Valuations Continue to Trend Higher in Today’s Booming, Highly Competitive M&A Market
Industry expert Paul Resch discusses the upward pressure on pricing and common mistakes made during the valuation process.
6 July 2021
SS&C Intralinks recently held a webinar with a panel of mergers and acquisitions (M&A) dealmakers about the rise of SPACs. During the discussion, one of the panelists mused that now is as good a time as ever to be a qualified buyer. He couldn’t be more right. After a brief pause in dealmaking when the COVID-19 health crisis took hold in Q1 2021, M&A rebounded dramatically. In the Q3 2021 SS&C Intralinks Deal Flow Predictor, our quarterly prediction of early-stage M&A activity based upon deals that are six months from a public announcement, our data points to 2021 going down in history as a record-setting year for the industry.
There’s a lot of confidence in the market for many reasons, including the successful rollout of COVID-19 vaccines in some parts of the world. Meanwhile, well-capitalized corporates, private equity (PE) firms and SPACs are more active than ever. This collective appetite has led to a highly competitive situation with a lot of cash chasing a dearth of deals. While potential headwinds are present, valuations are rising and multiples are up significantly from where they were two years ago.
To learn more about the state of valuations in today’s red-hot M&A market, I spoke with Paul Resch, CEO at Valutico. Paul’s firm provides technology-driven valuation tools that remove friction from the process.
SS&C Intralinks: Rising valuations are certainly top of mind in the current M&A market, especially as competition for assets has become fierce. The highly competitive landscape is driving up valuations in many industries. What are you hearing from your clients about the current state of play in the market?
Paul Resch: It is certainly true that valuations are quickly rising and approaching all-time highs, especially when looking at indicators such as the Shiller P/E ratio. In public markets, the last few months saw the re-emergence of the retail investor — the Robinhood crowd — who are driving up valuations for individual assets. Now we have SPACs, which at first sight seemed quite valuation insensitive. Add to that the continued low-interest environment, which often means that equities are simply without an alternative, and you will likely have even more capital flowing into the public markets, driving up valuations further.
This, of course, has implications for the M&A market, as public market valuations necessarily filter through to the private markets. What we sometimes hear from clients is that — while not a problem yet — this environment does seem to sometimes create unrealistic price expectations, especially in less “sexy” brick-and-mortar industries.
The current scenario of corporates seeking inorganic growth and the record amount of dry powder private equity can put to work will likely be with us for some time. Besides competition for assets, what factors are driving the rise of valuations?
Quantitative easing combined with low rates and, more recently, the COVID-19-related stimulus, have poured a lot of money into markets in search of yield. As a result, we see general inflation of valuation across practically all sectors and asset classes. If you like the old idea of markets being driven by greed and fear, then you have to conclude that currently they are certainly more driven by greed.
How is the rise of SPACs creating challenges for valuations?
For all the noise around SPACs, I think Tech was the most active sector for SPACs, and yet they only represent 50 deals last year. Healthcare is second with fewer than 30, and they are already notoriously challenging to value because markets have rewarded growth at all cost. For the average valuation project, I think SPACs will be a non-factor, but it’s a hot topic so valuation professionals need to be able to offer an opinion on the matter. For the rare case where a SPAC is used as an alternative to a strategic buyer, it’s likely to drive up valuations to some extent, but outside cases where that is a realistic option — maybe a few dozen projects per year — sophisticated buyers should let sellers use SPACs to drive the range higher.
From a purely technical valuation perspective, SPACs’ often complicated capital structure can create problems when analyzing multiples and other metrics.
In your view, what are some of the most common — and avoidable — mistakes made during the valuations process? How does technology help the process?
Finance professionals sometimes get so lost in the details so they don’t see the forest for the trees. What people sometimes forget is that a good valuation is the combination of narrative and numbers. A narrative alone is just a fantasy. Numbers alone are just that. But a coherent narrative combined with numbers in the form of a financial model is something much more powerful.
Another cardinal mistake is to not consider different perspectives. People will anchor their thinking around a particular peer or a comparable transaction, and neglect taking an objective look at market data to create a better and broader set of comps, or to even consider income-based methods or alternate exit scenarios like LBO. Technology can help because it removes the friction of finding the information, the challenges of analyzing it accurately (calendarize, normalize, spot outliers, etc.) and lets practitioners really focus on exerting best judgment rather than hunting data points across the web to feed into their models.
Amid the fast-paced nature of the current marketplace, what are some different valuation techniques and methodologies? Are there specific processes that prove to be more effective?
I think you can’t ever go wrong doing a DCF, even if only to get some grounding and for the value that comes from thinking through a forecast. I am excited about the move beyond spreadsheets in this area because, combined with modern big data technologies, it will facilitate exciting new simulation-based methods, so the way we think about forecasting might change fundamentally in the future.
And by the way, let me just say, I read about some very interesting things that SS&C Intralinks is working on in this field. I am fascinated by the idea that in the future we might be able to automatically analyze the content of a virtual data room, produce due diligence reports and potentially then be able to calculate the impact of these findings on both projected cashflows and their volatility.
When it comes to market-based methods I think multiples will continue to be the most effective way to have a pricing discussion. It’s also less confrontational to argue about what a good comp is rather than whether a forecast is plausible. What I find fascinating here is the idea of building models that include parameters that help explain why a certain multiple is high or low. The challenge here will be to bring together different data sources – both structured and unstructured – to enrich the data in a way to make it more descriptive.
Based upon your years of expertise, what advice can you offer dealmakers when it comes to valuations right now in this robust M&A market?
I guess it depends upon which side you’re on, but anchoring is a real factor in negotiations. So if you can be the quickest party to come to the table with a valuation range suggestion and be able to defend it with data and robust models, you are likely to have a leg up and keep that edge through the deal. Who wouldn’t want to have all the edges they can get? I suppose what SS&C Intralinks does in deal execution is similar, hidden behind the concept of productivity is a lot more than just time-saving, but actually value that can be measured in real dollars.
Anything else you’d like to add?
The financial services world is changing. It’s moving toward more data, more speed and more software. I think financial services providers that embrace technology for what it is — an enabler, not a replacement of their skillset — are likely to see great returns. Clients are having increasing expectations and won’t accept the pace and methods, or maybe even the fees, that were standards not that long ago. SS&C Intralinks, Valutico and many others are leveling the playing field in M&A, and I’m excited to keep bringing more innovation to our clients and to work with you.