March 13, 2015
We recently reached out to Cascadia Capital’s Christian Schiller to get his take on the U.S. Pacific Northwest’s M&A and economic scene. He was kind enough to work with several other Cascadia professionals to develop the following comprehensive answers to our questions.
Per Cascadia’s recent post on how the NW economy will outpace the U.S.’s as a whole, do you anticipate any significant challenges or changes in sector performance in the coming year and beyond?
The Pacific Northwest benefits from a diversified economy. The absence of any strong dependency or industry concentration creates a level of economic stability few regions enjoy. Additionally, a critical mass of large corporations across the spectrum of technology, retail, healthcare, aerospace, business services, real estate and consumer industries serves up a vibrant entrepreneurial base for startups and spin-outs benefiting from the ecosystem. We do not see the fundamental drivers of growth changing in the near term, as this growth cycle has a long and broad foundation.
Furthermore, the region is one of the most educated in the country, creating a deep talent pool that is attracting bellwether companies like Google and Facebook to the Northwest. Meanwhile world-class institutions like the Bill & Melinda Gates Foundation, Fred Hutchinson Cancer Research Center and the University of Washington are attracting top-notch professionals and intellectual talent from around the world and incubating innovation and entrepreneurship for the benefit of a broad range of industries and the regional economy.
And how much do you anticipate this regional growth will spur M&A interest from national/international acquirers, as opposed to local buyers?
The Northwest is no longer a secret from a corporate finance perspective. Across the industry spectrum, the region is growing at a remarkable rate and producing companies with uniquely disruptive business models. This has drawn the increased attention of buyers and investors from around the country, evidenced by the number of deals recorded with non-local buyers. From the Puget Sound and Portland Business Journal’s 2013 top deals involving Washington/Oregon companies list, 60% of the buyers were from outside the region. Cascadia Capital receives at least 50 inquiries per week from investors and buyers outside the region seeking access to regional deal flow—the strongest demand we’ve ever seen. However, other than Chinese and Asian investment in real estate, we are not seeing a high inflow of capital from international buyers or investors, which may be attributed to the strengthening U.S. dollar.
Are the family-owned businesses cited in that same article (aerospace, technology, agriculture and consumer products) primarily in the same sectors identified as fast-growing, or do you expect an expansion of strategic interest to other industries as opportunities to acquire local businesses increase? For example, do you anticipate an increased interest in healthcare providers, and will that be more due to the PNW’s strong healthcare industry or nationwide trends?
During the current cycle we have seen a balance between strategic and geographic acquisition motivations for our clients. Geographic motivations seem to be more prevalent in traditional industries such as retail, transportation and logistics, healthcare and agriculture, with strategic motivations more prevalent in technology, including healthcare technology, and consumer product related industries. The most prevalent activity right now is in technology, aerospace, agriculture and consumer industries. While the Pacific Northwest is riding the positive national M&A market trend, we do feel that the increased interest and activity from outside buyers and investors is driven by the relatively higher growth of our region and its companies. As long as this regional growth remains stronger than the national average, demand for Pacific Northwest investments and acquisitions from players outside our region will remain robust.
What are your expectations for valuations in 2015?
Valuations are currently at or near peak levels. The combination of an oversupply of equity and debt capital coupled with a supply/demand imbalance (favoring sellers) provides the opportunity for a subset of companies to achieve valuations that exceed the levels seen in previous cycles.
We see the risk/reward ratio tipping toward the risk side in the medium term, but these market conditions should prevail for another 12 to 24 months. The risks to this cycle come from outside the region and are largely rooted in national economic policy (tax changes or Fed missteps) and politics (national elections in 2016 and the impact on capital flows and M&A). One key difference between this and the 1999 and 2007 peaks is that buyers and investors are much more discerning. The rising tide has not necessarily lifted all boats. Companies that are small, highly cyclical or have issues such as high customer concentration are still finding it challenging to realize attractive valuations.
Do you see any signs of a slowdown?
Currently, we do not. This feels like a long-term market opportunity for a number of reasons. The broader market has been able to work through the geopolitical risks that caused volatility during the past six months. Inflation is not yet at the point where we see the Fed raising interest rates quickly or by large amounts (we feel there would need to be a move of at least 100 bps to have any negative effect on the deal markets, and that seems unlikely). In a flight to quality, the U.S. remains the economy of choice. Furthermore, our client base appears increasingly optimistic, which means they will continue to invest in growing their companies, hiring employees and expanding their markets.
We are in the midst of a virtuous cycle, where more begets more. Traditional up-cycles last an average of 42 months, and we are approximately 18 months into the current cycle. 2015 will be a strong year and we anticipate that will carry into 2016.
Do you see considerable intersection between industries as a growing pipeline for potential M&A in the PNW? For example, Dexter + Chaney, a provider of construction management software, was recently backed; with the healthy startup ecosystem referenced in that article, do you anticipate further industry intersection in the PNW, given its particular sector presence?
Yes. There is an increasing level of growth and consolidation opportunity to be found at the intersection of core industry sectors in the Pacific Northwest. For example, the proliferation of mobile into many traditional industry verticals, like retail and logistics, is creating a horizontal industry that plays into our region’s historical strength in the sector. We are also seeing an interplay between energy and technology, driven by oil, gas and energy suppliers eager to bring their costs down by leveraging technology to increase productivity. Similarly, the increasing integration of our robust technology ecosystem into the healthcare sector is driving innovation in personalized health and digital health.
To what extent is the M&A ecosystem local? Are PNW banks primarily the source of financing for deals? And are service providers such as Cascadia usually reached out to by outside strategics?
While local banks are certainly active, particularly in smaller transactions, non-bank lenders from outside the region have been a much more common source of capital in our transactions. Some of this is due to the nature of the products provided by money-center banks, coupled with the policies that restrict their activity in this market. At the lower end of the middle market most strategic acquisitions take place using balance sheet cash or existing bank facilities. With a broader and more diverse set of capital options found outside of the Pacific Northwest, we see an increasing trend of Northwest companies seeking capital outside our region. Cascadia is often engaged to raise equity, subordinated debt or unitranche funding for companies in our region, and the vast majority of those occur with investors elsewhere. For instance, we raised $75M for a local business, BDA, a major national agency and provider of promotional products to sports leagues and Fortune 100 companies, from a Washington, D.C.-based investor American Capital.
In terms of service providers, outside buyers and investors are growing more comfortable that they can get the same “money center” class representation from local legal, accounting and diligence/consulting firms, often at a lower cost, and are thus tapping regional providers at an increasing rate. This is a trend we expect to continue, as more buyers and investors look to be active in the region.
The PNW may be most popularly associated with software/IT and aerospace, but which fast-growing PNW sectors fly more under the radar and could see a lot of interest in 2015 and beyond?
Agriculture (particularly in Eastern Washington) is probably the most “under the radar” opportunity that we see driving tremendous deal flow in the relative near term. Our region also punches above its weight in the consumer space, with companies focusing on a unique “authenticity” to their brand and business that seems to drive high interest from buyers and investors seeking to tap into these unique companies and grow them outside the region. MOD Pizza is a great example of this—a revolutionary new pizza concept founded locally that has expanded nationally and raised a large capital round from an investor outside the region that understands and values MOD’s authentic brand experience and market potential.