Auctions are the Bermuda Triangle of the private equity world. Some sponsors make elaborate plans to charge straight into them in the hope of finding fabulous riches. Others make equally elaborate plans to skirt their edges or avoid them altogether with the aim of finding their own treasures far from the madding crowds.
But what these groups have in common is that neither is well-versed in the auction process. Auctions remain mysterious, with most market participants sensing – like the proverbial blind men touching the elephant – only parts of the truth.
The opacity of auctions derives from the very simple fact that publicly available auction data is effectively non-existent. Financing sources, lawyers, consultants and repeat-buyer private equity firms have some sense of how they work, and a pale emaciated shadow of auction dynamics can sometimes be gleaned from the background sections of disclosure statements in public-to-private transactions. But the only firms that really know what goes on in auctions are the sellside investment banks. Of these, the vast majority – including some of the traditional “bulge-bracket” investment banks – simply don’t have enough scale or scope to their sell-side practices to provide meaningful insight. Of the small group that does, some make no serious effort to systematically analyse their proprietary data.
At Houlihan Lokey, we believe we have the largest proprietary dataset in the world on corporate auctions. We use this data for a variety of purposes, including developing predictive analytical tools about individual buyer behaviours. The data, however, also provide some useful insights into the overall state of the markets. What it suggests to us is that the conventional wisdom about the state of the auction market is quite wrong.
That conventional wisdom suggests auctions are usually somewhat chaotic affairs, with large numbers of private equity “mouth-betters” tripping over themselves to bid ever more unrealistic values, while slower but more reliable strategic bidders plod themselves – tortoise-and-hare style – into the winner’s circle time and again.
This picture is misleading in several key regards: first, proper auctions remain highly structured events. We reviewed almost 500 broad auctions that we conducted from 2013 through the first half of 2018 and found that the average time between first-round and second-round bid dates, as well as the average time between second- and third-round bids (when there is a third, or “check-in”, bid), remained fairly constant over this time. What has changed is the time available at the start and end of a process, with the first lengthening materially and the second shrinking.
These changes are explained by changes in the market. Time between initial contact and first-round bids has expanded to accommodate early-look meetings – an increasingly important part of the deal landscape. While early-look meetings are by no means universal, they are occurring with increased frequency and are used to develop stronger interest among buyers. Back-end time in auction processes, conversely, has been shrinking, but this is explainable by the increased prevalence of “pre-emptive bids”. In our experience, this is usually a misnomer. Bids that truly pre-empt an auction before it begins are, while not unheard of, highly unusual. It is increasingly common, however, for buyers to shut off an auction in its latter stages by offering a price acceptable to the seller coupled with a credible assurance that a close is certain.
Second, the notion that strategic bidders are somehow the stalwarts of auction processes – in sharp contrast to those feckless and unreliable financial sponsors – is simply untrue. Surprisingly, our data show that, over time, financial buyers are materially more likely to follow up a first-round bid with a second-round bid than their strategic competitors. Moreover, there isn’t a very clear pattern as to whether strategic buyers increase their bids during the pendency of auctions by more than sponsors do.
To be fair, some of the reason for this lies in a simple fact (with apologies to Tolstoy): all financials are equally financial, but not all strategics are equally strategic. Strategic bidders whose business logic is more tenuous may fold early in an auction. But, since strategics do in fact win our auctions disproportionately to their participation in them, you can assume the most strategic of strategics continue to pony up for acquisitions that make sense for their stakeholders.
A final point that falls out of our database analysis is worth making: we have had the anecdotal sense over the past few months that valuations expressed as EBITDA multiples, which were already high by historic standards, have legged up yet again. A quick look at our database confirms that this is in fact the case. Looking at aggregated datasets is often somewhat fraught (the dataset we reviewed made no allowances for mix-shifts over time by size or industry, for example), but we assume that it is directionally correct. What it shows is that first-round auction multiples during the first half of 2018 were approximately 20 percent higher than they were through calendar year 2017. In the market for corporate control, the fun is just beginning.
Justin Abelow is a managing director in Houlihan Lokey’s financial sponsors group and co-head of the firm’s private equity practice. Matthew Palka and Matthew Herzog provided research assistance.