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By Brian Edwards | MiBiz
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WEST MICHIGAN — Mergers and acquisitions are keeping Jack Hendon and his partners at H&S Companies pretty busy these days.

The Fremont-based accounting and consulting firm is advising clients on transactions, but the 60-person firm with offices around the region also closed a couple deals of its own in the first month of 2012. H&S Companies acquired companies in Mt. Pleasant and Rockford and continues to look for add-on acquisition opportunities to expand geographically, add capabilities and leverage overhead, Hendon says.

“I think all industries, ours included, are starting to experience the fact that there’s strength in numbers and economies of scale,” Hendon says.

As the economy comes back, merger and acquisition activity is picking up in 2012, driven by strategic buyers and, to a lesser extent, private equity firms. Faced with tepid organic growth, a growing number of companies are turning to acquisitions to boost revenues, improve efficiency and generate returns.

“The deal world has gone bonkers lately,” says attorney Tracy T. Larsen, managing partner of Barnes & Thornburg LLP’s Michigan office and vice chair of the national firm’s 210-lawyer corporate department.

Barnes & Thornburg, which has 12 offices nationwide, has added a dozen M&A lawyers, including partners and associates, at offices across the country in the last two years, Larsen says. The M&A market is “pretty frothy” right now, he says, noting that the firm is working on transactions with a total value of nearly $6 billion.

“Everyone is very busy,” he says.

It’s a good time to be an M&A adviser, as the deal pace quickens among middle-market and small businesses. Transactions in the health care, high tech and manufacturing sectors are keeping local advisers and investment bankers busiest these days, as buyers shop for quality assets.

It’s also a very good time to be a strategic buyer with cash, or at least a healthy balance sheet that banks will lend against. A variety of market dynamics — from executive confidence and capital availability, to capital gains fears and owners getting older — are putting more companies in play.

Those same dynamics have brought a new reality for sellers when it comes to valuations. Multiples are down, advisors say, and while they’re strengthening in the market, they’re not back to pre-2008 levels.

MiBiz talked to lawyers, accountants, investment bankers and other advisers to get a feel for the deal flow environment in West Michigan, the state and around the Midwest. The consensus is that interest seems to be picking up and a number of factors will drive transaction activity to higher-than-anticipated levels in 2012.

Confidence

Confidence in the economy is a fickle thing: When it released its annual mergers and acquisition survey in mid-December, law firm Dykema reported that fewer executives, investment bankers and consultants surveyed expected a “strong” M&A market in 2012 relative to 2011.

That sentiment appears to be changing as executive confidence improves and deal flow increases, says Brian Page of the firm’s Grand Rapids office.

“Even since our survey, it seems as if the business community’s optimism has done nothing but grow,” Page says. “I’m seeing a lot more positive and optimistic stories from companies and CEOs, especially in the manufacturing area. Now that Governor Snyder has a year under his belt and can point to some results, I would take the position that optimism is running even stronger than when the survey was done, and that’s made people more bullish.”

Cash

In the Dykema survey, nearly 60 percent of respondents said they expect to be involved in an acquisition as an acquirer — the largest percentage since 2006. That’s likely a testament to confidence among executives who are sitting on cash — or at least generating it as the economy recovers.

“As business starts to pick up, some companies are doing very well because they worked on the business, cut out the fat and now that things are turning around, they’re more profitable,” says Hendon of H&S.

“Companies continue to have a lot of cash,” says Thomas Haan, principal of Global Equity Consulting LLC in Kalamazoo. “That’s not a big change from a year ago, but now they have a bit more confidence about the future. Plus, because the organic growth outlook is not so robust, management teams are starting to get pressure to do something with that money.”

“It seems that more people are viewing it as a lower risk thing to go out and buy a company than to expand their businesses and hire people,” Haan says.

Bank financing is becoming increasingly available for companies with cash and strong balance sheets, and investment bankers are reporting increased assignments and pitches. Cleveland-based Cyprium Partners, a mezzanine finance firm, recently surveyed 175 investment-banking firms around the U.S. and reported that 44 percent of respondents had signed more assignments than in the comparable period in 2010.

One adviser, who asked to remain anonymous, notes an informal indicator he sees when the M&A market is gathering steam: “When you talk to investment bankers these days, they’re holding really tight on their fees. That wasn’t the case a year-and-a-half ago, so they must be seeing more deal flow and better deals.”

While private equity firms are sitting on nearly $425 billion of “dry powder,” according to Seattle-based research firm Pitchbook, their acquisition activity has slowed over the past few years as the credit markets have constricted.

