To look ahead at M&A prospects for 2008, it makes sense
to examine what transpired in 2007. There were several factors last year, and
not just the subprime fiasco, that set the stage for what should be a very
interesting 2008. Among those were the continued rise of the strategic buyer
and the bullish activity around digital company bolt-ons. All of these factors
are informing the year ahead, which many observers remain cautiously optimistic
about, and expect it to be highlighted by a continued high-level interest in
digital properties and an expected move by strategic buyers to fill the gap
left by market-stressed financial players. Overall, however, the action will be
on the middle-market deals until the credit markets settle down.

A Tale of Contrasts

A look back to early 2007 reveals a market in the midst of a
feeding frenzy. The year 2006 had closed out at historic levels not seen since
2000 and in their 2007 M&A Report, DeSilva + Phillips said, “The outlook
for M&A in 2007 is as good as we’ve ever seen. All the pieces are in place:
Availability of funds, favorable interest rates, eager buyers without the time
to build rather than buy, brands that need new delivery platforms.”

Now, however, the tone is noticeably subdued. In this year’s
M&A Report, DeSilva + Phillips said this: “A year ago, we predicted a deal
market as good as we’ve ever seen, basing it on five factors… In essence,
four of the five factors are still at work. M&A transactions will continue,
but because of the increased friction from debt markets, at a slower pace than
in the past two years. The deal market may not be bigger than it was in 2007,
but it will be more complex, and ever more fascinating.”

Indeed, the subprime mess put the breaks on deals in the
fourth quarter of 2007—“Had the deal tempo stayed on the pre-September beat,
there would have been twice [as many] deals completed in the last four months
of 2007,” says the DeSilva & Phillips report.

But mid-market and smaller deals still got done, and this is
where observers are saying the action for 2008 will be—for both strategics and
private equity, which may be feeling the pressure to put its capital to work
sooner rather than later. “In the middle market, private equity will support
any deal at 5-times EBITDA, fewer deals at 6-times, ad no deals at 7-times,”
says Michael Alcamo, president of M.C. Alcamo & Co. “There is a very
substantial amount of capital that was raised in 2002 and 2003, meaning that it
has to be put to work before the end of 2008 or 2009. There will be strong
motivations to ‘get the capital out of the door.’”

“We think the middle market will remain active and will be
driven by interactive and marketing services sectors as the Internet continues
to transform traditional media sectors,” says Scott Peters, managing director
at the Jordan Edmiston Group. “Assets that are market leaders with strong
fundamentals will continue to trade for premium multiples. High-growth
companies will also be in high demand. Deals that rely on heavy leverage will
be a challenge given the state of the debt market. That being said, the middle
market will remain active and reasonable debt facilities are still achievable.”

With the combination of tougher credit facilities and a grim
economic forecast this year—the Feds chopped the short-term interest rates by
.75 percent at presstime, the largest cut in almost 20 years, more even than
the cut after the 9/11 attacks—the focus for buyers may be on properties that
are performing at a high level, as Peters notes. Buyer patience for
underperforming assets with growth potential may be cut short by the economic
outlook. “High-quality assets that are reasonably priced will continue to
trade,” says Thomas Kemp, managing director at Veronis Suhler Stevenson. At
least one executive, for the very same economic reasons, agrees. “It will be
more difficult to sell magazines that are not a leader in their field or that
are unprofitable,” says Effrem Zimbalist, chairman and CEO of enthusiast
publisher Active Interest Media. “A turnaround is much more difficult in a
declining economy, and advertisers tend to reduce commitments first to the
laggards in the field.”

A Strategic Comeback?

With the tight credit market, strategics are smelling
opportunity, and are likely to step up last year’s already gap-tightening
performance against fi nancial buyers. In its annual survey of 1,600 media
execs, AdMedia Partners found that 71 percent of respondents believe the
economy will be weaker thanks to the housing slowdown, subprime lending fallout
and a weakening dollar. In what the report calls a “dramatic shift,” 68 percent
of respondents indicate that acquisitions by fi nancial buyers will be down in
2008—an about face from the 72 percent who predicted the opposite for 2007.
This, conclude the respondents, opens the door for strategic buyers. Mark
Edmiston, a partner at AdMedia Partners, agrees: “Activity, generally, will
remain at 2007 levels, but with a shift from mostly private equity to more
strategic deals. Strategics will be more active because they will not be
outpriced by private equity and they need to acquire to grow.”

An area that strategics may be particularly interested in
this year is digital—especially if they’re buying for growth. The DeSilva +
Phillips M&A report went so far as to label 2007 “the year of the digital
niche acquisition,” and it’s likely the momentum in that market will continue
into 2008.

“The year 2007 was the biggest year by far for watching
traditional media using the acquisition tool to acquire digital properties,”
says the report. Indeed, Penthouse’s $500 million acquisition of Various Inc.
made the firm’s Top 15 deals list. The report also notes that Meredith, Hearst,
Hachette, Time Inc., National Geographic Ventures, Wicks Business, Forbes Media, PennWell, MediMedia, WoltersKluwer,
IDG and Ziff Davis Enterprises all made digital deals last year.

DeSilva + Phillips characterized most of the deals as adding
a niche focus to a big company, not a complete platform rollout. This means
that companies are largely interested in improving and building on something
they already have, whether features, technology, or talent, for example. It’s a
significant shift from the giant, transformational acquisitions traditional
publishers were making in the early part of the decade.

Overall, whether mid-market deals continue at a brisk pace
or not, buyers will be approaching deals on a more conservative basis, from
pricing to due diligence. “It will be much more difficult to complete
transactions in 2008 in light of declining economic conditions and tightening
credit markets,” says Kemp. “Due diligence will take longer than ever.”

And overpriced deals will also go away, says Zimbalist,
noting that overly generous offers will be reigned in. “It goes without saying
that the operating environment will be much more difficult in 2008, and one
needs to be conservative in modeling growth and cashflow of the target. This is
not the year to bid whatever it takes to win the auction and then figure out
how to make it work afterward.”

And the Race Is On

In 2008 the perennial struggle between strategic and
financial buyers will escalate in the middle-market.

The so-called strategic buyers—publishers with no private
equity backing—are predicted to be much more active in 2008 than recent years
when private equity buyers stormed the market with war chests stuffed with
capital. A tight debt market and a strategic change that favors acquisitive growth
over organic growth has non-financial buyers excited to buy again. Yet while
the big, $1 billion-plus deals may slow to a crawl, the middle market is still
expected to remain hot, and with multiples settling a bit, a more pragmatic
buying climate, and funds still fl ush with cash, private equity is hardly out
of the race.

“Lower and middle-market PE activity will continue to be
active in 2008 for the simple reason that PE fi rms need to put the commitments
in their funds to work,” says Veronis Suhler Stevenson’s Tom Kemp. “Also, the
pricing will likely be more reasonable, although credit terms will be tougher.
Don’t look for the large transactions of the recent past such as Advanstar,
Penton, Primedia Enthusiast, and ALM that took advantage of favorable credit
markets.”

And while private equity may be feeling pressure to act,
strategics are once again seeing the value in growth through acquisition. “We
see strategics picking up the pace of M&A as they have been building their
war chests over the last few years and will be less likely to be outbid by PE
funds,” says the Jordan Edmiston Group’s Scott Peters. “The continued shift
from traditional to interactive media will also drive strategic M&A as
companies look to acquire new capabilities and human capital to help transform
their businesses.”