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How the strength of private equity is changing M&A for corporate buyers.
Kate O'Sullivan, CFO Magazine
July 1, 2006
Kurt Braun looks at 75 to 100 possible deals every year. As finance chief at ClearPoint Resources Inc. (formerly Mercer Staffing), a growing private company in the highly segmented professional-staffing business, he has helped develop a rigorous methodology for valuing a target company and determining its strategic fit with the business. Lately, Braun has walked away from deals when other bidders have driven the price too high for ClearPoint's taste. In a twist on convention, those bidders offering outsized multiples have been financial buyers.
How times have changed. "A few years ago, in an auction situation, the seller's investment bank would typically say, 'Here are the strategic buyers,' and almost as an afterthought, 'Here are the financial buyers — we'll never get the same price from them,'" says John LeClaire, chairman of the private-equity practice at Goodwin Procter LLP. Today, private-equity buyers are competing far more aggressively for acquisitions. They have headlined some of the biggest recent deals, including Albertson's, Hertz, Dunkin' Brands, SunGard Data Systems, and Neiman Marcus.
There are three reasons for the change. One, private-equity and hedge-fund acquirers are flush with cash, as money continues to pour in from return-starved investors. Two, debt continues to be cheap. Three, private-equity buyers are increasingly seeking the same cost savings and operational synergies that strategic buyers have always used to justify paying higher multiples. They approach companies with plans for operational improvements, and in some cases are seeking to build on the capabilities of existing portfolio companies.
Strategic buyers, meanwhile, have plenty of cash themselves. But no longer can they expect financial buyers to shy away from competing on price, with recent private-equity deal multiples reaching nearly 13 times EBITDA. As a result, some corporate acquirers are looking for nonfinancial ways to strengthen their bids. Others are teaming up with financial buyers on large deals, while a third group is seeking private-equity backers of their own.
More Than a Number
Although in an auction situation the prize will typically go to the highest bidder, some corporate buyers are looking beyond valuation to other elements of a deal. Nonfinancial aspects of an acquisition agreement such as ability to close, time to close, and lack of contingencies can also play a significant role in determining the winning bid for a company, says Tiff Armstrong, a partner at Harris Williams & Co., an M&A advisory firm.
Armstrong says corporate acquirers are thinking more carefully than they have in the past about how to get an edge in the bidding process. Corporate buyers are continuing to offer an aggressive purchase price, free of financing contingencies and with very competitive time frames, he says. "They are also factoring in what they think the financial buyer is going to be willing to pay, and determining where they want to be relative to the financial buyer."
Braun agrees that intangibles can play a role in determining who ultimately wins at auction. ClearPoint executives recently walked away from a target company after a hedge fund entered the bidding and offered what Braun thought was an unrealistic valuation. "I thought that maybe because they had so much cash, they weren't under the same pressure to earn returns as we would be," he says.
Later, ClearPoint received a call from the target after the deal fell apart. "We have a reputation in the market that we make deals happen, we can bring a deal to close," says Braun. ClearPoint eventually bought the company at a lower price than the financial buyer had offered.
Corporate acquirers may also find themselves partnering with financial sponsors on large deals in the days ahead. In one recent example, the pending buyout of Albertson's, corporate and financial buyers formed a consortium to bid for the grocer. Pharmacy chain CVS teamed up with supermarket operator Supervalu as well as an investment group led by hedge fund Cerberus Capital Management to submit the winning $17.4 billion bid, with each participant carving out a part of the business. "We approached this as an opportunity to buy only select assets. We were never interested in acquiring the entire entity," says Supervalu CFO Pamela Knous. The purchase, which proved too big and too messy for any one buyer when it fell apart last fall before reviving over the winter, was expected to close in June.
Gerald Adolph, a senior vice president at Booz Allen Hamilton, predicts that more consortia between financial and strategic buyers will form, noting that in the Albertson's case, the group bid enabled each buyer to keep only that part of the business that was core to its operations.
Such complicated consortia are deal-specific, however, and may be the exception rather than the rule. "Typically, the corporate buyer has very different objectives, time lines, and exit scenarios than a financial buyer," says Kurt Jaggers, managing director at private-equity firm TA Associates. "There may be some situations where it makes sense, but these are very complex transactions."
If You Can't Beat 'Em
Another approach to the increasing competition from financial buyers is to join them. Michael Provenzano, finance chief at Aspect Software, describes his company as "a strategic acquirer with the backing of a financial buyer." Two years ago, Aspect's management team completed a leveraged buyout of the company alongside private-equity firm Golden Gate Capital. Since then, Aspect has benefited from both the M&A knowledge and the deep pockets of those investors. "They've given us access to capital without the administrative hassle of having to make public-company filings to seek shareholder approval," says Provenzano. "We also have the flexibility to respond to M&A opportunities faster than we would if we had to consider how the market would react."
ClearPoint Resources, too, has financial assistance waiting in the wings; the company has a secured line of financing from a hedge fund to support its current acquisition-driven growth phase. "They work with us to conduct due diligence on the potential acquisition and allow us to structure the type of deal that best fits going forward," says Braun.
With M&A showing no signs of slowing, corporate and financial buyers will continue to see a lot of each other. Despite the increased competition, if they are willing to pay an aggressive multiple, strategic buyers may still have the upper hand. "In a truly strategic deal, the arithmetic should still favor strategic buyers because they have far more levers for creating synergies," says Adolph.
"There are certainly cases where if a strategic buyer really sees a strong strategic argument for buying a company, it may be able to clear the decks and bring a valuation that is going to be compelling," says Jaggers. To beat out financial buyers these days, they may need to do just that.
Kate O'Sullivan is staff writer at CFO.
|A Competitive Landscape
The number of announced deals in the first quarter of 2006 lagged 2005's quarterly average, but prices climbed.
|U.S. M&A||2005*||Q1 2006||% Change|
|Number of announced deals||2,724||2,422||-11%|
|Total deal value (in $ billion)||$257.3||$283.0||+10%|
|*Quarterly average for the year
Source: FactSet Mergerstat