Navigating the M&A waters

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Business owners considering buying, selling or merging businesses have to weigh countless variables to help determine the success of a transaction prior to executing a deal. Scott Sergeant, managing director of Los Angeles-based Houlihan Lokey spoke with Waste Today about considerations that can help streamline and improve the process for those in the waste and environmental services sector.

Waste Today (WT): How does the economy affect the decision on whether or not it is the right time to pursue a merger or acquisition?

Scott Sergeant (SS): Given the essential nature of most environmental services, the timing of a sale is less relevant in this sector than in other industrial businesses. This is evident in the rise in prices of publicly traded waste and other environmental companies, as well as current M&A valuations. The sector is a relatively safe place to invest because the demand for these services does not go away—they are critical to the operation of all businesses and governments. That said, from either buyer or seller perspectives, the timing of economic cycles is always a factor, as is the target company’s exposure to cyclicality. Today, given the likelihood the economy may enter some recession during an investor’s next ownership cycle, buyers are measuring all targets’ exposure to cyclicality, and that could have an implication on valuation.

WT: How is the climate for M&A activity right now in the U.S.?

SS: The M&A market for sellers continues to be very strong, both generally across all industries and in the environmental/waste sectors. This is driven by an abundance of private equity capital, healthy corporate balance sheets, strong credit markets and the economy in general. It is hard to predict what the environment will be a year from now, but it is unlikely to be any better than it is currently. There is also real scarcity value in the environmental services sector today, as there is more capital chasing too few deals of size. This supply/demand imbalance is driving valuations up, which creates a favorable climate for sellers. This may seem like an unfavorable climate for buyers, except the valuation environment is encouraging some companies to explore a sale that otherwise wouldn’t. This is creating more opportunities for buyers.

WT: What are some metrics that business owners can look at that may signal it could be a good time to sell their business/acquire another business?

SS: Buyers attracted to a target’s operations are always going to evaluate historical financial performance. So, first and foremost, the key metrics are consistent recent growth and strong and stable profit margins. Free cash flow should also be a focus, so understanding a company’s earnings after accounting for capital spend is important. If a company is trying to decide if now is a good time to sell, we also recommend evaluating the near-term prospects of the business. More specifically, is there anything that is expected to occur that would meaningfully improve the company’s profile over the next year? If so, they should be assessing the achievability of that relative to market risks of waiting to sell the company and missing a strong window.

WT: What kinds of variables influence the success of a merger?

SS: Mergers are distinct from acquisitions. They imply the combination of two businesses that will generate greater value together than separately. Mergers depend on an agreement on the relative value of the businesses and the continued leadership roles—often the two biggest obstacles to getting the deal done. The success of creating value depends on a lot of things, including an effective integration of the businesses. Since culture is so important in environmental services companies, it is critical that they are appreciated and preserved. Careful consideration of cultural differences can mitigate the risk of losing key employees or customers. 

WT: What are outside parties most interested in when looking over a business to determine value?

SS: Unlike many businesses in other sectors, there are multiple drivers of value in the environmental services industry. Some key drivers include recurring revenue characteristics, capital intensity, scale and geographic footprint, quality of management, margins and organic growth track record. For private equity buyers, a recent trend has been to evaluate whether a target is a proven M&A platform. Since parts of the industry are not high growth, investors can achieve their returns through the consolidation of smaller companies. As a result, they are willing to pay a premium for companies that have a proven acquisition strategy historically and a pipeline of future opportunities.

WT: What are some steps business owners should take prior to considering a sale?

SS: Preparation is key. Before embarking on any sales process, the No. 1 priority for a business owner should be to prepare and be able to withstand the evaluation and negotiation of a sophisticated buyer. This starts with appropriately packaging all financial information and any other key documentation to facilitate a buyer’s due diligence process. Hiring an investment bank to represent the business in a sale allows the business owner to outsource this work, create marketing documents to describe the business in a favorable light and manage a competitive process. Competition amongst multiple buyers will result in greater valuations and more favorable deal terms. It is extremely difficult for a business owner to do this without an adviser, particularly when they need to continue operating the business.

WT: What resources should business owners look for that can help them navigate the M&A process?

SS: There is tremendous value-add to outsourcing the M&A process to professionals, not only because that is what they do for a living, but also because it allows the owners to focus on running the business. Hiring a well-recognized investment bank that has reputation in the market can keep buyers honest by executing a competitive sales process. If well executed, and with credibility and leverage over buyers, it can maximize both value and speed/certainty of the transaction—which can easily pay for the cost of working with a third party. Other resources include lawyers and accountants. A lawyer that specializes in M&A will ensure that the documentation minimizes the risks post-close. Business owners are also increasingly hiring accounting firms to complete a sell-side quality of earnings report prior to selling the company. This report helps package the financial reporting and identify any issues early that a buyer’s own accountants may raise late in a process. These resources all fall under the preparation theme—the more you prepare upfront before a sale process, the less risk of surprises late in the negotiation that could derail the transaction.

WT: Are there common missteps you see businesses make throughout the M&A process that you would caution against?

SS: Time is always the enemy. Focusing on maximizing speed and momentum will help minimize the risks that time exposes, which is why preparation is so important. A sell-side target should make sure they are well prepared to enter a sales process. Too many would-be sellers lose momentum and negotiating leverage, or even have the sale fall apart, due to the inability to facilitate key due diligence or make quick decisions. Also, if the business owner has plans to retire or exit the business shortly after the sale transaction, it is important that there is a succession plan in place and the key members of the management team are aligned going forward. Many buyers are backing management teams, not just buying companies, so they rely on some continuity of key employees. If the business owner is key to the successful operation of the company, he or she should not assume they can ride off into the sunset immediately after the deal closes, unless there is a thoughtful plan in place that was communicated early to the buyer.

The author is the editor for Waste Today and can be contacted at aredling@gie.net.