Healthcare and Technology Leading in a High-Energy M&A Market
The pandemic and ensuing economic turbulence of 2020 put a damper on many middle-market industry sectors for merger and acquisition (M&A) activity. 2021, however, has seen the lid come off for both private equity investors and corporate buyers and sellers. KeyBanc Capital Markets® (KBCM) M&A senior bankers noted increased activity across the board in the first quarter, and say healthcare and technology in particular will drive what’s on pace to be a record year for middle-market M&A deals.
“Some of the uncertainty has been removed in the economy, and coupled with the abundance of capital in the marketplace, we’ve seen demand momentum take off,” says J.R. Doolos, Managing Director, Mergers & Acquisitions for KeyBanc Capital Markets. “With the broad fundamentals driving the market showing sustainability, optimism is only going to continue to grow.”
Rob Fraiman, President of Cain Brothers, KeyBanc Capital Markets, Healthcare M&A, focused exclusively on the healthcare industry, added, “Compared to pre-COVID and the deal pause that happened between March and June 2020, the number of engaged clients and potential transactions we have is up 20-plus percent. Every single vertical that we cover in healthcare is experiencing robust dialogue and enhanced activity levels.”
He notes the M&A conversation includes everything from large hospital systems and managed care to more asset-light organizations such as physician practices to healthcare IT, medical devices, life sciences, and pharmaceutical and clinical research.
Pat Kratus, Managing Director, Head of Technology Investment & Corporate Banking, Technology M&A, confirms the strong outlook for technology M&A, saying, “Well-capitalized strategic buyers and technology-focused PE buyers have never been more actively courting high-quality growth companies in need of additional capital to fully achieve their growth objectives.”
Kratus adds that a significant number of software firms went into 2020 with ambitious internal top line growth projections of +60-70%. For many, that growth was tempered by the pandemic; many still posted impressive growth of +40%. Additionally, even at historically high multiples for private company buyouts, these companies are highly attractive to corporate and financial buyers as add-ons that come at a discount to where the larger public companies are trading. He says that in other segments, many companies that are currently highly attractive were in business models accelerated during COVID.
Here’s a look at three factors driving the overall middle-market M&A boom:
- Rewarding sectors and companies that showed resiliency in 2020.
Many deals on track for completion went into limbo when the economy shut down in spring of 2020, as companies and PE took a more protective approach to liquidity. In the second half of 2020 and into 2021, a large portion of those deals, and many new ones, came off the sidelines to fuel the M&A boom.
Now a combination of elements – low-interest rates, record high levels in the equity markets, sector innovation during the pandemic, and strong economic fundamentals – have created an environment ripe for more players to enter M&A on both the buy and sell side.
Companies that came through the pandemic and identified opportunities that require having a larger scale or capital to invest in innovation and technology are now assessing how that can be acquired through M&A. Strategic buyers are motivated by an imperative for growth and general optimism about the economy and are in acquisitive mode. At the same time, founders may be looking to capitalize on coming through the pandemic in a stronger position.
“Whether it’s a founder or entrepreneurial team, anyone who might be thinking of selling a business may be thinking about it when markets are robust and capital is plentiful,” said Kratus.
- Unprecedented capital and investors eager to place it.
The availability of private equity capital is at an all-time high and continuing to grow as private equity firms have raised unprecedented amounts, including through vehicles such as SPACs (Special Purpose Acquisition Companies). In addition, the equity markets and, in particular, the IPO market is remarkably robust for issuers. Now this capital needs to be put to work.
“There’s approximately $2 trillion held by private equity funds today in dry powder,” said Jeff Johnston, Managing Director & Group Head, Industrial, Consumer, Oil/Gas, Real Estate M&A. “And that’s just the equity. If you assume you can get four to six plus times leverage, the buying power is tremendous.”
- Rising valuations backed by strong growth propel activity.
The stock and equity indexes are trading at all-time highs, having a major impact on valuation of businesses. Fraiman and Kratus agree that eye-popping valuations are not necessarily evidence of a bubble, but rather an indicator of the overall strength of the market and a premium on growth.
“There’s been a reset, what investors are valuing today is growth,” said Fraiman. “They’re finding it largely in technology and healthcare companies and it’s fairly valued given the high growth prospects for many companies.”
Kratus adds that while many of these technology multiples may look eye-popping on a one year forward basis, when examined over a slightly longer time frame, they come quickly in line. Especially for businesses that have demonstrable margin expansion in their forecasts, PE buyers are able to factor that into their initial purchase price. In the case of strategic buyers, their robust current valuations enable them to efficiently raise equity and/or debt to pay for their inorganic growth.
Founders also have an added incentive to move quickly in this high valuation environment – due to the potential for a capital gains tax increase that the Biden administration has put on the table.
The pieces are in place for a booming year for middle-market M&A: the economy is strong and shows resilience, employment levels are rebounding after the steep drop in 2020, the U.S. Federal Reserve has committed to low interest rates, and businesses and investors have come through the pandemic in a position to deploy capital.
“Fewer businesses – including banks – are over-leveraged than during the 2008 recession,” Johnston says. “The COVID downturn was sharper and more precipitous, but this recovery is much steeper, as well. I think it speaks well for where we’ll be for the remainder of 2021 and beyond.”
Already M&A transactions in North America have been record-setting in 2021 – with $717B in total deals in the first quarter and the second-highest deal volume this century. This growth shows no signs of slowing over the second half of the year, especially in the blazing healthcare and tech sectors.