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As the current M&A cycle in the lower middle market marches onward, first-quarter 2019 data shows the continuation of a familiar pattern, where valuation multiples bounce off the ceiling set by leverage availability and willingness of sponsors to over-equitize transactions (or not), according to GF data’s recently published May report.

Two hundred private equity sponsors and other acquirers reported to the data tracking firm on 57 transactions completed in the $10 million to $250 million Total Enterprise Value (TEV) range. The sample set is limited to deals with multiples (TEV divided by TTM Adjusted EBITDA) of 3x to 15x. The average valuation multiple for the first quarter of 2019 was 6.9x, down slightly from the average of 7.3x recorded in 2018, but still quite healthy compared to historic middle market averages in the low to mid-sixes.

“The market continues to have plenty of momentum at this late stage of the cycle, but the first quarter of 2019 is another example of the ricochet we have seen following a stronger quarter in an overall robust market,” said Graeme Frazier, IV, co-founder and principal of GF Data. “We have seen this pattern before, where a slower first quarter is followed by stronger improved quarterly performance as the year unfolds.”

At the same time, Total Debt/EBITDA rose from 3.8x on average, to 4.1x, edging back towards the current cycle peak seen in 2017. “Debt levels driving equity levels is not a new dynamic, but we are seeing it at work increasingly in the smaller deal segments of our data set,” said Andrew Greenberg, GF Data’s CEO. “The valuation spread between larger and smaller deals narrowed a bit in the first quarter, and this pick up in debt utilization appears to be the driver.”

GF Data’s first quarter leverage report showed that add-on transactions continue to utilize increased leverage, particularly in the smaller size segments, while average valuation multiples for add-ons re-established their position at somewhat lower multiples than platform deals, with add-ons averaging valuation 6.7x TEV/Adjusted EBITDA vs. platforms with an average of 7.4x.

“Driving down platform multiples by buying lower multiple add-ons has been more difficult over the past year or so but still remains a viable value creation strategy,” said Scott Lutzke, founding partner of Indianapolis-based Centerfield Capital Partners. “The integration of add-ons is always a challenge but if there are cultural, operational, market and product fits then higher multiples may be more tolerable and result in higher combined exit multiples.”

GF Data provides reliable external information for use in valuing and assessing M&A transactions to private equity firms, investors, lenders and other users. The firm collects and publishes proprietary transaction information from private equity groups on a blind and confidential basis. The pool of active contributors comprises 200 private equity firms, mezzanine groups and other financial sponsors. Data contributors and other subscribers receive five products: (1) a quarterly report containing high-level valuation, volume and leverage data; (2) a quarterly supplement offering detailed information on debt and capital structure trends; (3) a semi-annual supplement on indemnification cap, escrow and other details; (4) quarterly industry drilldown reports; and (5) continuous access, through GF Data’s secure website, to detailed valuation data organized by NAICS code.