How would you characterise the current valuation climate for TME businesses In Europe?
William Doran: There is a sentiment that it is a seller’s market in this industry. Overall valuation trends in the mid-market are upward but not aggressively so because they are already pretty high. There’s also a bit of a view that potentially the next two maybe three year will see the end of that cycle. This is bringing more sellers to the fore. Sellers who have been standing by are now saying maybe it’s time to sell so that we’re not selling at the absolute peak. And with an increasing number of sellers approaching the market, it tends to bring a little more balance to bear. I’m seeing that the multiples and the valuations are already up and will continue to rise but I would say at a measured as opposed to an aggressive pace.
Do you think outlier deals in the sector such as the Facebook purchase of WhatsApp has helped to drive up valuations?
WD: Yes, large outlier deals such as Facebook/WhatsApp do drive up valuations, but not in the middle market because it’s not directly comparable. This was an example of a deal that was getting done in the space without a reliance on traditional valuation metrics such as earnings. It shows the buyers are looking strategically at the future of the acquired technology, the acquired content and the acquired human capital – those assets which can’t be valued according to traditional metrics. The acquirer is attempting to figure out what the target will do to its own metrics and then apply valuation methods to the growth that it predicts from the acquisition.
That said, proving that deals of that magnitude can get done opens up the doors for activity in the middle market, so it’s more of an indirect impact.
What are the deal drivers in the US and cross-border and how do they impact on valuations?
WD: Convergence and the demand for content and technology are big factors, as well as economic factors here in the US. Robust US debt and equity markets have created tremendous liquidity and confidence to fuel M&A. There is also a substantial access to debt at very favourable interest rates, and a large amount of available capital both in terms of financial buyers, private equity players, and also strong balance sheets among strategic buyers.
Activity is also being driven by buyers sensing that they have neither the time nor the ability to produce or grow internally and that buy-side pressure’s going to keep valuations up and rising.
Then there is a multitude of foreign capital interest in acquiring technology and human capital in the US, including inbound focus from China and from Europe. We are also seeing increasing emboldened inbound M&A activity coming in to the US from India firms. And then, of course, there is a relative scarcity of quality target opportunities. So there are a multitude of factors that play in to the current and continued strengthening in valuation multiples.
What should investors keep in mind to bridge the valuation gap?
WD: Buyers need a disciplined approach and should avoid going into an auction situation. One way to avoid overpaying is to do the legwork to find opportunities that aren’t being shopped competitively, because that auction dynamic will tend to lead to that.
Many buyers are exerting greater efforts to seek out the non-competitive situations, sometimes through networking connections and focused enquiry, trying to find opportunities that will lead to an M&A prospect outside of advisor-led auctions.
I also see a steady use of contingent forms of consideration such as earn outs to help bridge the valuation gap.