October 21, 2022
High interest rates and recession forecasts clouded the atmosphere at last week’s the Denver ACG “Dealmakers’ Forum, ” however robust closings in the Lower Middle Market reinforced these companies remain a sought after asset class.
Jacob Koenig, Partner overseeing Deal Execution at Woodbridge International, joined a panel on the “Evolving Deal Marketplace”, along with Nicholas Sly (Denver Branch Executive at the Federal Reserve) Doug Dell (Senior VP of Middle Market Finance at Key Bank) and Will Oliver (Principal at PE group Revelstoke Capital).
The panel agreed that while bank financing has become more challenging, PE firms and strategic buyers still hold plenty of dry powder. Koenig stated that while “Private Equity in fact has seen an influx of capital as cash gets re-deployed from the stock market, within PE, larger deals have become more challenging, leaving the Lower Middle Market as the shining outperformer.”
The Fed’s Sly spoke on the broad macro view that inflation remains too high. Beyond just exceeding a nominal target, this is problematic when it distorts behavior in the economy—trends which he sees as ongoing and concerning. The goal is not to cause companies to fire their workers, but perhaps to remove their new job listings. In the rising rate environment, Doug Dell noted that banks have had to get more cautious, pulling back from aggressive lending.
Countering the gloom, Koenig noted that Woodbridge just saw its best campaign ever, yielding 63 bids and counting, only weeks after another campaign garnered more than 50 bids of its own. Valuations haven’t dipped, even if deals are being funded by greater ratios of equity over debt. Will Oliver agreed, from a PE perspective, when there is an A+ asset that fits a strategic objective, they won’t hesitate to pay cash and close fast.
Demographics remain favorable, with the US in the midst of the greatest ever reallocation of wealth as Baby Boomers retire. Owners of strong businesses have reasons to diversify their assets in any macro environment.
Across sectors, Koenig noted that though there is occasional trepidation across consumer-focused spaces, investors remain keen on industries seen as “recession-proof” like restoration and disposables with interest remaining high even in spaces thought to be struggling like building construction and transport. Multiples differ across industries, but creative structures often help bridge expectation gaps. Though debt financing is costlier, sellers are more open to holding a note with yields near 10%.
In Q&A, the panel was asked about COVID adjustments and pro-forma changes for inflation. While all were agreed that these remain a challenge, so long as performance remains robust month after month, companies can still prove out their business models. Koenig highlighted that “broad-based campaigns to market companies can consistently uncover a buyer with a contrarian viewpoint or a strong strategic angle.”
While some funds may be bracing for a downturn, still others are eager to fund deals before interest rates rise higher.