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Middle-Market Financing: Steady in the Face of Volatility

  • By John Hintze
  • Published: 2/3/2016
cashpile100sIn today’s topsy-turvy financial world, financing for larger middle-market companies has started to tighten up, in step with their large-cap cousins. More relationship-driven financing for companies with $50 million in EBITDA and below, however, remains readily available for those borrowers, which, facing organic growth challenges, are expressing increasing interest in acquisitions.    

“The financing market for borrowers with EBITDA of $50 million or less is in good shape, and for those at $20 million or less is in excellent shape,” said Ted Koenig, CEO and president of Monroe Capital. “So it will remain a sellers’ market, although it’s hard to predict past the [federal] election” in November.

If only there were sellers

Alas, sellers may be few and far between. Wayne Hunley, EVP at PNC Bank, said that while acquisitions by sponsors were more prevalent in the large-cap market, strategic acquisitions by corporates were up 50 percent in 2015 compared to the year before, and that trend typically trickles down to the middle market. So far, however, that has yet to happen.

“When we talk to clients, they have a desire to do strategic M&A, but we’ve yet to see a follow through” requiring senior debt, Hunley said, adding there’s been a pickup in M&A supported by asset-based loans, which are favored by private equity sponsors seeking more leverage.

According to Hunley, there appears to be a “bit of a waiting game going on,” as middle-market owners stall, in hopes of higher and “unrealistic” price multiples.

“If it’s a well-run middle-market company, the owners always feel they have the option of continuing in the business, and waiting for a more attractive price,” Hunley said.

Given volatility in the market today, rising interest rates, and macro uncertainties such whether the U.S. will enter a recession, they may be waiting a long time. “This environment of economic uncertainty affects buyers, and the expectations of sellers are high. We don’t see that changing, so it’s hard to see many transactions coming to fruition,” Hunley said.

Sellers’ lack of urgency to pursue acquisitions appears to jive with the findings of a survey conducted last year by the National Center for the Middle Market (NCMM) and the Milken Institute, which found an uptick in 4Q 2015 compared to 1Q in the number of middle-market respondents saying they are carrying less debt than a year ago—33 percent compared to 30 percent.

“So the number of companies saying they’re carrying less debt has increased, suggesting they’re paying it down,” said Tom Stewart, executive director for the NCMM.

Less debt means less of a cache to pursue acquisition opportunities. Nevertheless, 16 percent of respondents said in 4Q they were likely to make an acquisition this year, the same percentage as 1Q. The percentage of companies saying they were likely to take on new debt also held steady, at 16 percent, although that percentage increased to 23 percent for companies with $100 million in revenue and up. The percentage of companies saying in 4Q they had somewhat easy or very easy access to capital was 41 percent, approximately the same as 1Q, while 19 percent said it was extremely or somewhat difficult, and 39 percent said it was neither difficult nor easy.

Middle-market outlook for 2016

Middle-market companies looking for financing will likely find eager lenders in 2016. Organic growth, however, has been stunted, with slow-growing economies around the world, plenty of financial and economic uncertainty, and the M&A outlook appearing muted. Nevertheless, private equity firms such as Carlyle and Silver Lake, which typically acquire larger companies, have become increasingly active in the middle-market sector as they search for better value. And middle-market private equity firms have raised $500 billion that’s now sitting on the sideline, according to Koenig, that they’re eager to put to work. So factors are in place to ignite more activity.

In addition, Hunley noted, oil prices and interest rates are at record lows (even despite the Federal Reserve’s December rate increase). Those factors, however, may be outweighed by less positive ones, such as volatile commodity prices and credit markets, global economic developments and a lack of visibility into China. “There’s just an atmosphere of uncertainty,” Hunley said.

A longer version of this article will appear in an upcoming edition of AFP Exchange.
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