The Lincoln 350 Index and a discussion of our unique perspective on the middle market. Key M&A market and purchase agreement statistics

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Company Group Inside this Issue Welcome to the August / September 2013 issue of the Company Group DealReader, a newsletter focused on merger-and-acquisition trends, transactions and events of interest
Company Group Inside this Issue Welcome to the August / September 2013 issue of the Company Group DealReader, a newsletter focused on merger-and-acquisition trends, transactions and events of interest to owners of private companies and their advisors. In this issue, we pose five questions to Michael Schoenbach, a Managing Director with Aon Transaction Solutions. Mr. Schoenbach discusses how M&A transaction insurance products can be used to help manage risks and to ensure a successful outcome. His interview provides The merger-and-acquisition newsletter for owners of private companies and their advisors a short history of the products as well as an overview of situations in which transaction insurance may benefit private company owners. Other topics covered in this issue include: The Lincoln 350 Index and a discussion of our unique perspective on the middle market Key M&A market and purchase agreement statistics Profiles of recent transactions, including the sale of Whalen Furniture to Li & Fung and the capital raise of Pace Industries We hope you find this newsletter a useful tool and we welcome your comments or questions. Five Questions For: Michael Schoenbach, Aon - M&A Insurance Products Michael Schoenbach, Managing Director at Aon Transaction Solutions Aon s Transaction Solutions team is dedicated to providing solutions for transactional risks in mergers and acquisitions, real estate and financing transactions. They service a wide range of private equity and corporate clients as well as their principal legal, accounting and financial advisors. Michael J. Schoenbach, CPA, is a Managing Director at Aon Transaction Solutions based in New York City. He has 33 years of accounting, finance and insurance experience. He has been with Aon for 21 years, where he has developed Transaction Liability products and leads a team working with clients to provide ongoing transaction solutions. We asked Mr. Schoenbach five questions regarding Aon s Transaction Solutions group and how private company owners can use M&A insurance products to manage the risks inherent in a business transaction. Q: How can M&A insurance be used strategically to improve a bid, allow sellers to achieve a clean exit, or simply remove a roadblock? A: Shifting risk to the insurance markets can dramatically alter a negotiation. In many cases, it could mean closing a deal that would otherwise have little possibility of success. Insurance policies can be structured quickly and inexpensively to provide the seller with the ability to substitute insurance for most or all of an escrow or indemnity cap, thus enabling a cleaner exit. At the same time, this can allow a buyer to advance its bid in an auction by using this insurance solution to provide the security that would otherwise be available through traditional reps and warranties ( R&W ). Transaction Liability Products by the Numbers $10 billion in policy limits sold in 2012 (anticipated to grow by 50% in 2013) Take up and acceptance rate have increased exponentially over past 10 years Pricing is down nearly 50% from 10 years ago Process and timing over past 10 years have moved from 3 weeks to 7-10 days Company Group D E A L R E A D E R Q: Very briefly, can you provide insight into the details of these policies? A: Coverage is designed to replicate or enhance the general term of an indemnity. R&W policies can match or exceed the survival period in a given transaction whereas tax and contingent liability policies will generally track the relevant statute of limitations. Pricing, generally expressed as a percentage of the policy limit desired, is paid as a one-time premium at the close of a transaction. It varies based upon