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BoyarMiller Breakfast Forum: The Current State of the Capital Markets 2015


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As part of its ongoing Breakfast Forum series, BoyarMiller gathered industry experts for a panel discussion on the Current State of the Capital Markets. Speakers included:

Drew Kanaly, Kanaly Trust – Equity & the Public Markets
Colt Luedde, GulfStar Group – Private Equity and M&A
Brandon Annett, Texas Capital Bank – Commercial Banking & Real Estate Lending

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BoyarMiller Breakfast Forum: The Current State of the Capital Markets 2015

  1. 1. 2015 STATE OF THE INDUSTRY Capital Markets
  2. 2. To Our Readers, As part of our commitment to knowing our financial clients’ business, we collect insights on the capital markets from some of the best minds in the industry. This understanding contributes to how we deliver counsel that exceeds our clients’ expectations and our ability to help them make strategic decisions about their business. The information in this ebook has been invaluable to us and to our clients, and we hope that it will benefit you as well. Read some of the trends and best practices gathered from industry-leading clients and 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 CONTACT 4265 San Felipe, Suite 1200 Houston, Texas 77027 713.850.7766 Visit TABLE OF CONTENTS 03 : State of the Industry 04 : Expert Insights Equity and the Public Markets Private Equity and M&A Commercial Banking and Real Estate Lending 07 : Attorney Insights Current State of the Capital Markets – Middle Market MA and Private Equity 10 : Practice Leaders LEARN MORE ABOUT THE FORUM
  3. 3. Energy showed promise for people who believed this downturn would be a good entry point into the indus- try. Many of them still see the time for significant investment as 6-9 months in the future. CAPITAL AVAILABILITY, ESPECIALLY ON THE DEBT SIDE + EARNINGS GROWTH AMONG PRIVATE COMPANIES ENERGY, HEALTHCARE AND TECHNOLOGY ARE THE MOST ACTIVE SECTORS FOR MA MACROECONOMIC OUTLOOK MA ACTIVITY IS STRONG PAGE 03 State of the Capital Markets 6th year of a strong, active MA market A year ago, the consensus among Wall Street analysts was that SP 500 earnings would experience 10% growth in 2015. Today, there is no growth. Private companies are seeing growth that outpaces that of the larger, public companies in the SP 500. EARNINGS: PUBLIC VS. PRIVATE Public Private Technology remains an active sector because it is growing and influencing people’s daily lives in more and more ways. Healthcare markets have changed so much as a result of recent legisla- tion that many believed there would be opportunity in the dislocation and change. U.S. dollar is gaining strength Domestic unemployment is at 5.1%, its lowest since the Great Recession U.S. domestic companies are very healthy right now U.S. GDP growth rates have slowed Pullback in Chinese consumer and manufac- turing sector, resulting in yuan devaluation Concerns in the Eurozone, particularly with regards to Greek economic turmoil
  4. 4. WHAT ARE WE SEEING? • FIRST SIGNIFICANT DECLINE OF 10% IN MORE THAN 46 MONTHS This is a natural occurrence in the marketplace, a cor- rection that occurs cyclically. In fact, the only anoma- lous part of this decline is that it has been a much longer interval than normal since the last correction. • PAY ATTENTION TO VOLATILITY PREDICTIONS The VIX – a measure of expected volatility looking 30 days out – is showing a spike in expected volatility into a part of the chart that indicates “flat-out panic.” While these spikes are quite common, they do say something significant about expectations looking forward. • THE SP 500 IS EXPENSIVE Stock valuations are well above the median 30-year average of stock prices measured by the price-earnings ratio. Fundamental stock pickers looking at the SP 500 today would say that stocks are expensive. • CREDIT SPREADS ARE WIDENING Credit spreads are widening, and the markets are paying attention. Historically, this has been a warning signal: widening credit spreads have meant bad news for stocks. Equity and the Public Market “This is a time for caution.” DREW KANALY, Chairman – Kanaly Trust PAGE 04 As Chairman of Kanaly Trust, Drew Kanaly manages the ongoing investment strate- gies and personal wealth management programs of several family relationships. He specializes in investment management, charitable trusts and family limited partnerships. Since earning his BBA in Finance from the University of Houston, Drew has attended the American Bankers Association’s National Graduate Trust School at Northwestern University, the Texas Bankers Association Regional Trust School at Southern Methodist University and earned a CFTA designation. Expert Insights
