly 21% of all deals last quarter were PEG related, as opposed to just 13.5% in Q4 2013. Unsurprisingly, mega-deals dominated chemicals in Q1 2014; North America witnessed just 10 deals with prices greater than $50 million, but the composite value of these deals was $6.2 billion. PWC forecasts a mildly improved second-half of the year for M&A in the chemicals industry.
IV. Construction & Engineering
Growth in construction and engineering boosted M&A in this sector in Q1 2014. Several mega-deals were completed, lifting average deal value to high levels, despite lower volume than in previous quarters. Performance of the housing industry remains steady, but growth is still uncertain. According to the Census Bureau, housing starts in March were at a seasonally adjusted annual rate of 946,000. This is 2.8 % above February’s 920,000, but is still six percent below the March 2013 rate of 1,005,000.
Perennial weakness in housing has led many C&E companies to refocus and traverse non-traditional avenues. These partnerships are in a broad assortment of industries; for example.
Note: ClearRidge’s construction and engineering experience focuses on industrial, energy and telecommunications, rather than residential and commercial.
V. Energy: Oil & Gas
Overall activity in oil & gas:
The American interior continues to provide shale opportunities. While North Dakota’s Bakken and Texas’ Permian oil plays are the typical examples given when discussing fracking, there are opportunities throughout Middle America, the Northeast, and the Gulf of Mexico. These opportunities continue to fuel growth and create lucrative business opportunities.
Despite the plethora of opportunities created by fracking, M&A activity is sporadic. From one quarter to the next, it is not unusual to see significant differences in merger activity. This does not necessarily reflect the health of the sector, but instead tells a story of availability of capital and resources for investment. The oil & gas industry experienced an erosion in profit margins last year as many producers entered a net capital spending phase with high operating and development costs. Companies are forced to invest heavily in development during the early phases of an oil play, thus less capital is currently available for M&A than two to three years ago. A KPMG study polled industry executives and 56% of them said they plan to initiate a merger this year while 39% expect to initiate a divestiture. This could bid acquisition prices to higher levels.
In Q1 there were 43 middle market deals, 27% lower than the average quarterly deal count over the past three years. This decrease in activity may not be a cause for concern, as technological improvements and changed labor market perspectives will provide fertile ground for future consolidation as economies of scale prevail.
Upstream, Midstream and Downstream:
Upstream accounted for 63% of oil and gas deal activity in Q1. Deal value increased by 65% year over year and was a slight increase from Q4 2013. Divestitures and Gulf of Mexico investment made up the largest share of upstream activity. There were 4 midstream deals in Q1, posting a 91 percent decrease in deal value from the fourth quarter of 2013. There were 3 downstream deals reported in Q1.
There were 9 oilfield services deals in Q1, posting a spike in deal activity compared to the past year, with deal value up approximately 300% year over year.
Note: Within oil and gas, ClearRidge’s primary experience is in oilfield services, manufacturing and related industries that support oil and gas production, processing and transportation.
Obamacare has three main affects on the growth of M&A in healthcare: economies of scale, measuring health outcomes, and the rise of consumerism. Due to the need to measure health outcomes, medical companies are purchasing additional divisions concerned with outpatient monitoring. Some of these units include pre-admit, post-discharge, home healthcare, and long-term care.
In Q1 2014, deal volume declined by 14% compared to the previous quarter with 239 deals closed this past quarter. On a year-over-year basis, however, deal volume increased by 13%, and total deal value was relatively high.
VII. Industrial Manufacturing
Economic activity in the manufacturing sector expanded in March and, according to the nation’s supply executives in the latest ISM Manufacturing Report, the overall economy grew for the 58th consecutive month. The ISM’s March 2014 PMI number of 53.7 increased from the seasonally-adjusted February number of 53.2 (a reading above 50 indicates expansion). In our last M&A report three months ago, the PMI number was at 51.3, indicating that the manufacturing economy was growing slowly. This month’s reading indicates a sector that is growing at an increasing rate.
