Mergers and acquisitions gained momentum in the second half of 2012.
They finished the year with a bang.
Thank the tax collector.
“The third and fourth quarter were extremely busy,” said Allan Siposs, managing director of Irvine-based valuations firm FMV Capital Markets LLC. “That was motivated by clients that decided that they wanted to get out before the end of the year and wrap up deals before the tax laws changed.”
Primary causes for concern among buyers and sellers were a 5% bump in the tax rate on long-term capital gain—from 15% to 20%—and a 3.8% Medicare tax on investment income.
Medicare taxes have historically been as-sessed only against wages. That changed on Jan. 1, and the tax can be applied in some cases to income from interest, dividends, capital gains, rental revenue, royalties and other sources.
“The issues with which the sellers were concerned, especially in the [private equity] and closely held company situations, were the potential loss of the beneficial tax rates, but it did not appear that they were willing to take a reduction from their target price in order to complete the deal before the end of the year,” said Tracey Ridgway, a transaction tax partner for accounting firm Ernst & Young. “Buyers were also concerned in the due diligence process as to how any of the upcoming tax law changes might affect the operations going forward. For example, they wanted to understand how the tangible personal property regulations or the medical device excise might affect acquisitions in certain industries” (see related story, New Drill on Due Diligence, page 24).
That meant structuring deals in ways that would soften the blow of the new taxes, including maneuvers that might become standard.
Medicare Tax
“With respect to the Medicare tax, we believe that this will focus more activity on the deal structure and specifically on the operating structure going forward,” Ridgway said. “It will likely have a greater impact on deals where there is an opportunity to have a flow-through structure versus a corporate structure.”
The pace of deals last year also got pushed along by an improving economic outlook and a deep roster of investors with cash on hand.
“Valuations were pretty healthy, and private equities were sitting on a lot of cash,” said Bill Simpson, partner in the Costa Mesa office of Los Angeles-based Paul Hastings LLP, and head of the law firm’s private equity practice.
Paul Hastings LLP’s office in Costa Mesa typically works on about $2 billion worth of deals a year.
Last year’s roster included Santa Ana-based SRS Labs Inc.’s $148 million sale to Calabasas-based DTS Inc., and a $282 million deal that saw Viasystems Group Inc. in Missouri acquire Anaheim-based printed circuit board maker DDi Corp.
Sectors that are expected to heat up in 2013 include: industrial products, financial services, oil and gas, mining and metals, consumer products and health care, according to Ernst & Young’s Capital Confidence Barometer survey.
Mixed Opinions
Opinions on whether the overall level of activity this year will match 2012 are mixed.
So far the first couple of months have shown a slowing in M&A activity, Ridgway said.
“Many times in the past, January has gotten off to a slow start, but we often see activity pick up in February and March, but this year it has been seemingly slow,” she said.
Simpson leans more toward optimism.
“I think people are now starting to discuss selling, and starting to talk to investment bankers,” he said. “If you’re starting that conversation in March, you’re probably looking at a September closing. I think the first half will be slower than normal, and the second half will not be as good as the last half of 2012, but I think it will be good. One, because of the fundamentals. People are a little skittish, but not a lot skittish. Secondly, the credit markets are still great.”
FMV’s Siposs said this year is already off to a good start.
“We had expected a lull following the rush of exits toward the end of last year,” he said. “It has been exactly the opposite. My theory is that there’s a perception of greater stability in the market.”
Nick Iyer is a freelance contributor to the Business Journal.
