Holding Back InThe M&ARace? Strategic buyers rack up the deals but do nothing to push the M&A envelope

Deal numbers don’t support the nagging suspicion I have that corporate M&A chieftains are holding back on making deal commitments. They’re not on the sidelines by any means – completing about 75% of all transactions – but it feels as if they could be doing even more. Despite doing the lion’s share of deals, strategic buyers seem skittish about pursuing some of the more innovative and market-transforming transactions, and content with targeting “safe” tuck-ins. Many of the biggest mergers and acquisitions completed in recent months have been done by private equity and buyout firms. Financial buyers have moved up in deal sizes and prices. Historically, private equity deals had largely flown under the M&A radar because of their smallish size, but now PE firms are completing bigger transactions, which are attracting more press coverage. That could give the impression that strategics are reining in their deal activity, but my hunch stems from something deeper than news headlines. Experts I spoke with agree with my gut feeling in varying degrees, but the overall consensus is that strategic buyers are indeed a bit slow-footed in pursuing certain types of transactions. Dealmakers and advisers acknowledge that corporate buyers face definite disadvantages in this M&A environment but assert that there are ways for strategics to better compete against financial buyers. “Our strategic clients are doing more deals than they’ve ever done before and are planning more deals. They’re ramping up their internal corporate development departments, improving their ability to find deals and integrate companies, but they’re not deal machines as much as the PE firms are right now,” says Ravi Chanmugam, a New York-based Partner in Accenture’s Strategy/M&A Group. Helped by their bulging coffers for doing deals, cheap debt, and increasing ability to gain cost savings and synergies from their deals, financial buyers have been leading the M&A pack in terms of willingness to pay higher multiples for targets, deal-structure innovation, and new-market penetration. The need to make investments has taken financial buyers into new fields. They furiously seek opportunities for investing their money, spurred by the principle of “use it or lose it.” The strategics playing in the market are stressing caution over boldness – thoroughly scrutinizing targets and not making the kinds of aggressively priced bets that were common in the frenzy M&A years of the late 1990s. Russell Iorio, Vice President of M&A at diversified manufacturer Leggett & Platt, which remains an active buyer, notes, “The deck is stacked against us a bit right now, and I also think there’s aversion to doing market-transforming deals because of high-profile deal blow-ups, the Hewlett-Packard spying scandal, the stock-options backdating scandal, etc.,” he says. Management teams are reluctant to pull the trigger on big deals, he adds, because they don’t want to have to deal with possible fallout. “A PE firm doesn’t want to deal with a blow-up, but it’s most likely not going to make the front page of The Wall Street Journal. Media coverage has fueled some risk aversion, in my opinion.” CFO and COO of First Capital, Mark Sunshine, agrees, adding that financial buyers generally are willing to accept more deal risk than their strategic-buyer counterparts. Financial buyers, he says, expect some of their investments to be “home runs,” others to produce average performance, and some to be “real busts.” “If they’re off a little bit over an 8-to-10-year period, nothing really happens to the portfolio manager,” he notes. On the other hand, if a corporate buyer overpays or does a bad deal, the health of the company may be jeopardized, and “it can ruin the lives of the management team and hundreds of employees.” “Strategic buyers don’t have the benefit of portfolio diversification because they have all their eggs in one basket, so to speak. Financial buyers have lots of eggs in lots of baskets,” Sunshine says. There was a time not long ago when corporate acquirers felt the heat from Wall Street and investors to grow via acquisition, but boards of directors were reluctant to approve deals. But according to Kip Clarke, a Managing Director and Co-Head of the M&A Group at KeyBanc Capital Markets, his strategic buyer clients feel less pressure these days. “Our clients generally seem more interested in making big bets when they’re under pressure to grow, but right now, they’re content with doing bolt-on deals.” One factor that accounts for strategic buyers’ relative contentment with doing add-on deals, says Bob Filek, a Partner in PricewaterhouseCoopers’ Transaction Services Group, is that the equity markets are rewarding corporates for sticking to their core competencies. Pure-play companies, especially those that dominate a sector, “appear to be getting better treatment in the equity markets than more-diversified businesses,” he says. “And I don’t mean a non-conglomerate versus a conglomerate but dominance in a specific niche. You see this in food, where the market tends to reward companies with leading positions in a particular food category, like frozen foods, versus those that have products in various aisles of the grocery store.” That dynamic, he believes, is limiting corporate acquirers’ M&A activity to some degree. The list of disadvantages that strategic buyers face today includes: * Debt, a favored financing tool for buyouts, continues to be cheap. * Private equity and buyout firms, many of which have created platforms in certain markets and have made add-on acquisitions, now can capture cost savings and synergies in deals – an advantage that used to be enjoyed by strategic buyers. * Financial buyers are willing to accept lower returns on their investments. * Strategic buyers can no longer expect financial buyers to back down in competing on price, with some recent PE deal multiples reaching the low-to-mid teens. * Financial