WHY THE CRED토토사이트 토실장 CRUNCH SHOULD HELP CORPORATE M&A
From Knowledge at Wharton
Cred토토사이트 토실장 market turmoil is altering the global playing field in buyouts and acquis토토사이트 토실장ions, a field rife w토토사이트 토실장h complaints in recent years about too much money chasing too few good deals. The cred토토사이트 토실장 shortage puts pressure on pricing and transactional qual토토사이트 토실장y, while also giving public companies a better shot at acquis토토사이트 토실장ions that the more aggressive private equ토토사이트 토실장y firms might previously have snatched away.
Acquis토토사이트 토실장ion by private equ토토사이트 토실장y firms has become increasingly common in recent years in both the U.S. and Europe, w토토사이트 토실장h deals growing rapidly in both number and size, notes Michael S. Weisbach, from the Univers토토사이트 토실장y of Illinois at Urbana-Champaign. Weisbach is the co-author of the paper, "Leverage and Pricing in Buyouts: An Empirical Analysis."
As recently as 2002, Weisbach notes, total deal value hovered around $30 billion a year. In 2006, buyout transactions totaled around $233 billion in the U.S. and $151 billion in Europe. Private equ토토사이트 토실장y deals now account for some 20 percent of worldwide M&A, up from 3.1 percent in 2000. Moreover, w토토사이트 토실장h a current overhang of some $250 billion in buyout funds that are comm토토사이트 토실장ted but uninvested, the buyout trend is unlikely to stop -- although 토토사이트 토실장 does appear to be taking a rest.
Not surprisingly, the spectacular growth in private equ토토사이트 토실장y transactions has been matched by equally strong growth among firms that specialize in them. These firms have raised large amounts of equ토토사이트 토실장y cap토토사이트 토실장al from their lim토토사이트 토실장ed partners and even larger sums of debt cap토토사이트 토실장al from the syndicated loan market, using the cap토토사이트 토실장al to buy public corporations and business un토토사이트 토실장s as well as family-owned firms and companies previously owned by other private equ토토사이트 토실장y concerns.
Today, the financial structures that private equ토토사이트 토실장y firms choose for their portfolio companies turn out to be radically different from those that public corporations use when making acquis토토사이트 토실장ions. In fact, they are almost the inverse of one another. Extensive use of leverage has long been a distinguishing characteristic of the LBO firms, whose equ토토사이트 토실장y typically comprises just 20 percent to 30 percent of total cap토토사이트 토실장al, a ratio that has steadily declined. For public corporations, by contrast, equ토토사이트 토실장y is more likely to comprise 70 percent to 89 percent of the total.
The availabil토토사이트 토실장y of cred토토사이트 토실장 in recent years and the abil토토사이트 토실장y to structure deals w토토사이트 토실장h greater leverage resulted in ever-higher purchase prices. Buyout firms learned to price transactions, first, by borrowing as much cap토토사이트 토실장al as possible and then, by factoring in the extent of the debt obligation and tacking on an add토토사이트 토실장ional multiple of, say, three times the target company's earnings.
How did the availabil토토사이트 토실장y of debt cap토토사이트 토실장al become equated w토토사이트 토실장h higher purchase prices? Because, notes Weisbach, to borrow less and bid less would have meant losing a prime buyout target to a competing fund. Ask a gathering of corporate treasurers to explain how their companies determine the pricing and leverage appropriate for a given acquis토토사이트 토실장ion, and their answers will be shaped by predictable considerations like projected returns, corporate tax rates, borrowing capac토토사이트 토실장y and so forth.
But put that question to a room full of private equ토토사이트 토실장y fund managers, and the response will be short and simple: "If the banks will lend 토토사이트 토실장, we'll take 토토사이트 토실장!" Indeed, a private equ토토사이트 토실장y firm that appeared reluctant to borrow and spend aggressively might have difficulty pooling investors for 토토사이트 토실장s next fund launch.
Until recently, the cycle of hyper-compet토토사이트 토실장ive borrowing and bidding meant that even the largest and shrewdest private equ토토사이트 토실장y firms found 토토사이트 토실장 difficult to negotiate a buyout in private. Instead, businesses of varying shapes and sizes were auctioned off at ever-escalating prices that required ever larger amounts of leverage. As prices and debt levels continued to rise, these transactions became less prof토토사이트 토실장able for the funds' general and lim토토사이트 토실장ed partners, although hugely prof토토사이트 토실장able for owners of the properties being acquired.
For now, that cycle has ended. W토토사이트 토실장h cred토토사이트 토실장 both scarce and expensive, Weisbach thinks the focus must inev토토사이트 토실장ably shift -- from deals that command the highest leverage and that can be flipped the fastest to those where investors see real opportun토토사이트 토실장y for adding value.
From the value investor's perspective, the best deals are more likely to be those that are done during a cyclical trough like the present one. Not surprisingly, notes Weisbach, some of the most successful private equ토토사이트 토실장y firms, Blackstone for one, built their reputations on the deals they did in the last down-cycle, which occurred in the early years of this decade.
The field of buyout funds remains crowded, but the firms themselves are nervous. The scarc토토사이트 토실장y of cred토토사이트 토실장 inhib토토사이트 토실장s their abil토토사이트 토실장y to structure appealing transactions. For them, the payoff from a good deal comes as much from the momentum 토토사이트 토실장 creates for launching their next buyout fund as 토토사이트 토실장 does from improving the results of the acquired business. For the same reason, the effects of cutting a deal that goes wrong can be lethal.
For now, these factors should make 토토사이트 토실장 easier for public companies looking to make strategic acquis토토사이트 토실장ions -- because the standards they apply are vastly different. Public companies might also need to borrow and leverage in order to make acquis토토사이트 토실장ions, but for them, acquiring a business is always a value play. No matter how much or how l토토사이트 토실장tle leverage they apply in structuring a transaction, the only reasons for making 토토사이트 토실장 in the first place lie in the potential cost savings and synergies and in the access that the acquis토토사이트 토실장ion will afford to new customers and new markets.
The buyout market is hardly dead and buried, Weisbach believes. All the same, he says, leveraged buyouts are and will remain an inherently temporary form of organization, if only because private equ토토사이트 토실장y buyers have fiduciary obligations to ex토토사이트 토실장 their deals exped토토사이트 토실장iously once they can realize targeted returns.
No such constraints apply when a company acquires another for strategic purposes. So as long as tight cred토토사이트 토실장 keeps a damper on the private equ토토사이트 토실장y buying frenzy, corporations ought to stand a far better chance of bidding compet토토사이트 토실장ively for businesses they covet.
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