Awaiting the perfect bid can be costly
In today’s uncertain environment, M&A activity remains relatively lethargic. That is true despite enormous stores of investment capital waiting for just the right transaction. Private Equity (PE) funds are sitting on more than $400 billion in new capital, while some corporations are awash in cash. Yet a growing stockpile of assets tagged for sale wait in the wings. In more normal times, most of these would have been quickly dispatched. A vast gulf between bid and offer prices is primarily to blame. Sellers cherish fond memories of the pricing available a mere 18 to 24 months ago, while would-be buyers are basing bids on current, steeply discounted valuations. Most observers bet that the deal market will resume by early 2010, but one thing is clear: for now, buyers and sellers need to consider the costs of their unwillingness to find the middle ground.
Questions. Many PE firms or corporations are holding on to non-strategic, money-losing or otherwise unwanted businesses or assets, hoping to attract a higher bid one day. These reluctant sellers should ask themselves some important questions, including: to what extent does carrying the lame-duck asset create hidden costs? For instance, holding out for a better price may drain money, sap valuable resources and blur management focus. In many cases, such losses may not be recouped by a higher sales price three, six or nine months hence.
Then there’s the crucial matter of how a seller would redeploy the proceeds of a sale. It would seem that investing in a higher yielding business or one worth more to the seller would be a prudent path at any time. And if a new asset can be picked up at a bargain price, selling an unwanted business cheaply should be of less concern.
On the buy side, the big question is: what are potential acquirers waiting for? Many have significant war chests, between banks holding TARP funds, corporations with cash surpluses and PE funds in control of much “dry powder.” Buyers may well consider whether the difference between bid and offer is worth the delay in acquiring the asset. Strategic advantage may be lost if the lack of a key acquisition postpones the launch of a new or reconfigured business initiative, product or service. And what happens to the price of the asset or business if there’s an uptick in the given industry or the broader economy? Could the eventual selling price be higher than it is today — and might the opportunity be completely lost?
In today’s business environment, of course, anything beyond the most conservative forecasts of future performance strain credibility. CEOs are focused on staying the course and conserving cash. Directors are vetting strategic plans closely. Although some observers suggest that the worst may be behind the US, tremendous uncertainty reigns. And this translates into lower forecasts, higher hurdle rates and, ultimately, deeply discounted present values. The result is the wide range in spreads evident in many sectors today.
There are other reasons for today’s relatively low deal volume. A lingering credit crunch still saps the markets of needed liquidity. In such cases, companies and financial investors are turning to alternative deal structures or simply injecting more cash or equity into the deal. However, some companies now sport balance sheets stronger than those of most banks and can readily finance transactions by issuing bonds or commercial paper or can even secure limited bank financing.
Indeed, leading corporations, anxious to position themselves for growth in a rebounding economy, understand the importance of growing by acquisition, rationalizing corporate portfolios and improving their returns on invested capital via transactions. In fact, a recent survey of more than 500 global executives by Ernst & Young and the Economist Intelligence Unit (EIU) shows that 34% of companies plan to execute strategic acquisitions in their core sectors within the next 12 months.
Meanwhile, 29% of companies say they are also hoping to divest non-core or non-performing businesses.
For the moment, though, many remain paralyzed by an uncertain economy and even more by a gulf in value perception that buyers and sellers cannot seem to bridge. Looking at economic history, many believe that those who act to reshape their businesses in turbulent times will emerge the strongest when the economy turns around. But to rescue their strategies from limbo, would-be buyers and sellers must adjust their expectations.
Steve Krouskos •Ernst & Young LLP (US) •Atlanta
Transaction Advisory Services
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