Opportunities in the Current Environment
Even amid adverse conditions hanging overhead, there is still a faint pulse to the M&A deal market.
Despite recent glimmers and rumblings of economic recovery, the M&A deal market continues to languish. The softness of M&A activity has been compounded by rationalized market fears, "analysis paralysis," increasingly restrictive lending terms and covenants, and a continued gap between buyer's and seller's valuation expectations for a business. If they can, sellers are being advised to hold out until the economy, and the value of their business, rebounds. Conversely, buyers are exercising patience, waiting for the effects of the current economic downturn to reduce seller's expectations, while keeping in mind that if they wait too long, the value of the seller's business may no longer be worth acquiring as a going concern.
Even with these adverse conditions hanging overhead, there is still a faint pulse to the M&A deal market. Earn-outs, seller financing, mezzanine financing and staged investments are some of the tools that can help buyers and sellers bridge funding gaps and valuation expectations.
While there are many people dawdling on the M&A deal sidelines waiting for the market to turn, those with experience in previous down cycles know that a down market is the most opportune time to acquire a business and a time when buyers can restructure and recapitalize businesses for better long term returns. Currently, the turnaround specialists are scouring the market for "special projects" and good deals on distressed companies, assets and debt. Strategic buyers are still consummating deals for critical add-ons that complement and generate revenue for their existing businesses. Additionally, proactive private equity firms and other financial buyers are staging some of their investments, working with mezzanine lenders to bridge the current funding gap, and considering smaller minority positions in good companies that need capital, but incorporating covenants to assert more control over the target if performance doesn't meet expectations.
Over the next 18 months there should be ample opportunities for buyers to acquire businesses or their assets that would not otherwise survive until the economy rebounds. In 2008, there were 43,546 corporate bankruptcies, an increase of 54% over the previous year and the highest level in a decade. A recent American Bankruptcy Institute poll found nearly two-thirds of respondents anticipated bankruptcy filings increasing by 35% or more in 2009.
In addition to the more traditional ways of structuring a deal, buyers have plenty of tools at their disposal to acquire good but struggling businesses or their strategic assets in a down market.
Prepackaged bankruptcies, for instance, are one tool. For a buyer seeking to acquire a business as a going concern, it may want to consider striking a deal with the distressed business to facilitate a prepackaged bankruptcy under Chapter 11 of the Bankruptcy Code. In a prepackaged bankruptcy, the major stakeholders (lenders, trade creditors, bondholders, landowners, et al.) seek to reach agreement before a bankruptcy filing on the most important issues in the case, including DIP financing, lien priority and the extent to which trade and other debt will be discounted or renegotiated. Prepackaged bankruptcies tend to work well where there are a limited number of secured creditors.
The primary advantage of a prepackaged bankruptcy is the substantial savings in time, money and business interruption compared to an ordinary Chapter 11 bankruptcy. While "standard" Chapter 11 cases are rarely confirmed in less than a year (and most take two to three years to be completed), a prepackaged bankruptcy generally takes less than six months to be confirmed. Prepackaged bankruptcies reduce the risk of a significant decline in a company's value because they expedite the operation of the company as a reorganized entity.
Section 363 asset sales are another opportunity acquirers are looking at. For buyers who do not wish to or cannot afford to acquire a company as a going concern, they may instead acquire certain strategic assets of a debtor in possession (i.e., land, plant, equipment, technology or intellectual property) through a Section 363 sale under the Bankruptcy Code. Section 363 sales are usually very quick, with sales often taking only 45 to 90 days to complete. The sale does not require the approval of creditors, but is subject to an auction, which raises the possibility of better and higher outside bids.