This is the third interview in our 2012 M&A Outlook series, looking at the way different middle market participants are anticipating the year ahead. In general, everyone so far has had a positive outlook for both this year and for the years to come.
Last week we interviewed both Prairie Captial and Peter Sokoloff & Co. This week we continue the series with Axial Member Tim MacColl of Larsen MacColl Partners, a lower middle market private equity group in Pennsylvania focused on working with family owned businesses, to get his thoughts on the coming year.
Cody: What is your outlook on the economy and how will it affect the businesses in the coming year?
Tim MacColl: Flat. I’m neither positive or negative on the economy. I don’t see anything in the economy that show it getting better or worse. In our companies we’re seeing a small uptick but that seems more related to the comparisons that come from how negative everything seemed last year than anything else.
We have a consumer company, our live music and bar based business, where we’re seeing an uptick of 10-15%. It seems like people are spending more money on entertaining themselves these days. The rest of our businesses, basic manufacturing and service companies, don’t seem to be growing because of any external factors. The only growth appears to be coming from company initiatives, not from the general market.
There definitely isn’t any wind at our back, the economy seems to just be bobbing. It’s a case of really needing to make your own luck.
How do you anticipate the year ahead to be for private equity and the deal business in general?
In the middle market it’s going to be increasingly difficult because of the overhang of capital compared to the number of companies on the market. It’s going to drive up purchase prices and drive down returns. We have several companies that could sell at strong multiples of EBITDA right now, but they’re growing very profitably [so we’re going to hold them]. That’s part of the problem in the middle market. All of the good companies are being held and grown for better times, so there is a lot of capital chasing a relative few good deals.
For the most part we work with brokers and m&a advisors. This is a less competitive segment of the market as the supply of closely-held companies looking to transition ownership outstrips the capital investing in these companies. I’m seeing better opportunity for returns in the very low end of the market as opposed to what I think is available in the middle and upper middle market. We do not see this dynamic changing for at least the next three years. I differentiate this from the broader middle market, where it seems that many of the deals are traded between different PE firms.
How is credit affecting the deals you’re doing and the companies you own?
Credit is very loose for good deals and generally unavailable for bad deals. Credit lines for good companies seem to be very strange these days. If your company fits in the box the bank requires, they give you exceptionally good, almost unexpected rates. If your company doesn’t fit in the box, you can’t get any credit. You would expect that rates would generally follow a curve where the rates increase steadily the more risky the firm is, but it seems to be a cliff instead.
Do you expect more or less transactions in the market this year?
We don’t really bump into other groups all that often so I can’t really tell you anything about the broader market in terms of who is in or how many people are going to close deals. If you think about the middle market really being between about $10-100MM EBITDA, there are probably going to be 1000 firms chasing 2-3000 deals this year. I don’t know the exact numbers, but the idea is that there is a lot of competition where demand for deals outstrips the supply of companies.
In our market, less than $5MM EBITDA, the supply significantly outstrips the demand. The indifference to the micro-market is what allows us to get good deals. The money from the middle market really hasn’t moved down to our level.
What sectors are you expecting to be hot this year?
Everyone seems to be talking about oil and gas right now. In Pennsylvania, where we are, it’s very hot and not just because of shale. We’re still trying to figure the [oil and gas] market out. It’s hit or miss if you’re dependent on a single, local geography, but if you can play a broader region or the whole US you should be fine.
Right now there are significant concerns about the environmental impacts of drilling in the US, though our other concern about dependence on foreign energy will seemingly outweigh potential environmental impacts. It’s not a question of if [the environmental impact will outweigh the need to drill], just a matter of when. We really see a huge amount of organic growth, we just don’t know exactly when or where it will be and we’re figuring out how to play it.
This interview is part of the larger discussion about what our Members expect to see in the deal business this year. We encourage you to get involved and voice your opinion as well. Comments are open below for you to agree, disagree, or comment on what you’re seeing in the market going forward.
The series will conclude on Thursday when we sit down to talk with Will Dietrick, Head of Corporate Finance at NewOak Capital in New York City. Subscribe below to receive email notifications of upcoming articles, interviews, and network activity reports.