  5. 5. WHAT ARE WE SEEING? • TURNING TO FOREIGN ACQUISITIONS Private equity buyers are focusing more on foreign acquisitions. The three most common countries for geographic expansion are Canada, the United Kingdom and China. • CORPORATE BUYERS OUTBID BY FINANCIAL BUYERS Although the perception is that a strategic buyer is likely to pay more than a private equity group, in the last 8 years, corporate buyers have actually been out- bid by the financial buyers about 60% of the time. • LEVERAGE MULTIPLES HAVE EDGED UP In the first half of 2015, leverage multiples in aggregate for deals in the $10-250 million range have edged up. With deals funded 50/50 with debt and equity, increased leverage multiples increase buying power. • A DOWNTURN IS COMING Historically, the market has tended to improve over 4-6 year periods, followed by 18-24 months of downtime. We are in the sixth year of a strong MA market – and at some point, the market will correct. Private Equity and MA “If you look in the first half of 2015, what you see is, other than 2014, it’s the strongest start to the year that we’ve had since the recovery.” COLT LUEDDE, Managing Director – GulfStar Group Colt Luedde has more than 25 years of investment banking and corporate finance experience. He has completed more than 100 MA transactions and has deep transactional experience advising the owners of manufacturing, distribution, ser- vice and software businesses in the industrial and energy sectors. He serves on the board and is past-President of the Association for Corporate Growth and is a board member of the Hicks, Muse, Tate Furst Center for Private Equity Research at the University of Texas. He holds a BBA in Finance from The University of Texas at Austin. EXPERT INSIGHTS : PAGE 05
  6. 6. Commercial Banking and Real Estate Lending “In general, I would say that banks are very positive, looking for growth, and looking to put on assets for quality companies.” BRANDON ANNETT, Managing Director and Head of Capital Markets Syndicated Finance – Texas Capital Bank EXPERT INSIGHTS : PAGE 06 Brandon Annett has more than 20 years’ experience in the credit and capital markets, and has served as Managing Director and Head of Texas Capital Bank’s Syndicated Finance group since May 2012. With previous posts at BBVA Compass, Concerto Asset Management in Charlotte, North Carolina, and the Leveraged Finance group at Wachovia Securities, he has considerable knowledge of com- mercial lending. Brandon holds a BBA in Finance from Texas Tech University. WHAT ARE WE SEEING? • REAL ESTATE LENDING ACTIVITY IS HIGH Low vacancy rates and an expanding economy have driven real estate activity. Over the last three years, 22% of national banks have experienced over 50% growth in their commercial real estate assets. This robust pipeline of new supply is tempering lender activity toward new projects, as many banks have reached or nearly reached exposure levels on construction-related loans. • FOR EP COMPANIES, BANKRUPTCY IS THE THEME FOR 2016 With no forecast in material price improvement for oil, EP companies are seeing revenue and margin declines. As hedges roll off, they are looking to tap the $50 billion in capital on the sideline targeted for the energy sector. But if asset sales cannot solve their complex capital structure issues, bankruptcy may be a more realistic option. • BANK REGULATORY OVERSIGHT OPENS SPACE FOR NON- BANK LENDERS Oversight has dampened the risk appetite for more leveraged transactions, and despite the liquidity and heightened competition, middle market leverage multi- ples are down from 2014. As a result, equity is a higher percentage of the capital for leveraged transactions, and the non-bank lending universe is growing to fill the void as banks pull back.