“We still have not seen private equity return to its heyday because they depend on leverage to hit their (internal rates of return),” says Larsen of Barnes & Thornburg.

Capital Gains

When the ball drops at midnight on Dec. 31, 2012, the federal capital gains rate will rise from 15 to 25 percent as the Bush tax cuts expire. President Obama extended the cuts in 2010, but few are expecting a repeat performance, especially after the brouhaha surrounding Mitt Romney’s tax return.

The revelation that the Republican candidate made more than half his income on capital gains and paid an effective tax rate of 13.9 percent on his 2010 adjusted gross income has elevated the capital gains discussion in Washington, D.C. Democrats believe the wealthy should bear more of the nation’s tax burden, and capital gains taxes are paid mostly by the wealthy. Republicans seem to be angling for a flatter tax with lower marginal rates for all incomes and the elimination of special tax preferences like capital gains.

The threat of a tax hike is driving some private business owners to take their chips off the table at the 15 percent capital gains rate, experts say.

“What’s going on now is that we have some sellers that maybe would have come out next year that are coming out now because of concerns about changes in the capital gains rate,” says Barnes & Thornburg’s Larsen.

“Most owners realize that tax rates are pretty low right now and they’re not going to go any lower,” says Hendon of H&S Companies, which provides tax and consulting services to more than 6,000 clients.

Not everyone puts the same weight on capital gains driving deals.

“I think it’s a factor, but I’m not so sure it’s been the priority of trying to get a deal done,” says Thomas Hiller, a partner in the Grand Rapids office of BDO USA LLP. “In all deals, there are strategies to limit the impact of capital gains and make sure the transaction has minimal tax cost.”

Aging Owners

Another factor that may be at work in some businesses is an aging owner class. Many Baby Boomers started and have grown successful businesses, but are now in their 60s and approaching retirement age. If 2012 provides an opportunity for liquidity, some will jump rather than risk holding on for the next window, which could take them into their 70s.

“What they don’t want to do is go through another business cycle,” says Global Equity’s Haan. “(A lot of them are) tired and they feel like this phase of the business cycle has a bit to run…and they have to be concerned about going through another down cycle.”

Valuations

In talking to advisers and bankers for this story, one word came up consistently when discussing valuations: reality.

“The big multiple bubble burst a few years ago,” says BDO’s Hiller, who is currently working with several clients on the buy-side for deals valued between $20 million and $100 million. He says buyers are looking at 3-4 times EBITDA these days, as opposed to 5-6 times in pre-2008.

For the smallest deals, lower multiples and seller financing may well be the new normal, says Global Equity’s Haan, who also provides investment banking services through Chicago’s Capital City Advisors LLC. Dykema’s M&A survey also found that 62 percent of respondents were seeing more seller financing than in previous years.

Barnes & Thornburg’s Larsen, who often works on transactions in the $50 million to $1 billion range, says there is more reality and understanding that valuations expectations are not what they once were.

“A lot of that is supply and demand, and there are not as many people chasing the process,” he says.

That’s especially true with private equity firms. While there is growing activity among strategic acquirers, the majority of private equity fund managers expect to close only two or three deals during the next 12 months, according to the third annual “PErspective” private equity study by BDO USA. The vast majority of the survey’s respondents — 95 percent — indicated they will seek add-on acquisitions in the coming year.

With fewer PE firms in the mix, that’s also helping keep valuations in check, Larsen says.

“Back when there was a lot of debt, private equity firms bid on most every deal,” he says. “They didn’t win every deal, but the influenced a lot of them.”

As with any valuation, quality will almost always reap a higher price.

“There’s a big dichotomy in the marketplace between quality deals…and the companies that are marginal or distressed,” says Tom Vaughn, a partner at Dykema’s Detroit office.

“Michigan has seen so many distressed deals that we’ve kind of hit the bottom and are ready to move on,” says Vaughn. While he expects fewer distressed deals, he’s quick to add that there will be companies that survived to this point, but have not bounced back, that might see a window of opportunity to get out of their problems now.

“Clearly, there are people who would have been happy to sell over the past few years, but couldn’t because of pricing and financial conditions,” Vaughn says.

With strategic deals potentially up, private equity deals holding flat and distressed deals down in 2012, there is one type of deal you probably won’t see in the coming year, says Global Equity’s Haan.

“I think there will be fewer ego deals: … the kind of deal that doesn’t make strategic sense, but the CEO wants to be the CEO of a bigger business or has some grandiose plan he’s trying to execute — but the strategy is really a stretch.”

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• west michigan