Could M&A be a springboard for sustainable growth?
In a subdued economic environment, an increasing number of midsize Australian businesses are using strategic mergers and acquisitions (M&A) as a springboard to sustainable growth. According to Kyle Harding from Macquarie Bank’s Middle Market team, a well-structured M&A strategy can bring a host of benefits, from greater scale and more diversified revenue streams to reduced risk, yielding new opportunities for both business founders and investors.
Middle market M&A activity has increased
A recent report from Pitcher Partners found that Australian M&A activity has increased for four years running, with deal numbers rising almost two thirds between 2016 and 2018. Notably, midsize businesses have been the engine room of M&A growth, with 70% of transactions in 2018 involving the midmarket.
Kyle Harding, Associate Director with Macquarie Bank’s Middle Market team, says a low growth environment and easy access to capital have helped fuel the rise. “Right now, many businesses see acquisitions as an easier pathway to growth. And because debt capital is readily available and relatively inexpensive, M&A activity has been really strong.”
Harding says this environment has made M&A strategies attractive to midmarket businesses across a wide range of sectors – from those undergoing technological transformation, to those experiencing rapid growth. “For businesses exposed to technological change, a strategic acquisition can be an opportunity to acquire new technologies and expertise,” he says. “For sectors like education and healthcare with strong demographic tailwinds, it can help build scale and capture a larger share of a growing market.”
The benefits for middle market businesses
Harding explains that a well-structured merger or acquisition can offer multiple benefits to the business and its owners, including:
- Scale: greater scale not only brings potential cost savings and higher profits, it can also lead to greater market power, increasing your ability to capture organic growth, negotiate effectively with suppliers and win larger deals.
- Diversification: more diversified revenue sources help reduce risk and create a more sustainable business.
- A competitive edge: a strategic acquisition can help you access new intellectual property, technology and people, giving you an edge.
- Recruitment and retention: a larger business with a greater variety of roles and development opportunities can help you recruit and retain talented staff.
As a result, the right strategy can multiply overall enterprise value. “For business owners, having a larger business with greater market power will generally be reflected in higher valuation multiples on exit, increasing the value of the business when they’re ready to sell.”
Risks to avoid
However, there are also pitfalls to avoid. Harding cautions against growing for growth’s sake, without an underlying strategic rationale. He also says there can be a risk of overpaying for an asset, especially given the low cost of debt and strong demand for assets at a time when there is a deep pool of undeployed equity capital. He also says that the temptation to overpay can be greater where business owners anticipate an unrealistically high level of cost-saving synergies.
To avoid the risks, Harding says it’s important to focus on three key areas:
- Due diligence: a comprehensive due diligence process considers much more than just financials, covering everything from licensing and contracts, HR and legal risks, and the business’ cultural and strategic fit.
- Integration risks: a successful M&A process involves integrating multiple aspects of the business, including software and systems, administration, HR, management structures and potentially very different business cultures.
- Capital structure: most importantly, Harding says your M&A funding mix and the resulting capital structure are critical in determining overall balance sheet risk and the sustainability of the new, combined business.
Choosing the right funding mix
The funding mix you choose affects not only your cost of capital, but also the level of risk you take on, the level of control you give up, and the overall value of the business when the deal is complete. As a result, there is no one-size-fits-all solution.
“Ultimately, what it really comes down to is cost of capital versus risk, and that equation will be different for every business,” says Harding. “Debt versus equity is the fundamental question, but there are a number of options under each of those umbrellas.”
While finding the right mix can be complex, the good news is that midsize businesses can now access the same expertise and capital solutions long enjoyed by larger companies. Harding says that Macquarie’s Middle Markets team was specifically created to help midmarket businesses find the optimal funding strategy for the future.
“Unlike a traditional banker, we look at your business in the same way you do, as a profit-generating enterprise, not just a list of assets,” he says. “So we can offer you flexibility and a wide range of funding options based on your true enterprise value, rather than your balance sheet.”
Case study: How a six-person business became a $750m-plus listed entity.
In 2007, Paul Dwyer started a small insurance broking business with five employees in the Melbourne suburbs. Twelve years later, PSC Insurance Group is an ASX listed company with a market capitalisation of around $750 million. That growth has been driven by a series of strategic acquisitions, supported by funding from the Macquarie Bank Middle Markets team.
“We've done probably 40 acquisitions, all of different shapes and sizes,” says Joshua Reid, PSC Insurance Group’s Chief Financial Officer. Yet he also stresses that “we're not looking to just buy things for the sake of scale”. Instead, the Group’s aim is “grow the revenue, [deliver] better products for customers, and do it more efficiently just by applying common sense business practices in a disciplined manner over time”. The result has been year on year organic growth ranging from the high single digits to the mid teens since the Group listed on the ASX in 2015.
Reid says that finding the right financial partner can make a big difference. “Macquarie was involved with PSC from the absolute beginning … they’ve been on that journey the whole way through.”
“Macquarie's advantage was – and I think it still is – the ability to back entrepreneurial businesses,” he says. “Where Macquarie is strong, I think it's probably the best in the market, because it backs people.”
The Macquarie team’s industry knowledge has also made it easier for PSC to take advantage of opportunities as they emerge. “You don't need to reinvent the wheel by explaining how the economics of the industry works and what's going on in the industry, because the bank's all over it,” he says. “They know what the margins on the business should be. They know roughly what the valuations in the industry are. Any regulatory things going on in the industry. So that definitely gives them – and us – an advantage.”
Macquarie’s Middle Markets team brings sophisticated corporate finance and corporate banking solutions to midmarket businesses. We specialise in helping midmarket enterprises grow, preserve and realise value through sophisticated capital management and funding strategies.
Would you like to grow the value of your midmarket business?
Macquarie’s Middle Markets team brings sophisticated corporate finance and corporate banking solutions to midmarket businesses. We specialise in helping midmarket enterprises grow, preserve and realise value through sophisticated capital management and funding strategies.
