Middle Market M&A Outlook: Prairie Capital

Darren Snyder and Tony Danielak from Prairie Capital

As the first month of 2012 comes to a close, we thought it would be interesting to have conversations with a number of Axial Members about what the rest of the year might hold in the deal business. There are issues in Europe, a Presidential Election, and the Dodd-Frank SEC Registration requirements going into effect, adding up to a year with the potential to be very interesting.

Over the next two weeks, we will be publishing four interviews. Two of the interviews are with middle market private equity groups and the other two with middle market investment banks. To start the series, we sat down with Darren Snyder and Tony Danielak from Prairie Capital, a middle market private equity group in Chicago with portfolio companies in a wide range of industries, to get their thoughts on the coming year.

Cody: What are your thoughts right now on the general economy and how it will impact mid-sized private businesses?

Darren/Tony: We’re definitely positive on the economy and see it continuing to strengthen. Many of our portfolio companies had a very good year last year and we anticipate the same this year. Housing will continue to struggle as we’re still looking at underwater equity and foreclosure issues, but we’re seeing really good things in the rest of the economy. Our pool related businesses appear to be entering the season on a strong note. Additionally volumes are increasing at our companies that provide parts and services to major US sectors and companies, including automotive, appliance, and Caterpillar.

Do you anticipate any impact from the issues happening in Europe right now?

The only effects we’ve really seen so far were that it has taken a few European strategic buyers off of potential buyer lists for some of our portfolio company sales. We feel like American banks have done their job shoring up their reserves and we’re not too worried about contagion. Europe just doesn’t have the impact in our portfolio that Asia or South America/Mexico would. Then again, because we focus on the lower middle market, the international markets have limited impact, so we don’t spend a lot of time thinking about global macro issues.

What is your outlook on Private Equity and the deal business in general over the course of the next year?

We’re very optimistic in general. We see lots of companies coming to market in the next 5-10 years and there’s a strong, consistent need for private equity. We don’t see that changing any time soon and see a lot of opportunity ahead.

Over the last 20 years the business has certainly changed to become more competitive and more efficient. Now smaller companies are getting better distribution and more groups are coming across deals they wouldn’t have seen before.

On the whole though, we really see a very strong deal pipeline this year. Most business owners are getting back to valuations they’re comfortable with and expected a few years ago. Leverage seems to have opened up again and is allowing deals to get done at reasonable terms. Most of the business brokers and investment bankers we speak with seem to be very busy either negotiating deals or starting processes with a lot of companies.

Also, because the economy seems to be growing again, there will be plenty of great deals and most will be able to pass through due diligence. Over the past few years there were occasionally problems or surprises between LOI and closing that caused deals to be aborted, but it seems that most companies are only getting stronger now, making the closings much easier.

What types of deals do you see being done in 2012? Are you anticipating smaller deals, larger deals, etc?

Macro-economic issues seem to affect the big blockbuster deal flow the most. We work primarily in the lower middle market which has very consistent deal flow because we’re working mostly with family owned companies. Most of the reasons why companies exit in the lower middle market, like retirement, health, or family situations, aren’t driven solely by the economy or capital markets. We are starting to see more corporate spin-outs as companies are restructuring after the last few years. [Large companies] are starting to spin off non-core divisions and are making strategic acquisitions to strengthen their focus areas.

Do you see any sectors being particularly attractive this year?

We see it being pretty fairly even across the board, but there are a few interesting industries. We’ve seen a lot of interest in health care services, what we call ‘health care lite’, the types of companies where there isn’t the impact of regulation but there seems to be a lot of opportunity. We’ve also seen a lot of interesting opportunities in education, especially as new technologies, delivery methods, and business models are changing the industry.

Generally, consumer products is probably not going to be very good again this year, but transactions may increase with fairly good values available buying solid brands that have solidified, but not yet rebounded. Our experience is that retailers have been extremely cautious on inventory purchases, even pushing out plan-a-gram resets, which is always a disappointment. Costs from Asia have continued to rise along with commodity fluctuations, impacting margins. That said, the lower end consumer seems to be willing to overspend a bit now, which along with declining unemployment could provide some upside.

How is your firm approaching the market this year? Are you expecting to acquire more companies since you’re bullish on the economy?

We bought four platform companies last year and we’ll probably do about the same this year. We try to acquire between four and seven companies a year across all economic cycles. It has a lot more to do with the size of our staff, the health of our portfolio, and our funding than anything else.

As a fairly generalist firm, it seems like specializing a bit as the industry gets more competitive would give you an advantage. Do you anticipating changing your acquisition strategy this year?

We stay very consistent in our mandate and have been that way for the last 15 years. Staying true to our mandate is what helped us through the dotcom days and is what has helped us the last few years. We focus on family businesses in the low end of the middle market and we’re very generalist. We like to keep management in place rather than having a big stable of industry executives so that forces us to only work with good companies.

We see big value in being generalists as it gives us good trendlines over the years. For example, in 2005-6 we saw a significant uptick in the number and size of deals being done in building products and consumer products. In the past we had closed deals in consumer products and had looked at a lot of deals in building products but, despite starting a few deals [in ‘05-’06], we couldn’t get any done because our terms weren’t competitive. We couldn’t understand the valuation terms at the time and it seems our trendlines saved us.

Do you anticipate anything else happening in the next year that will have a significant impact on your business?

The Dodd-Frank SEC regulations and registration requirements are the biggest thing we’re anticipating in the next year. For smaller funds like ours they will be a hurdle but most of the reporting seems to be form over substance. We’re a very small part of the economy and really don’t have much of an impact from a GDP standpoint so we don’t really understand all the regulation. Also, it’s not like our investors don’t know what’s going on. We work with very activist, wealthy investors and institutions who know exactly what is being done with their money. As a fund we’ve always been very transparent and have substantial reporting capabilities, so we won’t be impacted significantly [by Dodd-Frank], but we can imagine that the burdens on a lot of smaller firms could impact the industry over time. There is a certainly an investment requirement in having a ‘chief compliance officer’ plus new requirements in archiving email, personal public trading restrictions, political contributions, etc. This will be a barrier to entry for small start-up funds that don’t have the infrastructure of an established group.

This interview is part of the larger discussion about what our Members expect to see in the deal business this year. We encourage you to get involved and voice your opinion as well. Comments are open below for you to agree, disagree, or comment on what you’re seeing in the market going forward.

The series will continue on Thursday, February 2nd with the interview of Peter Sokoloff, Senior Managing Director at Peter Sokoloff & Co. Subscribe below to receive email notifications of upcoming articles, interviews, and network activity reports.