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Q4 2015 Review

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Dear Colleagues,
I hope you enjoy our updated newsletter format, designed for better viewing from your phone or device.  We believe 2016 will be an extremely interesting and volatile year.  Some thoughts: 
  • Potential sellers will finally come to market in 2016, many will find they should have sold in 2015 as “supply” increases will start to meet the “demand.” Multiples will drop somewhat.
  • There will be scrambling for yield and pockets of illiquidity. See Robin Engleson’s article below re the debt markets.
  • There will be huge surprises in private tech company valuations. A few winners and many pratfalls.
  • China will continue to disappoint the markets, but we believe that corrective actions are starting to take place. No “China based Crash.”
  • Political discourse will be even less civil than it has been in 2015. There will be more street riots in US cities.
  • Healthcare innovations will expand and be exciting, as we try to figure out how to pay for it all.
  • Consumer spending will drive first half GDP growth, but limited corporate growth will be a drag on GDP. Corporate M&A will be strong as CEOs seek growth and use the cash on their balance sheets to make strategic acquisitions. Tax inversions will continue.
  • The Supreme Court will put a hold on some of the regulatory excesses (see Maegan’s article) and uphold “separation of power,” a rebuke to the Obama presidency. Particularly important will be the first “Obamanet” smack down.  This will occur in early 2016. See WSJ 12/28/15 “The Obamanet Overreach.” 
  • Oil Prices will firm up, maybe to low 40’s. Oil and Gas M&A and Restructurings will be a very hot business for FRG/IMAP (a special newsletter will follow in January on this subject.)
  • “Clicks” vs Bricks: The battle will continue and result in more retail bankruptcies.
  • Colleges and universities will be forced to cut back on bloated administrations and over stuffed tenured professors.  Signs of distress will grow – Colleges may be forced to merge. See factoids in Maegan’s article herein.
  • Micro Cap Companies are stuck in an illiquid market. Many will be acquired.

What is the Prognosis for the Debt Markets in 2016?

Robin Engelson
Aggressive lending practices continued to drive overheated M&A valuations in 2015. Despite regulator’s efforts, 2015 leverage and purchase price multiples exceeded pre-prior crisis levels while debt service coverage ratios fell to historical lows. Regulated lenders not only found ways around published lending guidance, but they loosened credit terms in ways not previously experienced, raising even more concern about what the next default cycle might look like. In addition, the unregulated shadow banking world exploded, taking up all of the “taboo” practices and more. It’s possible that we will see more of the same in 2016, but there are several warning signs that trends could change.

What will be the trigger point that will bring more normalized leverage (4x average historically) vs. the nearly 6x that even the middle market saw in 2015? I will posit the potential trifecta: more regulation, higher interest rates and liquidity issues. It was, after all, liquidity that brought the last aggressive lending cycle to a sharp halt. The argument about what caused it will likely continue for decades.
For those that thought it was a lack of regulation, unfortunately efforts to curb aggressive lending practices by publishing leveraged lending guidance and then classifying most loans that didn’t comply has simply resulted in the banks syndicating nearly all of the classified and non-compliant exposure to the shadow banks. But while the regulators are mulling how/if they can find a way to get the Business Development Corporations (BDCs) under their purview, the public market has actually done that efficiency thing and hammered BDC stocks this year; several BDCs have become the targets of activist shareholders. Those that could, have made sure to tap private as well as public sources of funds to diversify [aka preserve liquidity] to bolster their continued lending activity. But it is pressure from the free market, not regulation that appears to be curbing activity. In fact, liquidity concerns in the shadow bank market resulted in many deals pricing up as much as 100-200 basis points to meet year-end closings as appetite waned while lenders preserved capital. 
The final hammer the Feds have which will impact all parties, however, is interest rates.  While the economy and free market may cause more rational behavior without that intervention, even the small, long-awaited, 25 basis point rate increase caused the junk bond market to tumble as investors fled and one distressed debt fund had to put up its gates to protect remaining investors from fire sale liquidation prices. If the economy is weak, credit will suffer without intervention.  If the economy is strong, we will see more rate increases.  We are still 3% below average normal historical rates. In the leveraged lending world a 2-3% increase in interest rates even in a good economy, which most of today’s book was underwritten during, would trigger a lot of covenant violations. For those that sold or recapped in 2015, it’s not too late to do some interest rate hedging. While there may be a short-term cost, it could be clairvoyantly prudent insurance.

Ms. Engelson facilitates debt and raises capital for M&A transactions, recaps and growth financings.  She can be reached at or 612-808-5760.

