2013 State of the Industry

CAPITAL
MARKETS
Chairman’s Letter

To Our Readers,
At BoyarMiller, when we partner with clients, we work as
a strategic part of their busi...
TABLE OF CONTENTS
Introduction

State of the Industry
SHIFT IN INVESTMENT PRIORITIES

JOB CREATION STILL ON THE RISE
FOREI...
INTRODUCTION
Your strategic partner should be an
expert in your industry, not just law.
At BoyarMiller, we’re committed to...
STATE OF THE INDUSTRY
SHIFT IN INVESTMENT PRIORITIES

HISTORICALLY, FEDERAL
RESERVE HAS BEEN 70% OF
TREASURY AUCTION BIDS
...
EXPERT INSIGHT
Private Equity and M&A Activity
WHAT SETS HOUSTON APART?
Houston is now considered the No. 4 gateway market...
WHAT SETS HOUSTON APART?
In comparison to the U.S. GDP growth rate of 2% , Texas is growing at 5% and Houston is
growing a...
WHAT SETS HOUSTON APART?
Houston is the No. 1 ranked apartment market in the nation with more than 15,000 units to
be deli...
By BoyarMiller’s Philip Dunlap and Bill Boyar
With the September 18th announcement that the U.S. Federal Reserve will not ...
Middle Market MA and Private Equity, continued

PRIVATE EQUITY
While the capital overhang of uninvested private equity com...
FINANCE AND CAPITAL FORMATION

PRACTICE LEADERS
Gary Miller
Chairman, Business Group
Gary oversees the firm’s corporate an...
Steve’s practice includes private placements and other sales and
purchases of debt or equity securities; mergers, asset ac...
BoyarMiller
4265 San Felipe, Suite 1200
Houston, Texas 77027
TEL 713.850.7766
FAX 713.552.1758

boyarmiller.com

At BoyarM...
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BoyarMiller Capital Markets eBook 2013 State of the Industry

