[Mergers & Acquisitions Supplement] 2012: Taking Stock

Supplement - Mergers & Acquisitions Supplement

Why 2012 was the year that many of us didn’t want to end.

January 29, 2013
Lance Tullius

Earlier this year, I wrote a white paper titled “2012: The Perfect Storm,” which forecasted a host of reasons that would drive perhaps record-setting M&A activity in 2012. Since 2012 is “in the books,” I thought it fitting to look back and take stock of what actually happened, and considering that, what’s likely to be in store for the immediate future.

First, let’s step back and revisit some of the forces that I felt would create this “Perfect Storm.”

Makings of the Perfect Storm. Entering 2012, and for some time prior, large corporations and investment funds were sitting on unprecedented levels of cash. These cash balances only have grown since, largely because these beneficiaries are challenged as to what to do with this cash in order to generate reasonable returns without incurring unreasonable risks. Despite these challenges, however, these cash holders were (and continue to be) under mounting pressure to put it to work.

In the midst of what continued to be a difficult and uncertain economy for generating organic business growth, businesses remained slow to hire, not convinced that the addition of personnel would yield additional revenues and profits. Yet simultaneously, the pressures were also mounting on these businesses to grow revenues and profits. These collective factors, I hypothesized, would motivate particularly large businesses and investment funds to look toward acquisitions as a means to deploy cash and generate growth.

At the same time, there were several forces that I felt would drive an unusually large number of business owners to contemplate selling their businesses. Most notably, the Bush Tax Cuts were due to expire at the end of 2012, effectively raising the federal capital gains tax rate from 15 percent to as high as nearly 24 percent — an increase to close to 60 percent. For a business owner considering the sale of a $5 million business, this could mean almost as much as an additional $500,000 in taxes taken out of the consideration they would receive. Viewed another way, if the tax cuts were to expire, to achieve the same net proceeds after 2012, that same business owner would effectively have to sell their business for roughly $5.6 million. You simply make up in value what you’ll lose in additional taxes in that short a time.

Beyond tax incentives, our country’s population demographics continue to contribute to rising M&A activity. Baby boomers make up a large share of this country’s business owner population, and as they reach their 60s and 70s, particularly those that don’t have children in the business, a meaningful number of them will be selling their businesses.

Effects of the Perfect Storm. The collision of these factors driving both buyers and sellers to come together, I predicted, were destined to create a “Perfect Storm,” which would result in significantly heightened M&A activity across nearly all industries, including the pest control industry. By most all accounts, this was the case.

The pest control industry, specifically, has witnessed one of its more active years for mergers and acquisitions, with many notable companies transferring ownership this year. Further, it is expected that an overwhelming amount of this volume pick-up actually took place in the closing months of 2012. Most of us, by nature, are procrastinators, and that combined with the fact that it’s very difficult to predict how long it takes to complete transactions of this type, forecasted a frenzy of transaction activity right up to the end of the year.

2012 played out as many expected. Cash reserves continued to be an obvious driver to this activity. In fact, there remains more cash at the disposal of corporations and investors than there are quality companies to deploy said cash to. Given this supply and demand imbalance, and the fact that these investors don’t typically resort to buying lesser-quality companies, the result has been that they’re paying more for quality companies.

It also remains costly to hold cash in this environment. Given the rate of inflation, holders of cash are generating net wealth decreases, and there is no end in sight to the depressing returns for which our cash currently generates. For large companies wishing to grow their value, this has meant they must spend, and to a large degree they did in 2012.

Moralistically, many argue that this cash should be spent adding jobs, and it does appear that overall, jobs have been added — but not that many. That’s because, as predicted, there has remained too much economic uncertainty. Executives leading these companies aren’t yet convinced that consumers are prepared to buy again in a big way. And, as long as they remain unconvinced, they will not hire en masse.

What's Ahead?
Yet the flip side to this is that large businesses have to grow revenues — the pressures to do so are unreal.

People and institutions that invest money on a large scale simply don’t tolerate wealth stagnation. They mandate that their wealth grows, and if you can’t do it for them, they’ll find someone who will. Given the constraints, corporations and investment funds have turned to acquisitions in a big way. In doing so, especially if done properly, they generate revenue growth and earnings synergies that lead to value accretion and, of course, gains in investor wealth.

On the other side of the table, as if they needed extra incentives to consider a sale of their company, business owners took notice in 2012. Owners were solicited hard by various types of business buyers, and they did the math that results when you combine premium valuations with preferable, yet expected increases, in tax rates. The result was that there were at least enough sellers to fuel the other side necessary to make for this Perfect Storm.

With 2012 now in the books, what can we expect for 2013? Unfortunately, in many respects, continued uncertainty is the only sure thing. However, with the election now behind us, there are certain things we can now be relatively sure of. The Bush Tax Cuts were not extended in full form. Business owners selling businesses for millions of dollars are almost sure to face higher capital gains taxes. Accordingly, I believe we will see somewhat of a slowdown in merger and acquisition activity in 2013. That said, many of the drivers that contributed to the Perfect Storm in 2012 will continue to be seen in 2013 and perhaps far beyond. Cash supplies remain high and due to the challenges that come with large cash reserves, as well as other economic factors, buyers will remain in strong supply. And let’s face it: none of us are getting younger, which means that more baby boomers will become sellers as time goes by. In any event, while we may see less activity in 2013, you can be sure we’ll continue to see a steady dose of transactions. So if you didn’t act in 2012, perhaps your time has not yet run out.


Lance R. Tullius is managing partner of Tullius Partners, an investment banking firm that specializes in providing merger and acquisition and financial/strategic advisory services to companies operating in the pest control industry.