When Will the Madness End?
Here we are again. I honestly feel like a broken record. It has been at least three years of the same commentary.
The deal activity will continue but can it possibly sustain this pace let alone increase?
Multiples are up slightly but can they possibly go any higher?
And 2017 is no different. Just when we think we’ve reached the market high point, we are given a reality check. We are witnessing a marketplace that has an insatiable appetite for mergers and acquisitions. The activity levels are soaring to record highs for total deal count and valuations.
Overall, 2017 reflects the highest level of deal announcements in the history of MarshBerry’s proprietary database tracking, eclipsing the prior watermark of 456 deals in 2015. These figures may still be revised to include announcements for deals closed prior to December 31. Deal activity in December 2017 was slightly down at 33 announced transactions versus 38 in the previous month. Preliminary 2017 activity indicates there were 536 deal announcements during the year, up 21% from a total of 443 in 2016. This total represents an average of almost 45 deals per month. Absolutely incredible.
The top three acquirers in 2017 mirrored 2016: Acrisure leading (67 deals), followed by Hub International (42 deals) and BroadStreet Partners (29 deals). The top 10 acquirers accounted for 50% of the total deal activity. Eight of the top 10 firms were private equity backed brokers, with PE accounting for a total of 305 transactions or 57% of all announced deals. Arthur J. Gallagher & Co was the only public broker to crack the top 10. Gallagher completed a very respectable 25 transactions making it the fourth most active buyer. Independent broker Seeman Holtz Property and Casualty, a relative newcomer with only 2 announced deals last year, finished fifth with 23 deals.
Valuations in the industry also continue to rise. We saw a bit of a plateau in 2016, but 2017 shows a slight increase in the average base purchase price. Tracked as a multiple of Earnings Before Interest Tax Depreciation and Amortization (EBITDA), base purchase price is best defined as the amount of proceeds paid at closing, including any escrow amounts for indemnification items, plus any amount a buyer may initially hold back, but is paid as long as the seller’s performance does not materially decline, or may be paid at closing but is subject to a potential adjustment (i.e., live out).
The average base purchase price in 2017 is 7.93x EBITDA (as of December 7, 2017). This represents a 2.5% increase over the 2016 average of 7.74x but an 11% increase from 2014’s average of 7.14x. It is staggering to see the average base purchase price hover near 8x EBITDA. With the activity levels continuing into 2018 and demand likely increasing with new investors entering the marketplace, we believe it is conceivable to reach an average base purchase price of 8x EBITDA this year.
The rise in deal price and continued increase in M&A activity is helping to increase firm valuation, as most (if not all) valuation firms use industry deal comparables as one of the components for establishing a fair market valuation.
This rise in value may also be making it difficult to choose independence as a perpetuation option. The valuation for a firm that wants to perpetuate internally with key employees or family is likely not increasing as dramatically as the external valuations because of the need by most firms to cash flow their buyout with internal after-tax proceeds. So as the external valuations rise, the gap between internal and external valuations continues to grow as well. This gap may make the decision to remain independent more difficult, as owners must be willing (in most cases) to leave valuation on the table in doing so. While many factors play into an owner’s decision on who to sell to, in our experience, value typically plays a big role.
Last year was a very dynamic marketplace with new buyers and new types of private capital exploring their position. We are seeing more opportunity for creative deal structures, differing levels of investment, the typical 100%, majority, and minority, all being used more frequently than before.
We believe the industry’s outlook is incredibly strong. The implications of the new tax laws do not appear to be having an impact on the buyer field’s pricing or demand. With that major hurdle overcome, it looks like clear sailing in 2018. Activity will remain frenetic and, in our opinion, demand will likely outpace supply by more than 5x, which will continue to help keep valuations at an all-time high.
Trem is SVP at MarshBerry. Phil.Trem@MarshBerry.com
Securities offered through MarshBerry Capital, member FINRA and SIPC. Send M&A announcements to M&A@MarshBerry.com.