  1. 1. 2013 State of the Industry CAPITAL MARKETS
  2. 2. Chairman’s Letter To Our Readers, At BoyarMiller, when we partner with clients, we work as a strategic part of their business team, and that means we have to be experienced in more than just law. We also need to understand their industry so that we are able to work collaboratively with them and add value to their business. That’s why we bring together the top insights into industry trends and best practices, and deliver it to you. Not only has this information been invaluable to us and to our clients, but we hope it will be beneficial to you as well. The information in this publication has been gathered from industry-leading clients we have partnered with and from our own capital markets team. If you find value in it and would like to hear more, join us for our next BoyarMiller Breakfast Forum. Sincerely, Chris Hanslik Firm Chairman 1
  3. 3. TABLE OF CONTENTS Introduction State of the Industry SHIFT IN INVESTMENT PRIORITIES JOB CREATION STILL ON THE RISE FOREIGN MONEY TALKS Expert Insights PRIVATE EQUITY AND M&A ACTIVITY EQUITY AND THE PUBLIC MARKETS REAL ESTATE FINANCE MIDDLE MARKET M&A AND PRIVATE EQUITY Practice Leaders 2
  4. 4. INTRODUCTION Your strategic partner should be an expert in your industry, not just law. At BoyarMiller, we’re committed to providing insightful, versatile expertise to organizations of all sizes as we guide them through complex business issues. We know that in order to understand how best to collaborate with you, we need to know your industry and your business. To this end, we gathered the best insights into capital markets trends and best practices from industry-leading clients we have partnered with and from our own capital markets team. It’s our hope that the information we’ve accumulated through years of collaborative work in the capital markets industry will be beneficial for you. Your strategic partner requires knowledge of trends, industry and law. 3
  5. 5. STATE OF THE INDUSTRY SHIFT IN INVESTMENT PRIORITIES HISTORICALLY, FEDERAL RESERVE HAS BEEN 70% OF TREASURY AUCTION BIDS The “great rotation” from bonds to stocks is on the horizon. There has been a falling 10-year treasury yield for the last 30 years. As long as the Federal Reserve continues to set and manipulate rates, the marketplace can be expected to look the same. But the Fed has been 70% of the bid in recent treasury auctions; once their bid goes away, who can make up the difference? Smart investors are trading interest rate risk for credit risk – going away from the treasury – and watching for the Fed to taper its bond buying. JOB CREATION STILL ON THE RISE HOUSTON’S EMPLOYMENT GROWTH RATE IS 3.6% Small- and mid-sized companies are the majority contributor of net new jobs in the United States. As the beneficiaries of middle market private equity transactions, they have benefited from continued low interest rates. In Houston specifically, the ongoing growth of the energy market has helped the city to lead the nation in employment growth. Only Dallas ties Houston’s employment growth rate of 3.6%. FOREIGN MONEY TALKS $7.09B IN CANADIAN CAPITAL Cross-border capital into the U.S. remains strong. Canadian asset managers and REITs, Singaporean sovereign wealth funds, German investment managers, and Chinese private HNW individuals have been highly active this year-to-date. Canada leads the charge with $7.09 billion in capital this year. Meanwhile, South Korea, which has invested $1.45 billion this year, has generated a lot of interest in Houston and in the broader energy market. 4
  6. 6. EXPERT INSIGHT Private Equity and M&A Activity WHAT SETS HOUSTON APART? Houston is now considered the No. 4 gateway market, listed behind the expected leaders Manhattan, L.A. and D.C. The bottom line is that energy is a great place to be, and Houston has cornered the energy market. As we take advantage of the opportunities provided by cheap domestic energy, other industries will begin to grow as well and make Houston and the U.S. more competitive. 2013 REGULATORY TRENDS Cliff Atherton, PhD, CFA, Managing Director, GulfStar Group • IDDLE MARKET PRIVATE EQUITY DRIVES GROWTH: While middle market deals – those under M $250 million – normally represent about 25% of total deal value, they are 80-90% of deal volume. These transactions are very important for the U.S. in terms of providing companies with new capital – primary dollars. • OUSTON IS “DIFFERENTIATED” – AT LEAST WITHIN ENERGY: While Houston has made little H progress in differentiating outside of the energy industry, its upstream, midstream and downstream markets are strong. Private equity is getting ahead of the coming uptick in pipeline services, which will have a tremendous number of projects in 2014 and 2015. • A ACTIVITY BACK TO PRE-CRASH LEVELS: Middle market companies are back up and M trading above the multiples they were trading at before the crash, at least partly because of low interest rates. Because of the availability of capital, the marketplace for these assets is going to be pretty robust for the near future. • S THE DEAL MARKET REALLY SLOWING DOWN?: This question has gotten a lot of play I recently, but we’ve seen our volume of activity pick up since the first quarter. You’ll see those closings begin to happen late in Q3 and Q4, and on into the first of next year. It looks like plenty of capital is coming into private companies until year’s end. Cliff Atherton is an investment banker with more than 25 years of experience in corporate finance and more than 30 years of experience in teaching finance at the graduate level. As Managing Director at GulfStar Group, Cliff works with entrepreneurs and family-owned businesses with enterprise values between $25 and $250 million. He earned a BA from Rice University, MBA and PhD degrees from The University of Texas, and holds the Chartered Financial Analyst (CFA) designation. 5
