“Far and away the best prize that life offers is the chance to work hard at work worth doing.”
Happy Holidays and Happy New Year – martinwolf Annual Letter
To Clients, Partners, and Friends of martinwolf | M&A Advisors, Happy Holidays and Happy New Year!
2016 was our 20th year of operations, and we knew from the beginning it was going to be a big year. But no one—least of all, us—could possibly have known just how
significant of a year it would be.
The overriding theme for the year was change, both dramatic and evolutionary. From politics to economics to M&A to martinwolf itself, we’ve seen and experienced significant developments that shaped a year unlike any other and have presaged exciting times to come.
Before we close out 2016 and prepare to officially toast both the new year and our 20th anniversary on January 13, 2017, I hope you’ll join me in looking back at some of these changes—and how they shaped the overarching trends of today.
Much has been written about the 2016 election, but despite the stark disagreements on all sides, one thing is clear: the new administration represents a significant change from the policies, statements, and priorities of our 44th president.
The only certainty? Uncertainty. Never before has a president governed through late- night missives of 140 characters or less. And as executives at Boeing and Lockheed Martin found out, the light of a president-sized spotlight can get painfully hot (even if it’s quick to move on to the next target).
But with uncertainty comes significant opportunity. Since the election, markets are thriving. The Dow has celebrated 17 record closes, and today flirts with 20,000.
We expect real growth in the economy overall—perhaps even 3 – 4 percent (though not less than 2 percent). For investors, growth is no longer seen as such an elusive target— whereas before it all but guaranteed an extreme premium (resulting in the rise of FANGO), today there are many inexpensive growth stocks offering strong returns to the average investor. As a result, the market will continue to shift away from income equities.
It’s not clear where our incoming president will be on anti-trust issues. Our current president has made it very difficult, but we are not facing a typical Republican administration. Look to the resolution of the Time Warner/ AT&T transaction for an indication of what to expect going forward for large-scale M&A.
Last year, the Federal Reserve made news by announcing its first interest rate hike in nearly a decade. At the time, it projected four quarter-percentage-point increases in 2016—though we pointed out that it wasn’t clear whether this was data-dependent or the result of the Fed being boxed in by its own expectation-setting.
On Dec. 14 of this year, it felt like déjà vu. The Fed once again announced its long- telegraphed sole interest rate hike of the year—though this time, the economy appears much stronger.
We expect more rises in 2017 than in 2016, and continued improvement on economic metrics. The rate of underutilized employment (or U6 rate) should drop, and as the country approaches full employment we even expect a little wage inflation.
Perhaps one of the biggest changes for 2017 is that we expect meaningful fiscal stimulus for the first time in 8 years. From an economic standpoint, expect the new administration to implement deregulation in meaningful quantities, provide for new infrastructure (some in partnership with private entities, to maximize efficiency), and to finally address our bloated and outdated tax policy.
The repatriation of 2 – 3 trillion in foreign cash, if achieved at a meaningful level, has the potential to directly impact the economy. As Warren Buffett put it, capital allocation is a critical skill for high-performing companies. To the extent that some of the most profitable companies in the world have less restricted access to capital from abroad, we expect strong benefits in every sector of the economy (particularly technology, which accounts for 5 of the top 10 companies holding cash abroad).
Looking abroad, the situation continues to be more of a mixed bag. Japan is a basket case unless the yen keeps going down, though the Japanese economy expects slight improvement to 1.5 percent growth in the next year. 2016 marked the introduction of negative interest rates by the country’s central bank, and the fact that the country—the third largest global economy—is set to continue at these levels for the foreseeable future remains stunning.
The number 2 economy faces its own problems, heightened by its own political uncertainty. China overtook the US in outbound M&A volume, but expect a slowdown as the government institutes capital controls aimed at keeping money inside the country.
It’s very unclear whether we’re going to continue to see large acquisitions like HNA’s purchase of Ingram Micro or ChemChina’s acquisition of Syngenta in the coming year.