product, risk profile and geography, with U.S. risks generally more expensive than European risks. R&W policies are designed to cover unknown breaches while tax and litigation policies generally cover known events. Q: Could you outline the growth of M&A insurance or transaction liability products over recent years? A: The use of Transaction Liability or M&A insurance has expanded exponentially over the past 10 years. We estimate that the global market will place nearly $15 billion of policy limits for 2013 based upon historical placement rates. There are many reasons for this, including 1) growth of the product (Continued on page 2) 1 (Aon, continued from page 1) and its track record of performance in the market, 2) decreased product cost, 3) increased speed, flexibility and overall ease of the underwriting process. Q: Can you describe the arbitrage that exists in the pricing of these products and how it could positively impact the economics of a transaction? A: By reducing the amount expected from the seller in the form of escrow and indemnity and replacing it with insurance capital, we can reduce the net price the seller is willing to accept. The seller wins by avoiding escrow/indemnity and the buyer wins by achieving a lower purchase price. The example to the right is directionally correct based on our experience using R&W in lieu of escrow/indemnity caps. In theory, there is a multiple returned for every dollar spent on insurance in terms of purchase price reduction. Q: How do I know when an opportunity exists? A: M&A insurance products can serve a wide variety of needs, including some of the situations listed above. If a client believes insurance could prove an effective solution they should contact Aon. Note: Aon does not charge its clients for efforts to determine if an opportunity exists. Terms Representations & Warranties Insurance Example Deal A (No TL Insurance) About Aon Aon is the leading global provider of risk management, insurance and reinsurance brokerage, and human resources solutions and outsourcing services. Aon Advantage Deal B (With TL Insurance) A) Sale Price $100M $100M B) Escrow (1) 10% / $10M $1M TL Insurance Limit N/A $9M C) TL Insurance Costs (2) N/A $300K Cash Released at Closing (A B C) $90M $98.7M D) NPV of 10% for 1.5 years $8.7M $866K NPV of Sale Proceeds (A B C + D) $98.7M $99.6M Indemnity Period Afforded to Buyer (3) 1.5 Years 6 Years Exposure of Escrow / Indemnity Fully Exposed Minimal; Addressed by Insurance Notes: 1.Deal B escrow is equivalent to TL insurance policy retention 2.Premium rates vary and are a function of risk and total limits 3.Escrow released to seller after 1.5 years in both The key advantage is a broad view of two of the most important issues in the economy today: risk and people. With an employee base of 65,000 people working in more than 120 countries, Aon can anticipate how changes in one sector impact another. For more information on M&A insurance products, please contact Michael Schoenbach at Aon at (212) or Product Description Impact on Negotiations Examples of Issues Addressed Representations & Warranties ( R&W ) Protects the buyer against loss from unknown breaches of R&W, which are discovered post-close (or after signing if structured accordingly) Price Range: 3% +/- Increase speed of deal Favorably impact auctions Minimize escrows / indemnity caps Extend survival of seller indemnity Facilitate clean exit Provide credit worthy protection Will previous owners stay on as management? Is there an escrow over $5 million? Will the reps and warranties survive closing? Is the indemnifying party a collection risk? Tax Indemnity Alternative to Letter Ruling ( PLR ); protects insured from adverse ruling by IRS or relevant taxing authority regarding intended tax treatment of a given transaction or issue. Covers tax, interest, penalties, contest costs & gross up Price Range: 3% - 6% Improve execution by bridging the discount a buyer may put on an issue versus a seller Can cover 338(h) (10) elections, NOLs, 355, transfer pricing, sale of REIT shares, cross