  7. 7. WHAT SETS HOUSTON APART? In comparison to the U.S. GDP growth rate of 2% , Texas is growing at 5% and Houston is growing at 4.8%. We’re getting to borrow money at interest rates based on much lower national growth rates. We have a 300 basis point spread between the GDP growth rate of Houston and the 10-year treasury, which is very high in comparison to both other markets and Houston’s historical spread. 2013 PUBLIC MARKET TRENDS Drew Kanaly, Chairman and CEO, Kanaly Trust • GREAT ROTATION” FROM BONDS TO EQUITIES IS IN ITS EARLY STAGES: The Federal Reserve is “ preparing to normalize monetary policy. While it’s unlikely that we’ll see a major rate rise from the Fed before 2015, smart investors should look at the possibility that a 30-year bull market in bonds could soon be over. • ILL RISING RATES DERAIL THE STOCK MARKET?: Historically, even when interest rates rose W significantly, you still made money in stocks in the long run. However, we haven’t seen an unwind of a Fed policy of this magnitude. While the effect of this rise may prove similar to those before, it’s worth watching closely. • ANALY TRUST INVESTMENT PRIORITIES: At Kanaly, we’re going to avoid long-duration fixed K income strategies. For our municipal bonds, we’re in for less than five years. Some of the funds we’ve utilized have a duration of less than two years. We’re swapping interest rate risk for credit risk in the hopes that with selective management we can insulate ourselves from a rising interest rate environment. • OVEMENT TOWARD PRIVATE EQUITY, REAL ASSETS: Clients with the ability to do so are M moving into private equity and real asset plays. As some of our favorite risk management tools go away, we’re thinking about other asset allocation options. Drew Kanaly has more than 30 years of experience in trust and investments. He leads Kanaly Trust as Chairman and CEO. Since earning his BBA in Finance from the University of Houston, he has attended the American Bankers Association’s National Graduate Trust School in Northwestern University and The Texas Bankers Association Regional Trust School at Southern Methodist University, and earned a Certified Trust and Financial Advisor (CTFA) designation. 6 EXPERT INSIGHT Equity and the Public Markets
  8. 8. WHAT SETS HOUSTON APART? Houston is the No. 1 ranked apartment market in the nation with more than 15,000 units to be delivered in the next 12 months. And in the office space, Houston accounts for 28.6% of construction starts in the top 11 markets since Q1 2012. Despite all that new construction, more than 70% of that space is pre-leased. 2013 REAL ESTATE FINANCE TRENDS Tom Fish, Executive Managing Director/Co-Head Real Estate Investment Banking, Jones Lang LaSalle • OST INCREASES HAVE LESS EFFECT THAN EXPECTED: We have had a net increase of C roughly 50 basis points in the cost of long-term real estate borrowing in about a fivemonth period of time. While that’s pretty dramatic, the good news is that we have seen little effect on real estate values. It’s likely that because overall borrowing rates were so low, we were able to absorb much of that increase. That may change moving forward. • OMMERCIAL BANK LENDING REBOUNDS FROM DOWNTURN: For the first time since the C recession, commercial banks’ net exposure has gone up. They’re funding much of the construction around the city. They’re also providing, more than ever, longer-term stabilized property asset loans. They’re competing for loans that would usually be funded by the commercial mortgage-backed security market, life insurance companies or other lenders. • EXAS IS FILLING UP THE NATION’S OFFICE SPACE: 25% of all office absorption in the country T is occurring in two markets: the energy markets in Dallas and Houston. While the tech market is still taking a large share of the office space, it’s made up of many more markets: Silicon Valley, Austin, Portland, San Francisco and Seattle. • PTIMISM ABOUNDS IN THE REAL ESTATE CAPITAL MARKETS: We’re very optimistic about the O ongoing flow of capital into the commercial real estate space. This is still a disciplined space that requires deals to make sound economic sense. Attracting capital has become easier, and a continued cautious approach will keep the markets in check. Tom Fish co-leads the Real Estate Investment Banking (REIB) practice, which is part of the Jones Lang LaSalle Capital Markets Group. As Executive Managing Director, Tom focuses on national lender relationships, high profile loan originations and debt restructurings for owner and lender clients. He has specifically advised clients on more than $8 billion of debt/equity origination and/or product disposition over the past 10 years. 7 EXPERT INSIGHT Real Estate Finance
  9. 9. By BoyarMiller’s Philip Dunlap and Bill Boyar With the September 18th announcement that the U.S. Federal Reserve will not reduce its current $85 million pace of monthly bond buying, the anticipated “great rotation” away from a decades-long bull market in bonds will likely be delayed at least until the Fed begins to taper its bond buying. What does this decision mean for the capital markets for MA and private equity in the middle market? How will these sectors be affected when the Fed ultimately does begin to taper its current pace of bond buying? The answers to these questions will guide middle market MA activity and private equity investing through the end of 2013 and into 2014. MA Because the Fed will continue to purchase bonds at the same rate as it has recently, the rise in interest rates that many economists and industry experts were predicting will likely be delayed. This may be good news for MA activity, especially as it relates to private equity funds’ ability to finance their transactions. As interest rates remain at historically low levels, senior debt should continue to be an attractive and readily available source for financing M transactions. In the first half of 2013, senior debt accounted for an average of 42.1% of the total enterprise value (TEV) of transactions, while mezzanine or other subordinate debt only accounted for 10.8% of TEV. When compared to 2011 and 2012 levels where senior debt accounted for approximately 36.5% of TEV and mezzanine debt accounted for approximately 16% of TEV, it is apparent that senior lenders have been increasingly willing to lend to purchasers on buyout deals. With senior debt comprising a larger piece of the TEV pie, buyers are willing to pay higher EBITDA multiples. In 2012, the average middle market transaction was valued at 6.3 times EBITDA. The multiples change when looking at different deal sizes. Smaller middle market deals (those between $10 million and $25 million) saw an average EBITDA multiple of 5.7x in 2012, while larger middle market deals (those between $100 million and $250 million) saw an average EBITDA multiple of 7.5x. These multiples are similar to what was seen prior to the economic crash in 2008 and 2009. As long as senior debt is available on terms similar to what has been available in 2012 and the first half of 2013, EBITDA multiples should remain near the ranges that have been typical of the past 18 months. 8 EXPERT INSIGHT Middle Market MA and Private Equity