14 Mistakes Made by Sellers in Mergers & Acquisitions

Word Cloud with Merger   Acquisitions related tags
Selling a company is often difficult and time consuming.  The M&A process requires careful planning, competent professionals assisting the target company, and an understanding of the deal dynamics involved in the negotiations. CEOs and companies that have not been engaged in many M&A transactions frequently make mistakes that can result in a less favorable price or terms that would have been otherwise obtainable, or may even kill the deal altogether.
1) Not being prepared for the extensive effort and time the deal will take.
2) Failing to create a competitive sales process.
3) Not having a complete online data room.
4) Not hiring a great financial advisor or investment banker.
5) Having an inadequate understanding of competitors and market comparables.
6) Not appreciating that time is the enemy of all deals.
7) Not having an experienced M&A negotiator lead the negotiations.
8) Neglecting the day-to-day operation of the business during the M&A process.
9) Failing to communicate the vision and strategic fit.
10) Absence of credible financial projections.
11) Not considering change of control provisions in key contracts.
12) Not adequately taking into account employee-related issues.
13) Not understanding the negotiation dynamics.
14) Not carefully negotiating earn-out provisions.
This is an excerpt from a recent article by Richard Harroch of VantagePoint Capital.

Note: Falls River Group believes that the biggest mistake is the Buyer not having an Integration Plan.

European Data Shows Link Between
Minimum Wages and Unemployment by Dan Mitchell

Is anyone shocked to learn that countries with minimum wage mandates have higher unemployment levels, particularly for young people, as seen in this chart? I have two big observations and two minor comments in response to this data:

Table prepared by Mark Perry, American Enterprise Institute

The first big observation is the caveat that minimum wage mandates are just one piece of the economic puzzle. The numbers in Greece, for instance, are miserable for many reasons. The minimum wage mandate is just another straw on the camel’s back. Moreover, it’s possible for a nation to have a decent-performing economy with a minimum wage (see Luxembourg) and a decrepit economy without one (see Italy). It’s the overall burden of government that matters, which is why the rankings from Economic Freedom of the World are the first place to look when determining if a nation is market-oriented or statist.
That being said, Mark Perry’s table (on right) certainly shows a correlation between joblessness and minimum wage mandates. Part of the reason for this link is that higher minimum wages are bad for employment, and part of the reason for the correlation is that governments foolish enough to impose minimum wages are probably foolish enough to impose other bad policies as well.
The second big observation is that I periodically encounter leftists who say a minimum wage is needed because employers have all the leverage and would pay workers starvation wages in the absence of a mandate. To which I always respond by asking them, “Then why don’t employers use that leverage to reduce the wages of the 98 percent of workers who make more than the minimum wage?” That shuts down the conversation very quickly.
But now I’ll also ask these folks, “And why aren’t workers in Austria and Sweden paid starvation wages?” Their responses will be amusing.
For my minor comments, I’ll start by noting that Switzerland is a uniquely sensible nation. Voters recently rejected a minimum wage mandate by an overwhelming 3-1 margin. I fear American voters would not be nearly as sensible if we had a national referendum.

Dan Mitchell is a Senior Fellow at the Cato Institute in Washington, D.C.

Is Trump Right about America?

Dr. Maegan Evans
Have we slipped into second or third place, or worse in world standings? Has America lost her greatness? Lets explore some of the looming issues we face as a country in 2016 and beyond.

Unchecked spending and mountains of new federal regulations are a large part of the problem. According to the General Accounting Office (the department that monitors and audits government spending) “massive federal deficits and debt as entitlement spending and debt service will burn through 100% of tax receipts by 2030”. 

US Residents have more debt. As of June 30, 2015 the amount of debt held by the public was approximately $13 trillion or 74% of the average GDP over the last 12 months. This includes credit cards ($712 billion); auto loans ($1.21 trillion); student loans ($1.2 trillion) and mortgages (over $10 trillion). Debt has grown because the cost of living has outpaced income growth over the past 12 years. The average US household owes more than $129,000 of debt and pays close to $7,000 annually in interest. This is unsustainable when interest rates continue to rise.

The US has the most complicated tax system in the world requiring more CPAs and tax preparers than any other country. As of 2013, it takes 73,954 sheets of paper to explain the complexity of the US Federal tax code. Over 1.2 million people (CPA’s, lawyers and consultants) help prepare tax returns annually. The United States is one of two countries in the world that taxes its nonresident citizens on worldwide income, in the same manner and rates as residents; the only other country is Eritrea. The US also has the highest corporate tax rates in the world.

The US has the most laws of any country with more being passed annually at a much higher rate. No one knows exactly how many laws there are since they’ve been accumulating for over 200 years. For example, there were over 40,000 new laws passed in 2011 including local, state and federal.