  7. 7. 2015 marks the sixth consecutive year of strong middle market MA and private equity activity. However, current events over the last six months have people wondering what, if any, impact such events will have on the MA market. Should we be concerned about the sustained dramatic drop in oil prices, the economic slow down in China, the substantial recent corrections in the Chinese and US public equity markets or the inevitable interest rate hike by the US Federal Reserve? Because of the substantial amount of private equity overhang dollars available for investment, and lending appears to have little impact, middle market MA deal flow and multiples continue to be strong. So while robust now, markets are understand- ably more cautious – change could be just on the horizon. MA / PRIVATE EQUITY MARKETS Despite concerns related to the drop in oil prices, the first half of 2015 has been another strong period for MA activity, including private equity deals. If the current pace holds true through the end of the year, 2015 will be the sixth consecutive year of a strong MA market. Both strategic and financial buyers have shown an increased focus on international acquisitions, with a majority of those transactions expected to involve companies based in China, Canada or the UK. The three major industries in which MA transactions have been, and are expected to continue to be, focused in 2015 are energy, healthcare and technology. PAGE 07 Attorney Insights Current State of the Capital Markets – Middle Market MA and Private Equity STEVE KESTEN, Shareholder and Chair, Business Group PHILIP DUNLAP, Senior Associate, Business Group
  8. 8. Due in large part to the improved credit markets, on average, for MA deals in 2014, senior debt accounted for 38.4% of the total enterprise value (“TEV”), mezzanine and other subordinated debt accounted for 14.7% of the TEV and equity accounted for 46.5% of the TEV. For deals in the lower middle market (TEV between $10 and $25 million), debt (senior combined with subordinated debt) accounted for 58.3% of the TEV and equity accounted for 41.7% of the TEV. While there is more debt being placed on MA transactions, it is not all coming from traditional banks. A significant number of “non-bank” lenders are financing these highly leveraged transactions. The com- bination of bank lenders plus non-bank lenders has allowed the debt availability to rise. The increased availability of debt has led to higher EBITDA multiples which have served to increase the valu- ations for middle market MA deals. EBITDA multiples are as high as they have been since before 2007. In 2014, the average middle market transaction was valued at slightly less than 6.5 times EBITDA. The multiples change when looking at different deal sizes. Smaller middle mar- ket deals (those between $10 million and $25 million) saw an average EBITDA multiple of 5.5x in 2014, while larger middle market deals (those between $100 million and $250 million) saw an average EBITDA multiple over 7.5x. The average EBITDA multiple for all deals in the first half of 2015 has been 6.6x. The strong current market means that companies are being valued between 1.0x and 1.5x higher (as a multiple of EBITDA) than in a “normal” market. This premium has caused (and will continue to cause) many sellers to choose a private equity buyer that can close on a recapitaliza- tion rather than a strategic buyer that would purchase the entire company. Thanks to the premium being paid, recapitalizations can result in the seller achieving the same amount (or more) of cash proceeds as they would receive in a more normal market, while still retaining a minority stake in their company. Buyers who have not had a high concentration of ener- gy-related portfolio companies have shown a desire for energy targets because they believe 2015 is a good “entry point” for the energy space. However, with uncer- tainty regarding exactly when the price of oil has or will reach its bottom, it is expected that many private equity buyers will continue to hold off on energy targets for another six to nine months. Buyers have focused on healthcare because of changes, and opportunities, in the industry resulting from Obamacare. Technology has been another attractive industry for PE buyers because they realize that technology is affecting lives in an increasing amount. The primary reason for the continued robust MA market in 2015, despite the ongoing uncertainty surrounding the price of oil and volatility in the public equity markets, is the amount of capital that is available to buyers. MA activity has benefited from buyers’ access to capital resulting from private equity capital overhang and an improved credit market. Primarily for strategic buyers, improved public equity markets have provided the ammunition for these transactions. Thanks to the new funds raised in 2014, US-based private equity funds currently have approximately $535 billion of “dry powder” committed that has not yet been drawn upon. This overhang, which should serve the markets well through at least 2018, should continue to drive substantial activity in the private equity market. ATTORNEY INSIGHTS : PAGE 08
