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Deal count down, but Md. M&A market shows signs of a recovery

Maryland companies participated in fewer mergers and acquisitions during the first quarter of this year than during 11 of the past 12 quarters — but several experts said the raw numbers don’t tell the whole story.

Even though the total deal count was down, private equity investments are returning at an encouraging rate, and activity is bubbling up in a greater variety of industry sectors than in recent months. Several transaction advisers, who help companies negotiate mergers and acquisitions with other firms, said they’re actually pleased the overall number of transactions wasn’t even lower.

In 2013’s first quarter, 50 deals involving a Maryland company as the buyer, seller or target were completed, according to data compiled exclusively for The Daily Record by Bloomberg Financial. By comparison, Maryland participated in 60 transactions during the first quarter of 2012. The gap is even greater compared with the final six months of 2012, which saw 66 transactions during the third quarter and 62 transactions during the fourth.

But the disparity isn’t as distressing as it seems, experts said. The end-of-year totals were somewhat inflated because many companies were firing on all cylinders to close deals before the calendar flipped to Jan. 1, when the tax on capital gains jumped from 15 percent to 20 percent, among other changes.

“There’s still a reasonable amount of activity, but there’s no urgency anymore, so deals seem to be dragging out and taking longer than they would have in the past,” said Joe Kinslow, a partner with McGladrey LLP’s transaction advisory services division. “Deals that would ordinarily have closed in Q1 actually got accelerated and finished last year.”

In terms of total deal count, Maryland follows the national pattern pretty closely. Kinslow, who is based in Baltimore but advises companies throughout the mid-Atlantic and Southeast regions, said that’s what he anticipated, but he was surprised by the diverse names on the list.

Several advisers said they expected the mergers and acquisitions market to be dominated by industries like information technology, cybersecurity and health care — fields that have helped Maryland weather the storm of the recession. Those fields were certainly well-represented on the list, but they weren’t the only areas with activity.

“You’re seeing a comeback in a very broad number of sectors: chemicals, distribution, education, medical technologies. … It’s not just concentrated on the areas we’ve seen recently,” Kinslow said. “I think what that’s showing is that despite a downturn in M&A activities in areas that have typically been robust” — namely, Maryland’s sizable pool of government contractors, he said — “some of the other industries in Maryland are picking up the slack. Investors are being shown attractive opportunities in other industries we have here.”

More private equity

Many of those investors finally pulled out their checkbooks in the first quarter, unlike last year, when a shaky economy kept their cash on the sidelines. In the first quarter, 34 percent of deals were funded with private equity, compared to 24 percent in the prior-year period.

“There’s an abundance of capital out there,” said Larry A. Davis, partner and founder of Aronson Capital Partners, a Rockville-based merger and acquisition advisor. “The private equity firms are aggressively looking for transactions to employ the cash they’ve got. And interest rates are still so low right now, investors aren’t looking to put their money in bonds.”

Rather, they’re looking for companies that have good business models, but — because they’re strapped for cash — are on the market for cheap. Many companies have seen their valuations plummet if they’re in non-priority government areas, because their growth prospects aren’t as good with budget cuts on the horizon.

That’s when private investors pounce.

“Private equity firms are more opportunistic. They are looking to buy when a company’s valuation is at the trough of market. And right now, growth expectations in the government contracting industry, at the top level, are down,” Davis said.

On the other hand, he said, “certain submarkets, like cyber, health, IT and big data, that still have strong growth — those valuations held up.” Strategic buyers — companies looking to expand into high-growth markets through strategic acquisitions — are primarily sticking to those priority submarkets.

Firms that help government be more efficient, such as technology firms, will continue to grow, so acquiring one of those is less risky, Davis said.

The other industries, though, can still be attractive to private equity firms — if the price is right.

“It seems like companies that are pricing themselves appropriately are getting deals done,” Kinslow said. “I think private equity [investors] are the ones who are willing to go after something, even if there’s some warts on it, in hopes of turning it around and taking it to the next level.”

That dynamic, experts said, has kept the value of first-quarter deals lower than in the past. (Most transactions listed in Bloomberg’s data did not disclose a value.)

Also, company executives are still dealing with residual uncertainty over federal budget talks, which experts said could be another reason for the sluggish M&A market.

In the second half of 2012, uncertainty about the potential for sequestration froze much of the mergers and acquisitions market, impeding deal-making across the majority of sectors. Though the fog hovering over the fiscal cliff has started to lift, it hasn’t cleared.

“[Lawmakers] said there’s going to be sequestration, but it hasn’t yet run down to the actual program level,” Davis said. “So if you’re a government contractor, the agency that you deal with is just finding out or hasn’t yet found out how it will affect them. … So in the first quarter there was still significant uncertainty. Buyers were saying, ‘Hey, if we wait a couple of months, we’ll have a better idea on the impact of sequestration. We’ll have a lot more clarity.’”

Optimism ahead

In 2012, the second quarter was the slowest of the year, with 45 deals completed. Transaction advisers said they’re optimistic that won’t be the case this year.

“I guess I’m hoping that Q1 will be the worst quarter of the year and that we slowly build,” Kinslow said. “I think in the latter half of the year, as investors get more visibility into long-term projections, that will ease up some of their hesitation to dive in.”

January and February were relatively slow periods for Kinslow’s advisory practice, but he said business picked up in March and has continued at a healthy level this month.

Maryland data don’t necessarily follow the same distribution curve: 54 percent of deals closed in January. Experts said those transactions might have been the stragglers from 2012 that didn’t quite make the cutoff — and without them, the first quarter would have looked even bleaker.

The M&A market is typically more robust during the latter half of the year, but that pattern was even more pronounced in 2012, fueled by the anticipated tax hike and executives’ uncertainty over how else federal budget talks would affect their business.

It’s also encouraging, several experts said, that Maryland companies acted as the acquirer, rather than the seller, in the majority of deals.

“In general, you want companies buying,” Kinslow said. “If they’re selling, there’s always the risk that they would close their headquarters and move out. From a state’s perspective, it’s better to have companies that are buying because that means they’re growing and potentially bringing jobs into the state. In a healthy market, you’re always going to have some of both, but essentially, you want growth.”