Exit Smart: Combine increased animal spirits with strong company performance for the best M&A value Part 2

136243334Last week, we explored the history of M&A cycles as well as the typical phases of a staffing company’s performance. We then examined why maximizing your exit payout, requires selling at the right time during a cycle or growth phase. We are now ready to discuss how to achieve the optimum combination.

Based on our separate review of timing M&A cycles and company performance, the optimum combination isn’t difficult to describe. It’s when you enter the market early enough to go through the selling process before either the M&A cycle or company performance begins to peak.  A concept that is easy to depict in this graph, but not easy to accomplish without the ability to accurately forecast the future.

Optimum Combo

Important considerations. Achieving this perfect combination is rare, so when attempting this feat it’s important to remember four points:

  1. changes in the M&A cycle usually trump your operating performance;
  2. rising animal spirits drive the M&A wave and higher valuations;
  3. those high spirits are very sensitive to volatility and changes in public equity and credit markets; and
  4. buyers can lose interest before the economy begins to contract.

Points three and four are especially true for financial and leveraged strategic buyers, who are the “canaries in the M&A coalmine,” when it comes to sensitivity to changes in credit/equity markets.

Armed with this knowledge the difficult question remains – is it better to leave something on the table by going early, or should I risk being able to sustain performance and buyer interest if the market turns down? It’s certainly true that quality companies are acquired after a cycle has peaked. In those instances it becomes a question of getting the parties to agree on value.

PREMIUM CONTENT: 3Q14 Financial Results for North America-Based Public Staffing Firms

The bottom line. Contrary to analysts’ best efforts, no one can forecast the future of markets with any real certainty. On the other hand, every owner has a very good sense of their company’s strengths/weaknesses. We usually also have a pretty good idea of the investment and operating risks involved for getting to the next level, or sustaining ourselves until the next cycle.

To me, this suggests the best time to begin the selling process is when your company’s performance is approaching its peak, without unacceptable investment or operating risk. In a perfect world you would also want to sell when you see reports that M&A activity is beginning to pickup in the midst of low volatility, strong equity and credit markets, and improving economic conditions.

Where are we in the present M&A cycle? I believe the honest answer is that nobody can say for sure. We can say that overall M&A activity has begun to accelerate over the past 12 months. It is equally apparent that activity and interest in the staffing industry has been improving over the same period.

As in previous up-cycles, this has so far been the result of rising animal spirits due to reduced domestic political volatility, a remarkably strong stock market, cheap money, steady domestic growth, combined with the need to expand revenue/earnings through acquisitions, and technology driven activity. Interest in staffing is also being driven by the persistent “skills gap,” the growing preference for contingent work arrangements, and the impact of ACA regulations associated costs.

What’s the outlook for 2015? We believe continuing stock market strength and cheap borrowing, combined with acceptable U.S. growth and increased innovation across industries will continue to drive increased M&A activity through 3Q15. In that environment, we expect the increasing competition for skilled workers within a shifting labor market will result in accelerated staffing industry M&A at favorable valuations.

Downside risks. Barring an upsurge in volatility from an unexpected crisis (the ultimate animal spirits’ killer), the most notable risk to domestic M&A growth is the impact on equity and credit markets of the unwinding of quantitative easing and increased interest rates. There is also the possible negative impact on U.S. growth from the economic slowdowns in the EU, China, and other developing countries. Most analyst believe the U.S. will not be affected by the global slowdown in 2015, but expect it will eventually have a negative impact if it continues.

We agree with this assessment, but also expect the Fed will continue to be very sensitive to downside risks in the coming year and will not take any actions that might threaten U.S. growth and markets. We are nevertheless being cautious in our forecast because of the lead-time for completing a transaction, and M&A’s historic sensitivity to volatility in equity and credit markets.

MORE: The new mantra in M&A

Wil Beach

Wil Beach
Wil Beach is managing director, HRO at De Bellas & Co. He can be reached at wbeach (at) debellas (dot) com.

Wil Beach

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