  9. 9. Overall, unless another significant adverse economic event occurs, generally speaking, the near term lending environment appears healthy but cautious for MA activ- ity. However, with depressed oil prices being economic disaster for some and a significant windfall for others, what will almost assuredly be different are the types of deals that will get funded. CONCLUSION 2015 marks the sixth consecutive year of a strong MA market. History shows, however, that following an extended strong period (typically no more than 6 years), the MA market experiences a pull back. Further, the sustained drop in oil prices, the slow down of the Chinese economy and significant Chinese and US public equity markets corrections, as well as the uncertainty surround- ing the US Federal Reserve’s interest rate policy, could have a material effect on the future of the MA market. On the other hand, so long as the availability of credit remains strong, an MA market correction should not be as significant in 2016 and 2017 as compared to past MA market corrections. Additionally, any correction will likely get the MA markets back to a “normal” pricing environ- ment as opposed to the “premium” environment that we have enjoyed in recent years. Finally, the near term (through the end of 2015) should be a great time for sell- ers to achieve a liquidity event as valuations and EBITDA multiples remain high. DEBT MARKETS While US companies, for the most part remain financially healthy, banks continue to have an appetite for leveraged MA transactions; but due to recent events, with an eye toward caution. With US GDP slowing, no forecasted improvement in the price of oil and the continuing effects of greater regulation, banks continue to prop up the MA markets with lending but with slightly dampened terms. Expect to see MA transactions in the foreseeable future to be completed with a little less debt and more equity, as, generally speaking, middle market debt multiples hover at around 3 times EBITDA for senior and 4 times EBITDA for total debt. In the EP market segment, banks are expecting more pain for US upstream and energy service companies leading to a number of possible bankruptcies. Continuing depressed revenues and margins due to low oil prices, and extremely complicated EP company capital struc- tures are going to make it more and more difficult for work out solutions to be reached following inevitable technical and payment defaults; so expect more bank- ruptcies starting late this year and next year. On the other hand, in the real estate markets, banks have experienced big increases in their total commercial real estate portfolios. But once again, banks are expecting the recent fevered pace of real estate lending to soften. Sizable pipelines of projects that have already been approved are going to temper activity for new projects and banks are also anticipating less refinancing activity, not necessarily because banks are not willing, but rather because most US companies have already taken advan- tage of the sustained period of low interest rates and have already completed significant refinancings. ATTORNEY INSIGHTS : PAGE 09
  10. 10. BILL BOYAR Founding Shareholder, Business Group Bill’s practice focuses on representing 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 com- plex, multi-party acquisitions and project financings, with significant experience in corporate finance, private equity, mergers acquisitions, real estate and hospitality. STEVE KESTEN Shareholder and Chair, Business Group Steve’s practice includes private placements and other sales and purchases of debt or equity securities; mergers, asset acquisitions and sales; formation and representa- tion of private equity funds, venture capital funds and hedge funds; entity selection and formation; and general contract review. He represents both lenders and borrow- ers in asset-based lending transactions involving senior lenders, mezzanine lenders and factoring companies. PAGE 10 Practice Leaders GARY MILLER Founding Shareholder, Business Group Gary has extensive experience in mergers and acquisitions, capital formation, contract negotiations/documentation, lending, factoring and day-to-day representation of corpo- rations and other business entities. He participates in the organization and financing of business entities, as well as the negotiation and documentation of complex transac- tions. Gary is often called upon to represent insurance agencies in their capital transactions.
  11. 11. PRACTICE LEADERS : PAGE 11 GUS BOURGEOIS Shareholder, Business Group Gus’ practice involves a wide variety of corporate transac- tions, including the acquisition, financing and disposition of business entities through asset and stock purchase transactions; entity selection and formation; sales of debt and equity securities; negotiation and drafting purchase agreements; employment agreements, licensing agree- ments and other contracts; and general corporate matters. BLAKE ROYAL Shareholder, Business Group Blake’s practice includes acquisitions and dispositions of equity and assets, including recapitalization transactions with venture capital and private equity funds; entity and capital formation, including private placements, in domes- tic and international jurisdictions; and general contractual drafting and negotiation. PHILIP DUNLAP Senior Associate, Business Group Philip’s practice consists of corporate and private securities transactions, as well as serving as outside general counsel in MA, financing, employment agreements and raising capital through private offerings. Philip has represented hedge funds, private equity funds, venture capital funds and real estate funds in their formation, operation and compliance in multiple jurisdictions.