A slowing economy in the US combined with still steep price tags on target companies has private equity buyers focused on making strategic add-on acquisitions to existing middle market portfolio companies as a pathway to growth, bankers say.
Sustained high purchase price multiples have squeezed private equity returns and highly competitive auction processes have left many sponsors empty handed. As an alternative, so-called buy and build strategies offer compelling opportunities to build scope and scale around existing portfolio investments.
"When the economy starts to slow, add-on acquisitions are a faster way into a market versus looking at 5-7 years of organic growth," said Karen Davies, managing director and group head of Huntington Bank's private equity banking vertical. "It is a way for private equity firms to blend down cost of capital and provide multiple arbitrage."
Sponsors can effectively expand a business with the purchase of a competitor, a new product line or a complementary platform to diversify its geographic footprint or customer base. At the same time, private equity investors can effectively lower the cost of capital by making incremental acquisitions at lower multiples relative to the purchase price paid for an existing portfolio company.
At 49%, loans for add-on acquisitions account for roughly half of middle market sponsored M&A volume year-to-date versus 51% for new leveraged buyouts, according to LPC, a division of Refinitiv. Among middle market borrowers recently in market to raise incremental dollars for acquisitions are energy industry software specialist Quorum Software and bulk and specialty salt producer US Salt.
Quorum, a portfolio company of private equity investor Thoma Bravo, is in market with a US$90m add-on term loan slated to fund the acquisition of Coastal Flow Measurement Inc. The acquisition expands Quorum's oil and gas software and services portfolio with the addition of Coastal Flow's measurement services and data management resources, including subsidiary Flow-Cal Inc whose products are built for the hydrocarbon measurement industry.
The combination of Coastal Flow's measurement products with Quorums' suite of business applications creates an integrated platform for shared customers and energy industry participants, the two companies said in a February 26 statement. The acquisition comes less than a year after Thoma Bravo bought Quorum from Silver Lake in September 2018.
US Salt recently inked a US$285m first-lien term loan and a US$128m second-lien term loan to fund the company's acquisition of NSC Minerals. US Salt is backed by an investor group comprised of Metalmark Capital, Silverhawk Capital Partners and Demetree. Citizens arranged the debt financing.
LIFE CYCLE
The trend is also not unique to the middle market. Larger private-equity backed companies in the space between traditional middle market companies and large corporates are also pursuing such acquisitions, also known as tuck-ins or tack-ons.
Most recently, Dental Corporation of Canada Inc launched on March 1 US$177m in first- and second-lien incremental term loans to fund acquisitions, LPC reported. Jefferies is arranging the deal, which includes a US$127m incremental first-lien term loan and a US$50m incremental second-lien term loan.
Dental Corporation of Canada last June raised a US$925m credit facility backing the company's sale to L Catterton, LPC data show. Jefferies was lead left on the acquisition funding, joined by CIBC and TD.
Earlier this year, enterprise software provider Perforce Software Inc finalized a US$410m first-lien incremental term loan and a US$50m second-lien add-on loan to fund the acquisition of Rogue Wave Software, a provider of cross-platform software developer tools and embedded components.
Antares Capital led the transaction. Ares Capital, Varagon Capital Partners and AB Private Credit Investors were joint lead arrangers on the first-lien incremental facility. Perforce said the strategic acquisition expands its portfolio to optimize the application development process, according to a statement.
At the other end of the spectrum, as large corporates divest business units and carve out non-core assets, a whole new layer of investment opportunities are born. Late last month, industrial conglomerate General Electric said it would sell its biopharma business to Danaher Corp for US$21.4bn. From this sort of divestiture, additional carve-outs and spin-offs often follow suit, bankers said.
Mid-sized companies looking to diversify products lines, buy a competitor or enter a new segment are often the prime beneficiaries when large companies shed assets or divest business units. "Buy and build works best built around a strong management team or an industry leading platform, giving you operational expertise and a rock solid platform," Davies said "You see it a lot in healthcare and sectors that are highly fragmented, like dental and veterinary services, but it really is happening across the board.