Companies sitting on cash mountains or those with a proven track record in cash generation may want to start thinking about making a move in M&A while stock market valuations continue their downward drift. Bargains abound, particularly in manufacturing.
If you are looking to expand abroad, the scale of potential restructuring in Europe is enormous. Goldman Sachs recently conducted a survey of the 9,000 European corporates with sales of more than $250m a year. Of these, more than two-thirds fall into what are generally considered senior-creditor-friendly jurisdictions; that is the UK, Germany and France, where an acquirer is not likely to be mired down in restrictive legislation or have to confront militant unions.
However, the declining equity market works both ways. Companies can be acquired on the cheap, but it is becoming quite a trick for an acquirer to do a deal using its own shares. There is also the problem that, as one US banker points out, “this is a period of limbo, when what someone thinks his business is worth may still be seriously out of line with the market perception”. He thinks the economy will have to weaken further before the real bargains appear.
On the other hand, this may be a good time to strike because things have gone relatively quiet on the bank consolidation front and lenders are still happy to make their balance sheets available to corporate borrowers.
Bank mergers are a costly business for financial institutions because of the impact of goodwill, which hits regulatory capital when written off.
One of the reasons for the decline in M&A activity this year is the lack of a sense of urgency in the market. Worries about that vulnerable company being snapped up by a rival have all but evaporated. Certainly, the time lag between commencing and completing a merger is lengthening as companies take longer to make decisions.
But for those deals that are being done, cash is king, particularly in the US market where transactions done solely on cash are at their highest level for five years. In the first four months of this year, 30% of all US corporate mergers were executed on a cash-only basis. In the technology sector the figure rises to 45%, compared with 15% in the same period last year.
“Cash is a powerful consideration to put on the table,” says Byron Griffin, a director in corporate finance at Andersen. “Companies with large cash resources have a powerful advantage in the M&A market. The downside could be for the target company. If it is a listed company it may have lost a significant portion of its value and hence find itself susceptible to a cash offer on the cheap. Shareholders might prefer to wait for a market rebound rather than accept an offer which they believe undervalues the company.”
The good news is that if you are thinking of turning predator there is an abundant source of cash available in the market to finance your M&A ambitions, except perhaps in high-tech industries. “There is no shortage of short- to long-term bank debt as well as more expensive mezzanine finance,” says Lionel Young, head of transactions services in Deloitte & Touche’s Corporate Finance Division. “We estimate that the UK private equity market has more than $20bn split amongst five institutions, so there is a huge pool of funds available.”
Nevertheless, most listed companies would be more likely to turn to bank debt, which can be raised at about 150bp over base rates, instead of costlier private equity funding. Young points out that the real credit key is the status of the company that’s going into the M&A market and its cash generation capacity to pay for the assets being acquired. “The pros of cash are that it remains a fixed amount in value, unlike volatile shares; also on the plus side is the fact that there is tax deductibility for interest; and it is relatively cheap and can be refinanced with equity once the market comes back. On the negative side, if the target company is small, the takeover provides an exit for the sellers, who might be important for developing the target business.”
Cash has also become prevalent in deals involving listed company subsidiaries and private companies, which tend to rely on cash instead of shares as they don’t benefit from merger accounting. These transactions have risen substantially over the past few months compared with deals between public companies.
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