Industrial M&A started the year well, with four mega deals announced. Smaller deals were less prevalent, but may be fuelled by deal activity of larger companies. The strongest areas within industrial M&A are still industrial machinery and energy related equipment. Horizontal consolidation and divestiture of non-core assets is helping the bottom line of established industrial companies.
VIII. Transportation, Logistics, Distribution
Companies in the Transportation, Logistics and Distribution sector are using the current economic expansion to consolidate their existing markets and expand output. In Q1 2014, 96 deals were closed, which was supported by relatively inexpensive financing and increased demand. According to S&P Capital IQ and PriceWaterHouseCoopers, infrastructure targets sold rapidly last quarter and will continue to do so as profit margins are pinched by increased hiring expenses. The sub-sector projected to experience the most M&A in the next six months is trucking and logistics.
The following external drivers are likely to bolster TLD industry growth: improved consumer spending, accelerating ISM numbers, strong oil and gas industry performance and the related economy. This growth is likely to create a strong M&A environment through the remainder of 2014.
M&A across All Industry Sectors
Many analysts predict that 2014 is poised to be a record year for M&A activity. Seven years after the start of the financial crisis, companies are finally changing their attitudes about the economy. GDP growth is forecast at 3% for 2014, an improvement from the 1.9% realized in 2013, and a continuation on 2012’s positive 2.8% trajectory.
Understanding that top-line growth could be difficult to achieve following the financial crisis, many companies worked to become leaner. High levels of uncertainty led to risk aversion, particularly pertaining to expanding scale of operations. In response to the harsh environment, most companies refocused on improving operations in the five years following the crisis. This meant that companies divested non-core assets and released employees, raising cash in case of a further economic meltdown. The economy improved, and companies are now left with plenty of dry powder (excess working capital assets for deployment). Continued low-interest rates leave cash earning negative returns and make companies eager to invest money in growth initiatives and acquisitions, even if they are less focused on core operations. Positive economic forecasts suggest that 2014 may be the year when inactive capital is invested in both core opportunities and M&A.
How to Value Your Business?
ClearRidge specializes in valuation reports for business owners who want to know the real value of their company, if they were to sell in the current market to a willing buyer. We have certified valuation experts on staff and will follow typical valuation protocols, but we also look for business issues that may detract from value, as well as unique characteristics that add to the value of the company. Throughout your valuation report, we describe our findings, then close with recommendations for the business moving forward to increase the value of the company. We are also called upon to work with business owners after the report to resolve the issues we uncovered and assist in creating and executing a plan to increase the value of the business.
How to Sell Your Business?
We are Investment Bankers and Business Advisors. Our team at ClearRidge provides you with discrete, professional and effective representation in the sale of your midsized business. You benefit from the advice and expertize of a team with decades of experience successfully completing complex merger and acquisition transactions and corporate finance projects for midsized companies all across the U.S.
ClearRidge Perspective for 2014
Companies that we represent continue to gain significant interest from industry strategic buyers and private equity groups, with the individual deal dynamics being the greatest determinant whether the buyer is a strategic, private equity or a blend of the two.
As described earlier in this report, 2014 may be a good time to plan and execute the sale of your business. A better M&A environment notwithstanding, business and financial due diligence continues to be critical, given the increased scrutiny that buyers focus on sales, financial and business analysis in the past few years. Our discrete due diligence, in advance of talking to prospective buyers, continues to remove obstacles to closing and ensures that only the most likely buyers with the capital and commitment to close a transaction make it to the closing table. Companies that are better prepared prior to the sale process have been rewarded with higher valuations, smoother and less intrusive pre-closing due diligence, and a quicker cycle to closing the transaction.
Sources: This report has been compiled with data from government sources, independent analysis, IBISWorld research, as well as PricewaterhouseCoopers, KPMG, Forbes, Deloitte M&A reports, Rigzone and other sources cited in the text.