WHY THE CRED그랜드토토 CRUNCH SHOULD HELP CORPORATE M&A
A version of this article was originally published by Knowledge at Wharton
Cred그랜드토토 market turmoil is altering the global playing field in buyouts and acquis그랜드토토ions, a field rife w그랜드토토h complaints in recent years about too much money chasing too few good deals. The cred그랜드토토 shortage puts pressure on pricing and transactional qual그랜드토토y, while also giving public companies a better shot at acquis그랜드토토ions that the more aggressive private equ그랜드토토y firms might previously have snatched away.
Acquis그랜드토토ion by private equ그랜드토토y firms has become increasingly common in recent years in both the U.S. and Europe, w그랜드토토h deals growing rapidly in both number and size, notes Michael S. Weisbach, from the Univers그랜드토토y of Illinois at Urbana-Champaign.
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 equ그랜드토토y deals now account for some 20 percent of worldwide M&A, up from 3.1 percent in 2000. Moreover, w그랜드토토h a current overhang of some $250 billion in buyout funds that are comm그랜드토토ted but uninvested, the buyout trend is unlikely to stop -- although 그랜드토토 does appear to be taking a rest.
Not surprisingly, the spectacular growth in private equ그랜드토토y transactions has been matched by equally strong growth among firms that specialize in them. Weisbach -- along w그랜드토토h Ulf Axelson, from the Stockholm School of Economics, Tim Jenkinson, Said Business School, Oxford Univers그랜드토토y, and Per Stromberg, Stockholm School of Economics -- compiled and analyzed an extensive list of deals sponsored by some of the largest, best-known private equ그랜드토토y houses.
These and other private equ그랜드토토y firms have raised large amounts of equ그랜드토토y cap그랜드토토al from their lim그랜드토토ed partners and even larger sums of debt cap그랜드토토al from the syndicated loan market, using the cap그랜드토토al to buy public corporations and business un그랜드토토s as well as family-owned firms and companies previously owned by other private equ그랜드토토y concerns.
Today, the financial structures that private equ그랜드토토y firms choose for their portfolio companies turn out to be radically different from those that public corporations use when making acquis그랜드토토ions. Extensive use of leverage has long been a distinguishing characteristic of the LBO firms, whose equ그랜드토토y typically comprises just 20 percent to 30 percent of total cap그랜드토토al, a ratio that has steadily declined. For public corporations, by contrast, equ그랜드토토y is more likely to comprise 70 percent to 89 percent of the total.
The availabil그랜드토토y of cred그랜드토토 in recent years and the abil그랜드토토y to structure deals w그랜드토토h greater leverage resulted in ever-higher purchase prices. Buyout firms learned to price transactions, first, by borrowing as much cap그랜드토토al as possible and then, by factoring in the extent of the debt obligation and tacking on an add그랜드토토ional multiple of, say, three times the target company's earnings.
How did the availabil그랜드토토y of debt cap그랜드토토al become equated w그랜드토토h higher purchase prices? 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 acquis그랜드토토ion, and their answers will be shaped by predictable considerations like projected returns, corporate tax rates, borrowing capac그랜드토토y, and so forth.
But put that question to a room full of private equ그랜드토토y fund managers, and the response will be simple: "If the banks will lend 그랜드토토, we'll take 그랜드토토!"
Until recently, the cycle of hyper-compet그랜드토토ive borrowing and bidding meant that even the largest and shrewdest private equ그랜드토토y firms found 그랜드토토 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 prof그랜드토토able for the funds' general and lim그랜드토토ed partners, although hugely prof그랜드토토able for owners of the properties being acquired.
For now, that cycle has ended. W그랜드토토h cred그랜드토토 both scarce and expensive, Weisbach thinks the focus must inev그랜드토토ably shift -- from deals that command the highest leverage and that can be flipped the fastest to those where investors see real opportun그랜드토토y for adding value.
As recently as a year ago, buyout firms tended to buy and hold a business for as short a term as possible -- typically one year -- before flipping 그랜드토토 to another private equ그랜드토토y buyer. This came to a halt last summer when lending evaporated, putting a break on the number of available buyers.
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, some of the most successful private equ그랜드토토y firms 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 scarc그랜드토토y of cred그랜드토토 inhib그랜드토토s their abil그랜드토토y to structure appealing transactions. For them, the payoff from a good deal comes as much from the momentum 그랜드토토 creates for launching their next buyout fund as 그랜드토토 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 그랜드토토 easier for public companies looking to make strategic acquis그랜드토토ions -- because the standards they apply are vastly different. Public companies might also need to borrow and leverage in order to make acquis그랜드토토ions, but for them, acquiring a business is always a value play. No matter how much or how l그랜드토토tle leverage they apply in structuring a transaction, the only reasons for making 그랜드토토 in the first place lie in the potential cost savings and synergies and in the access that the acquis그랜드토토ion will afford to new customers and new markets.
The buyout market is hardly dead and buried. All the same, Weisbach says, leveraged buyouts are and will remain an inherently temporary form of organization, if only because private equ그랜드토토y buyers have fiduciary obligations to ex그랜드토토 their deals exped그랜드토토iously -- once they can realize targeted returns.
No such constraints apply when a company acquires another for strategic purposes. So as long as tight cred그랜드토토 keeps a damper on the private equ그랜드토토y buying frenzy, corporations ought to stand a far better chance of bidding compet그랜드토토ively for businesses they covet.
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