Posts Tagged market

No Doubt – Interesting Year Ahead


Image courtesy of randalldsmith

As we move into 2017, industry pundits are almost unanimously calling for a strong year for both M&A and IPO markets.

According to Global Capital Confidence Barometer conducted by E&Y, the general consensus among corporate executives is buoyant and full of optimism on the prospects for 2017 with 57% of executives expecting to pursue acquisitions within the next 12 months and 49% of those surveyed already having more than five deals in the pipeline.

While we certainly look forward to 2017 being a very positive year, we’re thinking that for companies north of the border “interesting” and “unsettling” may turn out to be better descriptors.

 

On the positive side:
  • 2016 finished on a very strong note with M&A announcements fueling expectations for a very strong 2017;
  • Certainly moving into 2017 capital market sentiment continues to be bullish;
Down Jones Industrial Average (Trailing 5 Year to January 15, 2017) NASDAQ Composite Index (Trailing 5 Year to January 15, 2017)
S&P 500 Index (Trailing 5 Year to January 15, 2017) S&P/TSX Composite Index (Trailing 5 Year to January 15, 2017)
Source: BigCharts

  • Stock prices continue to trade close to record-high levels, in large part due to the potential of: lowered US capital gains and estate taxes; the possibility of reduced taxes to incentivize US corporations to repatriate offshore cash holdings; a less restrictive regulatory environment; and, future stimulus spending;
  • Cash balances continue to grow on strategic buyers’ balance sheets, there is plenty of undeployed capital at private equity funds and debt financing is readily available;
  • While the stock markets drive higher, overall GDP growth 0f 3.0% will continue to drive the necessity for companies to make strategic acquisition to maintain competitive positioning and meet market expectations. Acquisition drivers will include increasing digitalization, changing business models (SaaS, Blockchain), entering new markets and pursing product extensions;
  • Interest rates, despite the forecast for an increase, remain near or at historic lows;
  • CAD/USD exchange rate continues to make Canadian companies attractive to US acquirers;
2017 Yield Durve
Source: InvestingForMe
Canadian Dollars
Source: Bank of Canada

 

So how do we see the upcoming year unfolding?
  • The uncertainty experienced during the run-up to the US election ended in November. Unfortunately, a new type and level of uncertainty is now beginning to take hold. Only time will tell as to the ultimate impact of the new Trump presidency, regime and GOP majorities but I’m pretty confident that you can count on three things: Canadian exporters could find it a very rough go during the next four years; markets hate uncertainty and associated risk so we can expect to see increased volatility, and traders are going to make tons of money in volatile markets.
  • It’s anyone’s guess as to the near and long-term impact of impending NAFTA discussions. While it appears that the main focus could be on the US/Mexico relationship it is difficult to see where there is any upside for Canadian companies in any renegotiation.
  • Probably more important than any NAFTA discussion, the possibility of the US implementing a “border adjusted tax” which would apply to goods imported by US companies would present huge challenges for Canadian exporters. Not only would such a policy have a devastating impact on Canadian exporters, I believe that it would also reduce US acquirer interest in Canadian companies while at the same time forcing more Canadian companies to look south of the border to acquire companies to protect market share and revenues.  In effect, the pool of potential buyers of Canadian companies could get smaller.
  • Large private companies and their institutional (VC and Corporate) investors have been sitting on the sidelines waiting impatiently for the right “market” to take their companies public. The first pure technology company out of the box in 2017 would have been AppDynamics (APPD-Nasdaq), an application performance management software company looking to complete a US$132 million offering priced in the $10 to $12 range.  Founded in 2008, AppDynamics reported revenues of $206 million for the 12-months ending October 31 2016 and is looking to value the firm on IPO at $1.76 billion or 8.5X trailing revenues.  Unexpectedly,  Cisco stepped in just the day before AppDynamics was to set its IPO pricing and acquired the business for US$3.7B or approximately 18X trailing revenues. So much for our first technology IPO test case of the year…
  • IPOs in both the US and Canada should rebound but we would expect to see valuations moderated towards the lower end of company and the bankers’ expectations, but this may change as a result of the large premium to IPO price that strategic buyers, like Cisco, was willing to pay for AppDynamics.
  • With the current S&P 500 PE Ratio in the range of 26.1 (historical mean 15.6), the Price to Sales Ratio in the 2.0 range (historical mean 1.4) and the Price to Book Value at 2.97 (historical mean 2.75) valuations for the broader market are high relative to historical levels. Near term valuations appear poised to rise but in longer term one should expect to see valuation levels decline closer to “normal” levels.
S&P 500 Price to Earnings Ratio
S&P 500 Price to Sales Ratio
Source: Multpl

 

The obvious:

  • Cybersecurity will become a “more” dominant theme in 2017 (duh!)
  • Sub-$50 million acquisitions will continue to dominate the number to M&A transactions;
  • Sluggish growth for companies competing in the small to mid-markets may lead to owner fatigue and accelerate their interest in looking for an exit;
  • The “biological imperative” (read – getting older) will continue to drive baby boomers to look for exits;
  • Slow organic growth rates drive buyer’s acquisition strategy.

