To buy or to sell?

Management teams are faced with numerous strategic alternatives when considering growth options for a company.

However, the most challenging and often most rewarding options can result in environmental shock to the company through the gain or loss of employees, processes and culture. These results are the after-effects of the most common growth alternatives, including the acquisition of a new business or the divestiture of an existing product line or business unit.

Although the sale of a business may seem counter-intuitive to growth, many examples are evident within the middle-market. The divested business could generate stronger growth with a more synergistic parent or with a financial partner that has greater access to capital to pursue growth.

In addition, the parent company of a divested business could use the proceeds from the sale to re-invest and grow more core operations.

Buyer’s market

Over the past few years, economic weakness, combined with less aggressive capital markets, led to a significant decline in mergers and acquisitions activity. In 2002, total M&A volume included 5,666 transactions, a decline of 14 percent (920 transactions) over the 2001 period. However, when compared to 2000, the decline was a robust 37 percent (3,346 transactions).

Many of the transactions completed over the past few years (approximately 17 percent) in 2002 included bankrupt businesses. In an environment of weak operating performance, coupled with limited access to capital, buyers of businesses maintain substantial financial and negotiating leverage in transactions — a buyer’s market.

If a company has the financial and human resources to pursue acquisitions, the current market environment is very conducive for acquisitive growth.

Seller’s market

The domestic economy has started to improve. Many larger, public companies are reporting stronger earnings, and anecdotal evidence suggests that middle-market companies are also generating stronger operating performance. With the economy on the rebound, the financial markets also have gained momentum, pushing valuations to higher levels.

In order to continue to generate earnings growth and sustain higher valuations, many companies pursue acquisitions ranging from entire companies to certain niche product lines.

In addition to the equity markets, the lending environment also has improved. Banks are more willing to provide capital for M&A transactions.

Also, private equity firms remain awash in capital — more than $175 billion in the past five years (from more than 1,000 firms) remains available for investment, either for add-on acquisitions for existing portfolio companies or to partner with management and recapitalize a business.

Transaction volume with private equity firms, as measured by dollars invested, actually increased, from $9 billion in the first half of 2002 to $33 billion in the first half of 2003, and we expect this recovery to be sustainable.

Overall, the strength in the capital markets, combined with improving operating performance for many businesses, has led to stronger M&A transaction activity — a seller’s market.

The current market conditions for middle-market businesses are unique — both buyers and sellers can excel. Businesses with solid management teams, defensible market positions and productive operations are highly sought-after by buyers in today’s market. As a result, sellers of these businesses garner strong valuations in the sale.

In addition, many companies continue to divest noncore assets, and in many instances, these are operationally or financially distressed opportunities that buyers can acquire at relatively low valuations. Management teams must be intelligently opportunistic in exploring either an acquisition or sale, but current market conditions will reward both alternatives.

Scott H. Lang ([email protected])is Senior Managing Director & Principal of Brown Gibbons Lang & Co. Lang is co-head of the firm and manages its growing Chicago operations, where he plays an active senior role in client engagements and business development. Reach him at (312) 658-1600.