sponsors’ need to put their deal war chests to work. Lack of cash is not one of the disadvantages, however. There has been plenty of talk about the piles of funds that PE firms are sitting on but strategic buyers have loads of cash themselves. Chief executives, however, seem reluctant to use it for acquisitions and instead many companies have returned cash to investors through stock buybacks and dividend payments. “PE funds are in this game to spend their cash, while strategics are still looking at whether deals would be dilutive, and are considering using their cash elsewhere,” says Lou Bevilacqua, a Partner in Cadwalader, Wickersham & Taft’s Corporate/M&A Department. Financial buyers are under pressure to invest their cash as quickly as possible because the returns on cash are poor, notes Sunshine. If they don’t invest their money, “it trashes their returns.” “These buyers may be willing to overpay’ for assets a bit because overpaying, even if they don’t over-leverage companies and make smaller IRRs, is better than not investing. As a result, in some deals, at the margin, they’re pushing up prices and valuations,” he says. One source noted that if a strategic buyer really wants to do a deal, in many cases, it would be able to out-pay a financial buyer, although it might not be willing to shell out too rich a price for a property. The bidding war between Ripplewood Holdings and Whirlpool for Maytag is a perfect example. Ripplewood bowed out of the bidding contest, deciding against topping an offer by Whirlpool, which upped its offer from an original $17 a share to $21 a share to secure the deal. While financial buyers in some respects have the upper hand in today’s deals arena, M&A experts are quick to offer suggestions to help corporate buyers compete more aggressively. Don’t Fear Leverage Many of the market-transforming deals of late have been based on financial engineering that requires higher levels of leverage, notes Sunshine. Strategic buyers generally shy away from taking on loads of leverage because the management teams have to produce the cash flow to service the debt. Nonetheless, says Chanmugam, “there has to be better use of leverage by the strategics.” One of the distinct competitive advantages of PE firms is their ability to create deal structures with various combinations of debt and equity. But experts note that while highly leveraged and richly priced transactions may produce greater returns, they often can produce greater volatility and less earnings predictability, which is not the risk/reward profile that’s desired by many public-company shareholders. Think Longer-Term Corporate development officers are gun-shy about doing a dilutive deal, and opposed to the potential hit to their company’s stock such a deal might cause. However, Philip Stamatakos, a Partner at Jones Day who focuses on M&A, believes that strategic buyers “would be well advised” to take a longer-term view of acquisitions. “You might think that strategic buyers naturally would take a longer-term perspective than PE buyers, who look to get out in three to five, but what often happens is the opposite. Strategic buyers are sometimes unwilling to take an action that could negatively affect their company’s short-term earnings, whereas many PE funds are willing to do deals that may not produce short-term results but in the long term are very beneficial,” he says. Assemble a Premier Deal Team M&A is not a forum for amateurs. To keep pace with the agility and creativity of PE firms, experts stress the importance of creating a dedicated deal team that can bid smart and close deals fast. According to David Peck, a Shareholder at Greenberg Traurig in Fort Lauderdale, Fla., who focuses on M&A, JVs, private equity financing, and restructurings, strategic buyers tend to be “slower, less creative, and more likely to be over-deliberative.” He shares the view of Stamatakos, who notes, “Deals will tend to go to companies that have well-oiled acquisition machinery in-house – a team that includes experts from throughout the company who have been involved in deals before, and that has a high degree of agility in making bids.” If You Can’t Beat ‘Em, Join ‘Em Just as SuperValu, CVS, and an investment group led by Cerberus Capital Management teamed up to buy grocer Albertson’s, Chanmugam asserts that corporate buyers could step up partnering with fellow strategic buyers or consider joining financial-buyer consortia, although he acknowledges that the differing deal objectives and exit strategies of financial and strategic buyers could limit such partnerships. “I don’t think this would become a significant trend, given the complexities of such transactions, but I think in some cases, strategics should give it some more thought. Many don’t even consider it as a possibility,” Stamatakos states. The Last Laugh? While corporate buyers face some a number of disadvantages in the current M&A environment, the experts point out that by walking away from a pricey deal, strategic buyers may actually win in the long run – by refusing to overpay. “You’re assuming that it’s a disadvantage that strategic buyers are holding back on some deals,” says Sunshine. Stamatakos backs him up by adding that the “winner” isn’t necessarily the company that’s won the auction; the winner can be the company that steps away from an auction. “I think there are many, many strategic buyers that are doing that today. We’ll see if they get the last laugh in the end, and I suspect that many of them will because multiples of 13 times EBITDA and the like that are being paid these days can be justified only through great operational results, and if you have a PE fund as the deal winner, it may be difficult for the firm to pull it off if it doesn’t have the advantage of synergies,” he says. If GDP growth eases up, we could see a number of corporate bankruptcies and reorganizations of companies that were acquired by financial buyers in highly leveraged deals. (c) 2007 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com