border issues, etc. Is there a tax issue the buyer is unwilling to take on without seller indemnification? Are NOL's a major source of value? Was there an attempt to obtain a PLR? Litigation Buy-Out / Contingent Liability / Fraudulent Conveyance Provides certainty via a box or ring fence around existing litigation to protect insured against catastrophic loss that exceeds the expected loss amount Price Range: 7% - 10% Improve execution by bridging the discount a buyer may put on an issue versus a seller Can function as signaling capital Critical issue is the attachment point Is there outstanding litigation, that could be material, but has an uncertain outcome? Are there known issues that could result in future claims, but where no claims have been brought yet (e.g. product liability)? Environmental Insurance Provides stop loss protection by capping the expected costs for existing clean-up activities and to transfer potential legal liability Price Range: varies by risk and number of sites Improve execution by bridging the discount Are there material environmental liability with a buyer may put on an issue versus a seller significant uncertainty as to valuation? 2 D E A L R E A D E R Company Group The Lincoln 350 Database Lincoln s Perspectives on the Middle Market About The Lincoln 350 Database: Lincoln maintains an extensive proprietary database in connection with its quarterly portfolio valuation activities containing valuation and financial data for a diverse group of companies across ten primary industry segments. The database offers a glimpse into the middle market where reliable data is otherwise limited. Valuation metrics reflect observed transaction multiples. Financial results reflect information available at the end of each calendar quarter (typically, financial statements for one or two months preceding the end of the period). The database contains over 350 companies. There continues to be a high amount of liquidity in the financial markets. Equity markets performed exceptionally well, with the major indices increasing approximately 12% for the quarter. The credit markets were similarly robust. LBO activity was slower than expected, but low pricing and attractive and increasingly competitive loan terms drove a further surge of refinancing activity. Based on the data collected by Lincoln, middle market company performance in the first few months of 2013 softened quarterover-quarter. Despite improvement in some macro-economic indicators, middle market companies continue to be challenged and are more likely than not to be experiencing revenue declines and margin compression. For the first time since we began tracking this data in Q1 2011, the number of companies in our data set showing quarterly year-over-year revenue and EBITDA declines exceeded 50%. In fact, nearly 60% of companies evidenced a decline in EBITDA, a sharp increase over the prior quarter. Declining performance was broad-based, impacting all size strata and most industry segments. Not only did more companies show declines this quarter, but the rate of decline also accelerated. This represents a continuation of a trend which we first observed in Q Flat to declining top line revenue on lower-than-expected demand and margin compression from higher input costs combined with various industryspecific factors are contributing to this trend. Presented below are selected data from our Q1 valuation activities as captured by our proprietary database. M&A Transactions Commentary: Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 TEV / EBITDA 6.6x 6.0x 7.1x 7.2x 6.6x 8.1x 7.5x 7.7x Total Debt / EBITDA 3.9x 3.4x 3.7x 3.9x 3.9x 4.5x 4.1x 4.3x Senior Debt / EBITDA 3.2x 2.7x 3.0x 2.9x 3.2x 3.4x 3.3x 3.4x Equity % of Total Cap 39% 41% 45% 43% 39% 44% 43% 46% LTM EBITDA (Average) $33 $21 $19 $30 $32 $35 $30 $32 Count Average total enterprise value (TEV) to LTM EBITDA multiple implied by closed M&A transactions increased in Q to 7.7x, up from 7.5x in Q Similarly, average total leverage increased to 4.3x from 4.1x in the prior quarter. Average equity contribution