Trouble In The American Middle-Market

U.S. middle-market companies are under siege by a confluence of factors, many of which have arisen as a result of the 2008-9 recession. The following factors are substantially undermining the economic health of the U.S., setting the stage for considerable economic distress in the near to mid-term. 

1. A Multi Speed World: Mohamed El-Erian at PIMCO has made much of the “multi speed world” we now live in, with emerging economies taking on the mantle of drivers of global economic growth while developed economies are seemingly consigned a much less vibrant, slow-growth mode.  This macro economic reality is a gut-punch to U.S. (and other developed countries) middle-market companies, as growth prospects in their home market slacken and the barriers to international growth opportunities threaten to shut them out of international expansion.

2. Commodities Prices: We are in the midst of a remarkable demand-driven commodity price shift which with threaten the gross margins of all companies lacking pricing power (hello middle-market).  Price trends have shifted radically in the past 10 years. Analysis of the IMF Primary Commodities Index since January 1992 starkly illustrates this trend.  By dividing the period of Jan 1992 – Dec 2010 into two equal periods of 114 months, we see that at the end of period 1 (Jan 1992 – Jul 2001) the index had increased 18.3%.  However, at the end of period 2 (Jul 2001 – Dec 2010), the index had increased 194.4%.  Not only are prices reaching new heights, but quarterly volatility in these prices is also remarkably high, presenting a purchasing manager’s nightmare (see Exhibit). 

IMF Commodities

3. The Lending Market: The recession of 2008-9 was extraordinarily harsh, and management teams that survived those harrowing days will not soon forget.  One of the lessons learned was a healthy respect for cash and an aversion to too much debt.  This is bad news for banks, which are seeing declining loan demand and a collapse in pricing in some segments of the market amid furious competition for what loan demand there is.  In addition to this many observers have noted the increasing bifurcation of the U.S. lending market, which is only being exacerbated by the pressures facing small banks.

4. PE Dry Powder: The pro-cyclical bias of the business press is such that there is always a new breathless article, post, etc about the massive overhang of committed capital that private equity firms must put to work.  Mega deals still appear to be out, which is heightening interest in middle-market transactions.  But we can’t all be winners, and some companies are going to find their niches invaded by PE portfolio companies acquired at aggressive valuations and under urgent orders to grow.

5. The Data Flood: We are living in an age of an awe-inspiring flood of data, but this flood is both a gift and a curse to middle-market companies.  Those companies that fail to seize the information newly available and convert raw data into actionable business intelligence will increasingly find themselves at a disadvantage to their more nimble, data-savvy competitors. 

The middle-market is an interesting place, especially now.  The five threats I identified above are ones that I believe will challenge all stakeholders in the middle-market in the coming years. Recent history teaches us that weakened but seemingly durable systems can collapse suddenly in the face of pressures that most consider manageable.  Change is coming to the middle-market, best to prepare.

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