Currency issues will continue to dog communist leadership, as each proposed acquisition will force regulators to determine whether it is a smart transaction or just a means of committing yuan to US dollar assets beyond their reach. Expect the Chinese government to work to adjust interest rates, discount rates and reserve ratios— especially in the face of the anti-free trade rhetoric sweeping countries across the globe.
Even India, which has had perhaps the strongest economics-oriented leader in the world for the past year or two, is experiencing its own hiccups. By demonetizing existing 500 and 1,000 rupee notes, the country scrapped 85% of its currency overnight, sending shockwaves through the economy and crashing the major exchanges. India’s oursourcing-heavy tech sector stands to benefit, but now more than ever it needs to transform itself. The country’s historical advantage has been its labor arbitrage—today, IT leaders have built cost-effective frameworks designed to manage the world’s cloud offerings. Tomorrow’s success will be experienced by those who are able to secure unique IP—through growth both organic and inorganic.
The result of this global uncertainty (evident as well in Europe with Brexit and continental populist movements) has been a strengthening dollar—good for domestic companies but problematic for multinational IT companies.
M&A & Markets
Last year may have been the record-setter for M&A, but it set the stage for the largest market we’ve ever seen. Today, there are more mid-market companies for sale than ever before—and, as a consequence, there are more broken processes as well. As public markets continue to close off, the path toward exit increasingly looks to involve a private sale. Presidio, which filed IPO paperwork in November, is the exception that might prove the rule. Given its size, there are few buyers that could afford an acquisition. We expect them to get public in 2017, but stranger things have happened. The best way to sell your company is to file for an offering—as Optiv demonstrated by getting swooped up by KKR less than one month after filing its own paperwork.
But what’s missed in this whole notion of the merits of going public is that so many major players in our space are private. For every CDW, Insight and PCM there is a privately held leader like SHI, World Wide Technology, and Zones. Many, like Sirius, SPS and ConvergeOne, are backed by private equity, and we expect to continue to see visible rollups in the coming year.
As a consequence we expect higher demand, higher deal values and higher multiples. In sum: it’s a great time to jump in to the market.
Looking Back, and Looking Forward
As our 20-year anniversary approaches in January I’ve found myself looking back at what has been an incredible two decades. We’ve never purported to understand cutting edge technology—that has not been our strong point. But we’ve been intimately involved with IT Solutions and Services providers through thick and thin, and we’ve seen waves of technological progress that have both elevated and decimated value across the industry.
In order to survive, members of the IT supply chain have become exceptionally hardy, selling other people’s IP and figuring out how to stay ahead of every change in the marketplace to make a profit. Today, many of the companies that were in existence when we started have been acquired. But even those that still exist are different—entire franchises have been disrupted, destroyed or consolidated.
Success required a unique collection of finance, technology, sales, and operations skills, and for many it resulted in significant wealth. But continued success is a rare accomplishment, and it has required continuous reinvention to stay ahead. When we started, solution providers traded on revenue. Today, they trade as multiples of EBITDA, and they are under constant siege from disruptors of all shapes and sizes.
But the solution provider space continues to be a source of reinvention, innovation, and value creation. I’ve met countless leaders who see the widespread disruption as opportunity, and today our active engagements span both the globe and the IT industry.
I’m excited as I look forward to what’s next. In our first transaction, we sold a company for $2.5 million, paid out over three years. In our first quarter last year, we collected 2 fees greater than $2.5 million each and our average transaction size was over $100 million. Even with our average transaction significantly larger than those from where we started, there are a few core qualities that have never changed. The mid-market remains our focus, and we always join our clients in long-term, intimate engagements. We work only with people we respect and can learn from, and we will only take an engagement if we know we will beat expectations.
There are too many businesspeople to thank over the past 20 years for me to name individually, so I hope you understand if I simply say this: some of the best people I’ve ever worked with are the leaders I’ve come to know from the solution provider space, past and present. Thank you all for the role that you have played in our success—we could not have done it without you and we look forward to creating new value together in the years to come.
I wish you all Happy Holidays, a Happy New Year, and, as always, Happy Selling! Sincerely,