 

And lastly, let’s go out on a limb!

The Canadian public markets appear to have an appetite for strong technology companies à la Shopify, less so for public tech companies like ViXS Systems (VXS-T).  There is a dearth of large cap Canadian public technology companies and I’m pretty sure that many investors want to see if Hootsuite, Vision Critical, Desire2Learn and BuildDirect present great investment opportunities. Looking into my crystal ball I see Hootsuite filing for an IPO but at a valuation less than $1 billion, BuildDirect, which has drawn the attention of Goldman Sachs with Co-founder Jeff Booth being named one of Goldman’s 100 Most Intriguing Entrepreneurs of 2016 also filing for an IPO, Vision Critical taking additional steps to prepare for an IPO but not in 2017 and Desire2Learn not going the public market route but is instead acquired.

Posted in: Q1 Blog

Leave a Comment (0) →

Why Owners Fail To Maximize The Value Of Their Companies

Here are five reasons why business owners fail to maximize the sale value of their companies:

  1. They do not have a solid understanding of the current value of their business in the market;
  2. They do not clearly articulate the acquisition rationale, have inadequate documentation, and are not prepared to undergo the intensive due diligence process that forms a crucial step in the acquisition process;
  3. They failed to identify and engage with buyers who will pay a premium for the company;
  4. They fail to structure a transaction that minimizes risk and maximizes their total cash consideration; and
  5. They sell their company at the wrong time.

Posted in: Things to Avoid

Leave a Comment (0) →

Here are five ways you can build additional value for your company before you plan to sell it

  1. Establish a strong and defensible market position

All buyers of companies look for the seller who has carved out a strong and defensible market position, has healthy and sustainable margins, enjoys excellent profitability, and has established barriers to competitive entry. Obviously, building a company that meets these criteria takes time, so the earlier you work at positioning your company the better.

It’s important to be able to position your company in your market and articulate your value proposition.  Clearly identify your market, its size, growth trends, competitors, and opportunities.  Be prepared to address questions related to your revenue growth vis-a-vis market growth and how your key financial metrics compare to those of your competitors.  Ask yourself what differentiates your product/service from your competitors and why your customers buy from you?

  1. Create a financial track record of predictable revenue and profitability growth

Buyers look closely at the financial history of a company in order to determine its value. They look for a track record of revenue growth and strong profitability with positive trends in both over the previous three to five years and a solid fundamental balance sheet.

The more you can keep costs well controlled and profits growing, the better.   It is very easy in a mature company to become complacent and while business owners often focus on gross margin improvement, we often see overall cost control and poor inventory management being areas of neglect.  As part of your preparation for selling your company you should implement a process to review all of the cost components of the business and make changes that positively impact the bottom line.  For instance, if your current sales process differs from that of ten years ago, you may want to review your policy regarding company cars for sales people.  Are there more cost effective ways to compensate your sales people for vehicle usage?

Another area where we see neglect is inventory levels and annual inventory turns.  Too often business owners fail to identify slow moving or obsolete inventory and instead continue to believe that “it will move some day”.  Today, online auction sites allow business owners to sell off stale inventory and while the value received may not be what is currently represented on the books, it’s better to sell these goods now, reduce your carrying costs and put that money back to work in the business.  You certainly should not be expecting obsolete inventory to slip past a diligent buyer.

Business owners should also look at ways to implement a steady and fairly aggressive plan to pay down their debt. Buyers of traditional businesses generally look to pay a multiple of EBITDA (earnings before interest, taxes, depreciation, and amortization), less normal recurring “Cap X” (Capital Expenditure requirements). The buyer expects to pay for a normal mix of assets and liabilities, excluding interest-bearing debt and capital leases.

Lastly, pay attention to the amount of working capital required to maintain the operations of the business.  While cash on the balance sheet can typically be added to the price, excess cash and high levels of net working capital raise questions about the actual investment in the business required by the buyers.  It’s always better to closely manage net working capital levels and move excess cash out of the company well before you go out to sell your business.

  1. Understanding growth potential

It is important to understand that while you may have built a profitable business, a buyer is looking to the future of the business and is more concerned about where it can go as opposed to where it has been.  In order to sell your business at a premium it’s important to be able to articulate the company’s opportunities going forward.  Take the time to complete a SWOT analysis (strengths, weaknesses, opportunities, threats) and implement a plan to address areas of concern.  For example, key concerns about customer concentration could be mitigated if addressed well in advance of selling the business.  At the very least, it might be possible to sign long-term contracts with key customers, thereby alleviating some of the buyer’s concerns about risk.

  1. Secure the intangibles

Intangible assets can increase the value of a Company. The most obvious intangibles relate to patented products or products subject to exclusive supply agreements. Trade names and trademarks create value so it’s important to be diligent about the legal maintenance of such intangibles. There was a recent article in the Report on Business (http://tinyurl.com/zjz3beq) that details the challenges and costs incurred by a business owner who failed to register appropriate trademarks.  Don’t find yourself in this situation.