increased to 46% from 43% in the prior quarter % Financial Growth Rates (Mean) By Size: Q1 '13 LTM Q4 '12 vs. Q4 '11 Q1 '13 vs. Q1 '12 EBITDA EBITDA Margin Revenue EBITDA Revenue EBITDA $0 - $ % -1.5% -7.4% -3.7% -4.7% $10 - $ % 4.6% 4.4% 3.4% -4.5% $ % 8.0% -2.6% -2.3% -8.1% Total 21.7% 3.3% -1.0% 0.6% -5.2% By Industry: Q1 '13 LTM Q4 '12 vs. Q4 '11 Q1 '13 vs. Q1 '12 Industry Sector EBITDA Margin Revenue EBITDA Revenue EBITDA Business Services 19.4% -2.7% -4.8% 3.5% 2.9% Consumer 17.8% 1.2% -3.2% 0.4% -2.9% Healthcare 27.4% 8.7% 1.7% 3.1% -14.4% Industrials 18.4% -2.9% 4.6% -3.5% -7.4% Technology 24.4% 4.2% 2.8% -7.9% -10.0% Total 21.7% 3.0% -1.0% 0.6% -5.2% Revenue & EBITDA Trends 80% 70% 60% 50% 40% 30% 20% 10% 0% 80% 70% 60% 50% 40% 30% 20% 10% 0% Revenue Growth - % of Companies (Qtrly YoY) 69% 31% EBITDA Growth - % of Companies (Qtrly YoY) 52% 48% 63% 37% 53% 47% Increases 59% 51% 49% Decreases 41% 53% 47% Q2 '12 Q3 '12 Q4 '12 Q1 '13 Increases Decreases Commentary: Since Q financial performance has trended downward as evidenced by the percentage of companies reporting revenue and EBITDA growth. Approximately 47% of the companies observed reported revenue growth in Q vs. Q This was a decrease from 59% in the prior quarter. Similarly, the proportion of EBITDA gains decreased from 51% in Q to 42% in Q Note: Aerospace & Defense, Automotive & Truck, Chemicals, Energy, and Financial Services excluded due to limited historical data 42% 58% Q2 '12 Q3 '12 Q4 '12 Q1 '13 Total Leverage (By Size) Average Multiple of LTM EBITDA Average Multiple of LTM EBITDA Q x 4.5x x 3.5x x 2.5x 2.0x 1.5x 1.0x 0.5x 0.0x $0.0 - $10.0 million $ $50.0 million $50.0 million LTM Adjusted EBITDA Q x 4.5x 4.0x x x 2.5x 2.0x 1.5x 1.0x 0.5x 0.0x $0.0 - $10.0 million $ $50.0 million $50.0 million LTM Adjusted EBITDA Company Group D E A L R E A D E R 3 The Market Pulse: DATA THAT AFFECTS THE MID-MARKET M&A LANDSCAPE Lincoln Completed Transaction Data (N. America) Last 12 Months Ended March 31, 2013 Equity 68% Seller Type Buyer Profile Enterprise Value Public Divestiture 5% EV / LTM EBITDA Company 27% Equity 54% Valuation Statistics: Average Enterprise Value Multiples Last 12 Months Ended March 31, 2013 EV / LTM Revenue Adj. Mean Median Adj. Mean Median Less than $75 million 6.78x 6.81x 0.99x 0.68x Greater than $75 million 6.93x 7.05x 1.10x 0.99x Note: Arrows denote comparison with M&A transactions completed during the 12 months ended December 31, 2012; adjusted mean excludes high and low values prior to mean average calculation 7% Publicly Traded 39% Observations Less than $75 million 63% Valuation multiples have remained stable Greater than $75 million 37% Larger companies premiums over smaller businesses, as measured by EBITDA and Revenue multiples, have remained relatively stable or declined slightly Key Purchase Agreement Terms Lincoln s North American transactions Last 12 months ended March 31, 2013 compared to last 12 months ended December 31, 2012 Escrow as a Percentage of Purchase Price All Sellers 7.13% 7.00% 7.14% 6.00% Public Buyers 8.16% 10.00% 8.71% 8.00% Equity Buyers 6.47% 6.00% 4.67% 5.00% Buyers n/a n/a 11.00% 11.00% Sellers 11.25% 11.00% 7.80% 7.00% Public Buyers 11.50% 11.50% 8.00% 8.00% Equity Buyers 11.00% 11.00% 6.00% 6.00% Buyers n/a n/a 11.00% 11.00% Indemnity Cap as a Percentage of Purchase Price All Sellers 8.47% 10.00% 9.92% 10.00% Public Buyers 10.20% 10.00% 10.40% 10.00% Equity Buyers 8.11% 6.50% 9.50% 10.00% Buyers n/a n/a 11.00% 11.00% Sellers 10.00% 10.00% 11.00% 11.00% Public Buyers 10.50% 10.50% 11.00% 11.00% Equity Buyers 10.00% 10.00% 9.00% 9.00% Buyers n/a n/a 11.00% 11.00% Basket as a Percentage of Purchase Price General Indemnity Term (in months) All Sellers 0.86% 1.00% 1.25% 1.00% Public Buyers 0.86% 0.74% 0.80% 1.00% Equity Buyers 0.85% 1.00% 1.00% 1.00% Buyers 1.00% 1.00% 5.64% 5.64% Sellers 0.94% 1.00% 2.03% 1.00% Public Buyers 0.87% 0.87% 0.75% 0.75% Equity Buyers 1.00% 1.00% 1.00% 1.00% Buyers n/a n/a 5.64% 5.64% All Sellers Public Buyers Equity Buyers Buyers Sellers Public Buyers Equity Buyers