During your company's annual meeting, the CEO asks how the company is going to meet its revenue growth goals for the year. The sales team
indicates that they have pushed every lever they could over the past five years, but growth has been particularly challenging during the COVID-19 pandemic. Now, the CEO is looking for new ways to grow. As a vice president, you mention how other companies are growing via mergers and acquisitions (M&A). The CEO loves the idea and asks you to research ways the company can expand its value through M&A.
Now what?
This article will help you understand a simplified valuation methodology (earnings before interest, taxes, depreciation, and amortization (EBITDA) times a multiple), how to increase EBITDA and the multiple, how to compare rates of return from M&A to internal rates of return, and how much diligence may be performed before you close the transaction. Although addressing company culture is critical to a successful M&A, it is beyond the scope of this article.
How to Best Use Company Resources
Based on November 2020 industry reports, the U.S. has approximately 3.33 million construction companies1 and an additional 3.32 million real estate companies.2 Many of these management teams are tasked with deciding how to best use the company’s resources, such as cash on hand and line of credit availability.
According to research released in November 2020, U.S. companies are sitting on the largest pile of cash ever, with cash holdings at nonfinancial companies growing to a record $2.1 trillion at the end of June 2020.3 Similarly, total “dry powder” levels (the amount of committed but unallocated capital that a firm has on hand) in venture capital and private equity firms hit unprecedented sums in early 2020 with more than $1.5 trillion available to fund managers worldwide.4
M&A Activity
With the available cash on their balance sheets, many companies are turning to M&A to help achieve their growth goals. While the COVID-19 pandemic slowed transaction volumes during the second quarter of 2020, some experienced rebounding transaction volumes throughout the third and particularly fourth quarters of 2020. The construction industry’s experience appears to be consistent with the overall market.
As shown in Exhibit 1, construction deals decreased nearly 6.4% in 2020 compared to 2019, despite a global pandemic that adversely affected numerous businesses. Furthermore, construction deal activity during 2020 was about 51.8% higher than average deal activity between 2010 and 2017.
When looking at the data by quarter, deal activity fell about 54.2% during the second quarter of 2020 compared to the first quarter (Exhibit 2). However, deal activity rebounded during the third and fourth quarters of the year, increasing on average about 21.8% compared to the second quarter.
Similar trends are found in the real estate industry. Deal volume decreased about 10.7% in 2020 (Exhibit 3), including about a 46% drop during the second quarter, with the fourth quarter experiencing a rebound of about 25.5% compared to the second quarter (Exhibit 4).