Multiples Report, released in December 2016, multiples, at least for private equity
deals reported, are high ( 8. 2 X EBITDA and 1. 5 X revenue). As usual, the multiples
experienced for smaller companies are much lower, but they are still attractive. It
is important to note that most reported transactions had trailing 12 months (TTM)
revenue growth and acquirers anticipating revenue growth in the next 12 months.
If you are looking at a distressed business, these multiples might not tell you much
for two reasons:
1. If your borrower has low, zero or negative EBITDA, these valuation models
don’t make much sense — any number multiplied by zero is zero.
2. Of the reported transactions, just 4% had T TM revenue negative 10% or worse.
Expect troubled deals to trade at far below median or mean pricing of healthy
private equity (PE) transactions. According to the same Pitchbook report, about
40% of all reported PE deals required seller financing or earnouts. Few bankers are
interested in earnouts, so in special situations, deals tend to be all cash, resulting in
much higher leverage and a purchase price that will likely rely on asset values, versus
multiples, leading to a substantially lower purchase price. All of that notwithstanding,
going concern businesses, even storied ones, are in demand and attracting aggressive
pricing, and an entirety sale should be pursued to avoid a liquidation.
While these issues aren’t new, it’s important to recognize them as they seem to
be common, and they are magnified right now. Keep these concepts in mind as you
use your usual tools and experience to get through workouts, and 2017 should be a
very good year for you. abfj
KEN MANN is senior managing director of Heritage Equity Partners.
We also noticed that the challenges associated with some appraisal and liquidation
issues were exacerbated in 2016.
Lenders must pay attention to valuation concepts, such as the difference between
orderly liquidation value (OLV) and fair market value (FMV), market changes since
the last appraisal, the deterioration of equipment through the lack of maintenance and
any sale or removal of appraised key equipment. With regard to the last issue, lenders
must be aware that without the equipment, there is less to sell than was appraised. If
the missing equipment includes key pieces, the draw for people to participate in the
sale may severely decline.
Inventory mix is also critical. When selling solid countertop materials, for
example, you need about three slabs to complete a kitchen. Therefore, two slabs of a
given style have less value because a contractor can’t complete the average job with
them. Styles change and inventory that hasn’t moved in the last 12 months is worth
substantially less per piece. Therefore, the per piece value indicated in the appraisal
can be vastly different from the average selling price in liquidation. Advances made
on inventory loans should be made the same way appraisers might stratify the inventory in the appraisal, rather than on a blended rate.
Valuation definitions used in appraisals do not necessarily reflect the best metrics
for predicting auction performance, which confounds auctioneers. There is no
exacting discount that can accurately express the gap between a fair market in place
value, or even an orderly liquidation, and the price achieved in a 100% sell-through
in 60 days. This is especially true on projects without frequent valuation update and
in sectors, like solar, with rapid technological obsolescence.
These specialized assets do not have the same liquidity floor of resellers, or easy
comparable sales data as do, say, CNC metal cutting machines. Values can vary significantly on a deal by deal basis. As a result, even when lenders ask for forced liquidation
value (FLV), appraised FLV often does not produce the same result as the reality of the
auction. In late 2016, we observed a big breakdown in appraised FLV versus auction
value in the current market. In the coming months, lenders should not make decisions
that are based solely on appraised values without further investigation.
Going Concern or Enterprise Values
Ideally, you want the borrower to sell as a going concern, and values have been very
good in this respect. After slipping a bit from their 2014 highs, multiples now appear
to be back to those historical highs. According to Pitchbook’s 2016 Global PE Deal
Before the company is out of runway and liquidation
becomes the only option, the lender should encourage
the borrower to try to fix the business or sell it as a
going concern. Be persistent and make introductions to
qualified professionals. In most cases, the recovery in a
going concern sale will far exceed liquidation value, a
truth that seems magnified coming into 2017.
Source: Information from the Federal Reserve combined with bankruptcy filing information from the American Bankruptcy Institute.
Note: Chapter 11 bankruptcies in thousands, Chapter 7 bankruptcies in ten thousands.