Buyers n/a n/a Observations In general, terms have become more seller-friendly, reflecting greater negotiating leverage for those companies selling during a relatively quiet first quarter Public strategic acquirers remain active Lenders remain active, driving private equity groups to be more flexible on terms Note: Arrows denote comparison with transactions completed during the 12 months ended December 31, 2012 Source: Legend Increase vs. prior period Decrease vs. prior period No change 4 D E A L R E A D E R Company Group Selected Recent Transactions Sell-side transaction (July 2013) Ochre House is a leading global provider of full end-to-end recruitment process outsourcing with regional hubs in Europe, Asia and latterly in the Middle East under the Carmichael Fisher & Taaheed brands. The company is headquartered in London, England. Acquired by Pinstripe, Inc., a portfolio company of Accel-KKR, a technology-focused private equity firm focused on control investments in middle-market companies. The company is headquartered in Brookfield, Wisconsin. Sell-side transaction (July 2013) Whalen is the leading platform providing branded consumer durables and services in North America, offering a diverse mix of products that include home and garage storage systems, closet storage systems and dining and juvenile furnishings. The company is headquartered in San Diego, California. Acquired by Li & Fung Limited, a holding company engaging in the design, development, sourcing and distribution of consumer goods worldwide. The company is headquartered in Kowloon, China. Buy-side transaction (May 2013) Clear Edge Filtration manufactures industrial process filtration products for mining, chemical processing, wastewater treatment, bulk food and beverage markets. The company is headquartered in Tulsa, Oklahoma. Acquired by Filtration Group Corporation, a portfolio company of Madison Capital Partners, a leading Chicago-based private equity group. The company is headquartered in Joliet, Illinois. Refinancing transaction (April 2013) Pace Industries is a leading vertically-integrated manufacturer of non-ferrous metal die castings for consumer durables and other products in North America and Mexico. The company is headquartered in Fayetteville, Arizona. The $200 million transaction included a $115 million term loan and an $85 million asset-backed loan working capital facility. Sell-side transaction (April 2013) Bioreclamation, LLC offers a complete range of disease state and healthy human, animal and cellular material biological products used as controls and test samples in research studies for drug discovery, compound and biomarker development, clinical diagnostics and other research applications. The company is headquartered in Westbury, New York. Acquired by Thompson Street Capital, a leading private equity firm which has completed more than 130 acquisitions in over 35 industries. The company is headquartered in St. Louis, Missouri. Sell-side transaction (March 2013) Dexmet Corporation is the technical leader in the development and production of highly engineered, expanded thin ductile foils and polymeric materials serving a variety of mission critical applications in aerospace and other high growth end markets. The company is headquartered in Wallingford, Connecticut. Acquired by Sverica International, a leading private equity firm that has raised over $425 million of investment capital. The company is headquartered in Boston, Massachusetts. Company Group D E A L R E A D E R 5 s Global Footprint Los Angeles New York Chicago Amsterdam London Paris Vienna Madrid Frankfurt Milan Moscow Tokyo Beijing 150+ professionals throughout the United States 100+ professionals plus a 24- person advisory board in Europe Mumbai Offices throughout the BRIC economies of Brazil, Russia India and China São Paulo Indicates office About specializes in merger and acquisition advisory services, debt advisory services, private capital raising and restructuring advice on mid-market transactions. also pro
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