The US spends more on the military than any other country. This averages 20-25% of the entire federal budget. Every hour US taxpayers are paying $8.3 million for debt of the total cost of wars since 2001. (Afghanistan 2001-2014: Iraq War 2003-2011; Afghanistan War 2015-present and the international campaign against ISIL (2014-present.) The USA outspends China, Russia, UK, France, Japan India, Saudi Arabia and Germany combined on defense. However, China actually has more troops than other countries (known as the Chinese Liberation Army.)

The US spends more on healthcare as a percentage of GDP. Obamacare alone will add $1.8 trillion to the national debt by 2024. According to the World Health Organization (WHO), the United States spent more on health care per capita ($8,608), and more on health care as percentage of its GDP (17.2%), than any other country on earth. Rising healthcare costs, the aging population and uncertainties about the efficacy of Obamacare will add significantly to the fiscal woes of our country.

The US has the largest national debt and trade deficit. As of June 4, 2015, total U.S. debt stood at $18.830 trillion. Washington spent nearly $3.5 trillion in 2014 while collecting approximately $3 trillion in revenues, resulting in a deficit of slightly less than half a trillion. In other words, 14 cents of every dollar that Washington spent in 2014 was borrowed. Over the past 20 years, federal spending grew 63 percent faster than inflation.

Total federal revenues in fiscal year 2015 are expected to be increased to $3.18 trillion. These revenues come from three major sources and it won’t be enough:
  • Income taxes paid by individuals: $1.48 trillion, or 47% of all tax revenues.
  • Payroll taxes paid jointly by workers and employers: $1.07 trillion, 34% of all tax revenues.
  • Corporate income taxes paid by businesses: $341.7 billion, or 11% of all tax revenues.
The federal government’s 2015 budget deficit will fall slightly this year to $468 billion which is the highest in the world. By 2025, the Congressional Budget Office projects a $1.1 trillion annual deficit or 4% of GDP unless Washington takes steps to reduce deficit spending.

The US has more regulations than any other country in the world. Over the past decade, the federal government has issued over 40,000 new final rules (regulations).The burden of regulatory compliance cost to American citizens and businesses is approaching $2 trillion dollars annually (U.S. Chamber of Commerce).

According to the Census Bureau, there were 105,862,000 full-time year-round workers in the United States — including 16,685,000 full-time government workers in 2011. These full-time workers are outnumbered by the 109,631,000 whom the Census Bureau says are currently receiving government benefits.

The United States spends more than other developed nations on its students’ education each year, with parents and private foundations picking up more of the costs than other developed countries. Despite the spending, U.S. students still trail their rivals on international tests. The total cost per student of public education in 1970 was $57,602. It is close to $175,000 today.

The US ranks 12th in the Index of Economic Freedom trailing far behind the top three: Hong Kong, Singapore and New Zealand.  Economic Freedom indicators include: rule of law, limited government intervention in the private sector, regulatory efficiency and open markets (Heritage Foundation and the Wall Street Journal.)  Clearly the USA is not the freest country in the world when it comes to generating wealth, personal freedom and avoiding the heavy hand of Uncle Sam.

So what still sets America apart as the greatest nation on earth given these dismal statistics and forecasts? We are still very much a country of visionaries, entrepreneurs and risk takers. We just need to have the freedom to explore the possibilities and not continue to be buried in a bureaucratic and regulatory grave yard. Is Trump right about the US? You decide.

Maegan Evans is a Managing Director at Falls River Group.  
Northern Trust’s Five Year Outlook

Falls River Group has a number of close relationships with financial advisors nationwide and we like to feature those throughout the year. 

Special thanks to our friend, Linda C. Flewelling, Senior Vice President and Managing Director of Northern Trust in Naples, who is responsible for leading the Wealth Advisory team for West Florida.
Linda is a Chartered Financial Analyst, Certified Investment Management Analyst, Certified Private Wealth Advisor and Certified Trust and Financial Advisor. Northern Trust is a leading provider of wealth management, asset servicing, asset management and banking to corporations, institutions, affluent families and individuals. As of September 2015, Northern Trust had assets under custody of $6 trillion and assets under management of $877 billion. In addition to offices in 19 states and the District of Columbia, Northern Trust has 20 international locations.
We have attached a link below to Northern Trust’s Five Year Outlook if you would like to learn more about their views:
In closing, I believe that citizens are tired of Washington / Federal overreach.  Nothing the federal government runs works very well (VA, IRS, Obamacare, TSA, etc.) Argentina is coming to grips with its totally inaccurate government statistics, the US needs to do so too. 

We look forward to serving you in 2016.


Kerry Dustin,

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