M&A and the Inherent Disconnect: A Contraction of Multiples

In their latest report outlining future Mergers & Acquisitions activity independent research firm, Bernstein Research, forecasts that total M&A volume, including private equity and strategic deals, will decline by 25% in 2009 from the previous year. The United States' largest investment banks bank holding companies, including Goldman and Morgan, have become increasingly reliant on the revenues generated through M&A advisory (fueled by the 2006-2007 LBO boom). This suggests that a significant decrease in M&A activity could put additional strain on these firms, and the financial services industry as a whole (as if they didn't have enough problems).

Most people point to the tightening of the credit markets as the main factor leading to the current, as well expected decrease in M&A deal volume. While this is true, and the so called "freezing" of the credit markets has certainly had an adverse affect on M&A deal volume there is also another factor at work (somewhat connected to the credit environment of course), and as we enter 2009 it is likely to be as, or even more influential than the condition of the debt markets.

There is an inherent and growing gap between seller and buyer valuation expectations. At one end of the spectrum exist sellers with valuation expectations that have thus far remained fairly static despite desolate economic conditions, a decreasing availability of debt, etc. These sellers are still basing their valuation expectations off of the multiples seen in 2006 and 2007 (multiples fueled by massive leverage, 5x and up, as well as a sense of economic optimism). The problem with this is that at the other end of the spectrum are buyers who no longer have the ability, access, or willingness to employ the type of leverage that supports the aforementioned multiples (with senior debt multiplies likely to further contact as we enter 2009, maybe 2x-2.25x). Furthermore, these buyers are (especially in the case of financial buyers e.g. the PE guys) becoming increasingly more risk adverse and conservative with the valuations they place on target businesses. It seems likely as we enter 2009 this gap will continue to widen, and bridging it will become increasingly difficult.