While you’re at it, don’t forget to consider one of your most valuable intangibles, your key employees.  It is important to ensure that appropriate non-compete agreements are in place and that the rights to all intellectual property developed by employees or contractors have been correctly assigned to your company.  The last thing you want to do is to put yourself in a weak bargaining position with key or ex-employees when news of your sale process becomes public.  You should also identify the employees that are key to the sale process and will be important post-sale in driving the value of the business and ensure that you have put in place the appropriate compensation packages and protections to keep those employees active in the business.

  1. Be Totally Prepared

We cannot stress enough the importance of being prepared to sell your business.  A sophisticated buyer will carry out extensive due diligence covering all aspects of your business and lack of preparation can not only delay the process but possibly also negatively impact your sale price.  It’s important to remember that when you are selling your Company and have an interested buyer, time is not your friend.  You want to complete due diligence and close the sale as quickly as possible.  Therefore, the time spent gathering, reviewing, and correcting deficiencies and cataloguing contracts, accounting statements, corporate, banking, and HR documentation goes a long way to moving the process along and reducing your risk of delaying or negatively impacting the closing.

Lastly, you should have a very clear understanding of the Representations and Warranties that you will be required to sign as part of the sale of your business.  Areas of concern should be addressed well in advance of beginning the sale process.  For example, if your firm requires environmental certification you should ensure that all tests, licenses, and government requirements are current and in compliance.

Posted in: Value Creation

Leave a Comment (0) →

Don’t Be The Last One Standing

The number of businesses and the value of assets set to hit the market during the next ten years are mind-boggling.

With many business owners having 70% or more of their personal assets tied up in their businesses, the Baby Boom generation cannot afford to delay preparation for the sale of their businesses.  There’s simply too much at stake.

In late 2012, CIBC World Markets published a report estimating that between 2012 and 2017 $1.9 trillion in business assets were poised to change hands and that by 2022 that number would explode to at least $3.7 trillion as 550,000 owners plan to exit their businesses. (1)

While it appears that the expected deluge of business sales has not taken place between 2012 and 2015, neither the companies nor the exit expectations have not gone away.

We are beginning to see more business owners in the 65+ age range ask the right questions about selling their businesses and some are moving forward.  Others are not ready to move forward for a number of reasons including:

  • Having still not recovered sufficiently from the last recession whereby their revenues and earnings can support their valuation expectations;
  • Finding the weak Canadian dollar to be negatively impacting their business,
  • Many are struggling with conflicting advice from multiple advisors;
  • Many are not ready to fully face the challenges and put forth the necessary time and resources to implement a sale process;
  • Some don’t view the current low interest rate environment as providing attractive investment returns on monies received from the sale of their businesses so they decide to just stay the course; and
  • Some simply have valuation expectations that far exceed what rational buyers are willing to pay and will never sell their businesses.

I find the game of Musical Chairs to be an interesting analogy for understanding what will probably happen when many of the Baby Boomers finally decide to sell their businesses between now and 2029.  As we all know, the first to sit in chairs win, all others lose and I’m guessing that it’s fair to surmise that there will be very few winners and a whole lot of losers.

Think of the “chair” as being the number one or two dominant industry players in any traditional business sector that have an appetite to consolidate the industry.  The first to market or the most attractive find a seat (are acquired) at reasonable prices and everyone else is left standing.  Power shifts to the buyers, acquisition prices decline, those left behind disappear.  I know it sounds dramatic and apocalyptic, but that’s just how industry consolidation takes place.

What are the options available to a seller of a business?

  • Private Equity firms will not be a viable exit for most of the companies: In 2014, there were a total of 296 deals completed by Private Equity firms for a total of $41.2 billion dollars with the top 10 transactions accounting for $26.8 billion or 65% of value.
  • Going public by way of an initial public offering, RTO, or CPC is not viable for many of the companies for many reasons including: size of business, sector, lack of liquidity, lack of sizzle…
  • Many traditional business owners are finding that their children do not have an interest in assuming or acquiring the family business.
  • Purchase by employees is a rare exit option.

So we arrive at two viable options for most of the owners: sell their business to an arms-length third party or continue to operate the business and extract value through salaries, dividends, and asset sales as they run the business to the end of their life.

For many, the latter will be the only option as valuation expectations simply are not in line with the market and there will be no offers for the business or the offers that come will be rejected.

In terms of selling to an arms-length third party, maximum value will be realized by those individuals who are well prepared, have attractive businesses with predictable revenues and earnings, are willing to consider terms and conditions on a sale that may include a vendor take-back or earn-out, have realistic valuation expectations, and are not coming to market at the same time as many similar companies in their sector.

We are currently in a sellers’ market.  Acquirers are looking to augment slow growth through acquisitions; interest rates are low, making debt financing attractive; and the weak Canadian dollar makes acquisitions attractive to US buyers.

If you’re thinking of selling your business over the next five years, now is a good time to start planning.  If you would like to understand the process for preparing your business for sale and the options that are available to you, we’re always happy to have that discussion.

(1) CIBC World Markets Inc., In Focus, November 13, 2012, “Inadequate Business Succession Planning – A Growing Macroeconomic Risk”

Posted in: Things to Avoid

Leave a Comment (0) →