Chasing Yield: Buyers Set Their Sights on Equipment Finance
by Rita E. Garwood Mar/Apr 2022
For buyers seeking yield, the equipment finance industry has become an attractive acquisition target. Chris Donohoe of Piper Sandler and Murat Tastan from Keefe, Bruyette & Woods discuss today’s M&A climate, outline what buyers are looking for and how deals are created and provide an outlook for M&A in 2022.
Chris Donohoe, Managing Director, Financial Services Group,, Piper Sandler
When we started planning this issue of Monitor, I asked our editorial board about the major trends affecting independent equipment finance companies today. The very first response I received was, “Who’s left?” Many of us noticed an uptick in acquisitions over the last year, so we set out to explore this trend with two M&A experts who provided an overview of the factors that have been contributing to the robust M&A market.
Chris Donohoe, managing director of the financial services group at Piper Sandler, believes the natural progression of the entrepreneurial cycle of many independents has played a large role. Many management teams have assembled the capital, built and grown the business, proved their business models and reached scale.
According to Murat Tastan, managing director of fintech and financial services investment banking at Keefe, Bruyette & Woods, “Industry participants are enjoying record profits driven by strong demand, low funding cost and benign credit conditions. Additionally, the outlook for the industry remains bright, as the economy is expected to continue its growth. The global pandemic and governments’ response to
this external development have resulted in an atypical environment in a sense that we not only have record-low funding and credit costs, but also have an economy pulling on all cylinders.”
Donohoe adds that two very specific contributing factors occurred in 2021. First, there was a carryover from the early days of the pandemic when people had to hit the pause button on many to-dos. “In many ways, we had a year and three quarters of activity in 2021,” Donohoe says.
Secondly, in the spring of 2021, Donohoe says many companies decided to pursue sale transactions hoping to close them before year-end and avoid any potential 2022 tax increases. “But with that said, I do think the matching of good buyers and good equipment finance companies was pretty positive throughout that period,” Donohoe says.
Yield is king for buyers in today’s market. “We’ve been in a very low yield market, and even with the treasury moving up, it’s still a very low yield world relative to prior cycles,” Donohoe says. “When you’re out there looking for revenue growth, there aren’t many asset classes better than equipment finance to provide a strong yield but also very attractive on a risk-adjusted basis.”
Tastan says a growing list of potential investor types have become interested in entering the industry since the Great Recession, as the industry enjoys attractive yields with limited downside risk in a world that has been flooded with capital.
“There is strong interest in the industry among different potential investor types, including financial investors, asset managers, global financial institutions, strategics and other lenders, including BDCs and banks that are actively pursuing new avenues of growth and profitability to mitigate ongoing margin pressures in their core businesses,” Tastan says.
What Buyers Want
Donohoe says buyers look for three primary factors while selecting an acquisition target: management, business fit and growth. However, communication and adaptability are important as well.
“In many of these transactions, save perhaps a private equity transaction where the company is in many ways unchanged with just a different owner, if you’re talking about a transaction with a bank or even a credit manager where you’re fitting into their whole ecosystem, there’s a lot of communication needed,” Donohoe says. “We really encourage that communication to be upfront well before the transaction signing and certainly before the closing.”
Banks have a lot to offer, such as great cost of funds, an increased access to capital and higher lending limits, but Donohoe says they sometimes also may need to trim back the bottom end of an independent’s credit funnel. Because of this, adaptable management teams who are excellent communicators capable of understanding everyone’s perspective going into a transaction and post-acquisition are essential.
Business fit, which can take many dimensions, is the second element. Donohoe says geographic location, clientele and a focus on certain asset classes or ticket sizes are all very important. “People don’t buy companies just to buy them,” Donohoe says. “It’s really important for transactions to fit and work well for both parties.”
Growth is the third factor. “People aren’t buying equipment finance companies just because they have a portfolio that yields X%,” Donohoe says. “More than anything, current portfolio yield demonstrates that the company can produce more and bigger variations of that.”
According to Tastan, “The beauty of the industry is that it has no shortage of business models that excel at providing valuable funding solutions for its customers while also generating attractive returns over economic cycles at scale. Industry participants that delivered successful outcomes for their stakeholders have demonstrated their ability to institutionalize their businesses by attracting talent and funding and [by] continuously improving their business plans for future growth and profitability.”
How Deals Are Made
How does the sale process usually work?
“We don’t believe one size fits all,” Tastan says. “We try to be good listeners and work hard to provide customized solutions that enable our clients to achieve their objectives.”
Although the process can vary, Donohoe says, typically, an equipment finance company management team and owners start thinking about a potential sale transaction roughly six to 12 months before they plan to go to market. They will discuss the business, potential buyers, investors and a reasonable range of value to expect plus the desired timing, process and market conditions with firms like Piper Sandler.
Donohoe says this usually leads to either a formal process his firm would conduct for the independent or selective outreach to potentially interested counterparties to gauge the market, which could lead to a one-on-one negotiated transaction.
While this is the most typical path of these transactions, Donohoe says purchasers also look to meet potential acquisition targets and his firm will introduce those parties. While potential buyers should be transparent about their intentions, these meetings can often result in wins for both sides even if the deal isn’t consummated.
Outlook for 2022
After a banner year of deals, what’s in store for the year ahead? Both Donohoe and Tastan expect the equipment finance M&A market to remain strong in 2022.
“Although the recent M&A activity has significantly reduced the number of independents with scale, we expect the M&A activity for the remainder of 2022 to remain strong, as both the macro and the sector conditions are forecasted to remain healthy in the near term,” Tastan says.
“There are a lot of good equipment finance companies that have reached that proven business model, scaled nature,” Donohoe says. “So, I do think the level of activity will remain elevated this year and likely into next year.”
Donohoe doesn’t believe rising interest rates will impact the market, as equipment finance companies can generally manage that through their borrowers. Since their borrowers are generally growing small and mid-sized businesses, they need equipment. Many of them have been impacted by the supply chain issues that have caused a backlog of equipment that will need financing. Additionally, Donohoe says many independents will obtain funding via securitizations or loan sales, which are often immediately hedged, resulting in a moderate impact on existing portfolios.
On the buyer’s side, rising rates could be a potential benefit. “As rates rise, the banks actually become more profitable with stronger cash flows, and in many ways will make themselves a better acquirer,” Donohoe says. “So, we certainly don’t anticipate that a rise in rates, as long as it’s within the realm of what is currently expected, should have too much impact on the business.”
Tastan says, “Industry participants are anticipating another year of strong growth and profitability despite an anticipated increase in funding and credit cost. Additionally, we believe the industry participants’ attractiveness to potential investors, including banks and BDCs, remain intact considering the industry’s superior growth profile and strong risk-adjusted net interest margin.” •
Monitor recently caught up with Tom Slevin, founder and CEO, and Brian Dundon, SVP corporate development at First Financial Equipment Leasing ahead of their company’s acquisition of NorFund, an independent leasing company specializing in capital equipment, solar and alternative energy and vendor finance programs.