  10. 10. Middle Market MA and Private Equity, continued PRIVATE EQUITY While the capital overhang of uninvested private equity commitments is declining, there is still significant dry powder remaining in 2009 and older funds. This overhang, coupled with the current attractive senior financing opportunities should continue to drive substantial activity in the private equity market – both in aggregate capital invested and total deal count. Additionally, because private equity funds currently hold almost 4,000 portfolio companies that we purchased in 2008 or earlier, there should not be a significant slowdown in MA and private equity led recapitalization activity for those portfolio companies through 2014 and into 2015. PRIVATE EQUITY FUNDS INVESTED 10 TIMES MORE NEW EQUITY IN THE MARKET THAN IPOS IN 2012. Despite the positive outlook for the next 18 months, whenever the Fed does eventually taper its bond-buying and/or increases the overnight interest rates, the resulting increase in interest rates across the board will likely force senior financing available, the ability to reach the fund’s targeted internal rate of return will require greater diligence and planning as funds are forced to look at mezzanine debt or other financing sources. CONCLUSION The Fed’s decision to delay the expected tapering of its bond buying should mean that the market and activity levels for MA and private equity of the past 18 months will continue for the near term. This is welcome news as private equity continues to be a major source of equity capital for the U.S. economy. In 2012, private equity funds invested 10 times more new equity in the market than IPOs. Furthermore, small and mid-size companies – those that are beneficiaries of middle market private equity transactions – are the majority contributor of net new jobs in the United States. However, when the tapering begins and interest rates eventually rise, private equity funds and those who work with middle market companies will be required to face the challenges of how to close deals with fewer dollars of senior financing in the capital stack. 9 EXPERT INSIGHT However, in the event that interest rates rise (whether as a result of the Fed’s tapering of bond buying or due to separate issues), it should be expected that senior financing would not be as plentiful. In that situation, buyers will likely turn back to mezzanine/subordinate debt sources to fill the gap in their financing needs. This will in turn affect the EBITDA multiples that buyers will likely pay in any given transaction. EBITDA multiples of 6.2x to 6.3x for middle market deals may ultimately decrease when interest rates rise.
  11. 11. FINANCE AND CAPITAL FORMATION PRACTICE LEADERS Gary Miller Chairman, Business Group Gary oversees the firm’s corporate and commercial matters, with emphasis in his practice on mergers and acquisitions. He has extensive experience in capital formation, contract negotiations/ documentation, lending, factoring and day-to-day representation of corporations and other business entities. Gary is often called upon to represent insurance agencies in their capital transactions Bill Boyar Shareholder, Business Group Bill’s practice focuses on representing the various parties involved in the acquisition, disposition, capitalization and financing of assets and businesses on a national and international level. He has served as lead counsel on numerous complex, multi-party acquisitions and project financings with significant experience in experience in corporate finance, private equity, mergers acquisitions, real estate and hospitality. He assists clients in strategic planning and capital formation processes, maintaining a network of private and institutional clients and contacts worldwide. 10
  12. 12. Steve’s practice includes private placements and other sales and purchases of debt or equity securities; mergers, asset acquisitions and sales; formation and representation of private equity funds, venture capital funds and hedge funds, entity selection and formation (including drafting complex limited liability company and partnership agreements and corporate charters having multiple classes of common and preferred stock), and general contract review. He also has experience representing both lenders and borrower in asset-based lending transactions involving senior lenders, mezzanine lenders and factoring companies. Stephen Johnson Shareholder, Business Group Stephen’s transactional practice includes mergers and acquisitions, asset and stock purchase and sale transactions, private equity investments, formation of business entities, restructuring, capital formation, contracts and similar agreements, and general corporate matters. He places the utmost emphasis on providing clients with the highest quality of service in an efficient and effective manner. Gus Bourgeois Shareholder, Business Group Gus’s practice involves a wide variety of corporate transactions including the acquisition, financing and disposition of business entities through asset and stock purchase transactions, sales of debt and equity securities, and complex domestic and international transactions. His clients range from small, start-up businesses to established enterprises with international operations. 11 PRACTICE LEADERS Steve Kesten Shareholder, Business Group
  13. 13. BoyarMiller 4265 San Felipe, Suite 1200 Houston, Texas 77027 TEL 713.850.7766 FAX 713.552.1758 boyarmiller.com At BoyarMiller, we help our clients’ access private and institutional equity and debt capital through our extensive network of domestic and international capital relationships. The firm’s experience covers a broad spectrum including: • Capital Plan Development • Growth Strategies • Capital Strategies • Mergers Acquisitions • Debt Sourcing including • Private Equity Conventional Asset-Based Mezzanine Financing • Strategic Plan Development • Equity Sourcing Venture Capital • Transaction Structuring

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