When the smoke clears and the dust settles, what does the Wall Street meltdown mean?

We’re back to cash is king. The Golden Rule has been restored: he who has the gold, makes the rules. It’s a return to old-fashioned investing. Companies with strong balance sheets and lots of cash are moving in to make acquisitions. In some cases they are paying 100% equity — no money down, no debt whatsoever, a completely unleveraged transaction. And they’re able to really have an impact on businesses that they weren’t necessarily able to touch before.

We certainly saw that with Warren Buffett. He had the gold, and he set the rules. He got a real sweetheart deal with Goldman Sachs. Granted he has money at risk, but he was able to get a highly preferential deal structure that a year ago he wouldn’t have been possible. It’s all about the cash position. The people that have dry gunpowder right now will do very well. Companies with little debt and good fundamental financials have the opportunity right now to really make a move and become even stronger.

A few things are going to follow. First, valuations will fall — it will be interesting to see how valuation companies (the experts who calculate what a company is worth) adjust to the new climate. Second, cash-rich buyers will be able to acquire companies that others cannot. And there is a third consequence to this whole upheaval: we will see a new layer of transparency and simplicity in the markets. Acquisitions in recent years have been largely driven by financial engineering. Now we’ll see a change in acquisition strategy. Today, the question hanging over possible transactions will be: “Does this make good business sense?” That’s a sea change in the M&A world.

Technorati Tags: Acquisition Strategy, acquisitions, Capstone, David Braun, External Growth, Integration, M&A, mergers, Mergers and Acquisitions

In the current crisis, people are rightly concerned about a declining dollar and its impact on all aspects of business, including Mergers and Acquisitions.

Outbound, the weaker dollar is making it more difficult for US companies to make acquisitions abroad, because they’re now more expensive. On the inbound side the impact has been positive. We’ve seen a strong increase in foreign investments in the US. With a weak dollar, many foreign players see an opportunity to buy companies at a discount.

The US firm seeking growth through acquisition might assume that this means increased competition, because that attractive competitor you want to buy is also being courted by cash-rich foreign buyers.

In reality, you’re seeing not more competition but different competition. In the past, competition came largely from private equity or hedge funds — and that was a very difficult competitor. These were sophisticated buyers, with a low weighted average cost of capital because they had good access to cheap debt. they understood capital asset pricing models, and they were tough people to compete against.

Now the scene has changed. The private equity players have withdrawn and the foreign buyers are stepping in. But these foreign competitors may not know the US market as well. They will tend to be strategic buyers, looking to improve their business or marketing picture, rather than purely financial buyers aiming to turn a quick profit, and as such they may prove far less sophisticated.Right now, it’s a little premature to determine exactly how they will behave. My sense is they will tend to be fairly cash rich because the dollar is weak. That means that in some cases they are likely to overpay. So from a seller’s perspective, we see strong activity right now by US companies looking to divest. They’re eager to accept inquiries at this point, especially from foreign buyers because they spot an opportunity to get a high price for their business.

Technorati Tags: Acquisition Strategy, acquisitions, External Growth, Integration, M&A, mergers, Mergers and Acquisitions

I was asked the other day about the meaning of “enterprise value”. We have two different terminologies that are used in the marketplace: enterprise value and equity value. Enterprise value is the value of a business including its debt. Equity value is the value of the business debt free.

In some situations, you might be buying a company while also assuming its debt. That would be its enterprise value. Equity value says: “I’m going to pay you a price, but I want it debt free. You pay off the debt, do whatever you want with it, but I want to buy your company debt free.”

In today’s M&A markets, the predominant transaction type is equity value. The exception would be if a company has a capital structure that is very favorable, and the seller therefore has reason to assume it. This is not a whole lot different from buying a house and assuming someone else’s mortgage. There aren’t a lot of fees associated with it — you just slip right in. Sign a few papers and you’re done!

In the commercial world, if I can buy a company and they have very good debt I might be glad to take it on. A common example is an industrial development bond from the local government that is on very favorable terms. As a buyer, that’s most likely something that I’m going to want to keep in place. Why would we want a low-cost loan paid off? On the contrary, we could use that as part of the deal structure. So, the primary reason for selecting enterprise value would be if the buyer can secure a deal structure that’s such that the existing debt provides a benefit. If the debit is not favorable, then as a buyer I would probably opt for equity value and bring in my own debt structure.

Technorati Tags: Acquisition Strategy, acquisitions, enterprise value, equity value, External Growth, Integration, M&A, mergers, Mergers and Acquisitions

It’s been a dramatic time for investment banking, and many people are anxious. We probably haven’t seen the bottom yet, but there’s no cause for panic. In fact, good things may come from this latest turmoil.

Take Lehman, the smallest of the four majors. They had tremendous exposure to real estate and their balance sheet was not particularly strong. Perhaps they could have weathered the storm but as so often, perception is reality. The perception here was that Lehman couldn’t pull through, and that made it very difficult for them to raise funds or attract new clients, so they went down.

Now the strong players smell blood in the water, and they are ready to seize on weaker prey. We see Merrill Lynch bought by Bank of America — it’s quite a shakeout. The negative in all this is a reduction in competition among the white shoe investment bankers. But there are positives, too.

We are seeing a breakdown in the old, stodgy way to doing investment banking. We can expect tighter regulation and more transparency in the markets. Clients will have a stronger hand in buying the services they want, rather than being forced into bundled products. More excitingly, I anticipate a new wave of creativity in the capital markets. Look out for new derivatives, greater fluidity, perhaps more tapping into foreign debt or alternative markets like AIM.

As a subsidiary of Bank of America, Merrill Lynch becomes part of a giant, and giants are inherently slow movers. So there are opportunities opening up for smaller, swifter niche players. Of course, there is pain in the transition, and the picture is by no means rosy. However, once the storm has passed we can look forward to new, fresh growth. 

Technorati Tags: Bank of America, capital markets, investment banking, Lehman Brothers, Merrill Lynch

There’s some confusion around about the direction of the M&A market, and it comes from seeing the market as an undifferentiated whole. For example, a recent article in the New York Sun predicts a comeback in M&A activity after a year in the doldrums. 

The article is generally correct and I do see a strong emanating market. However I question their premise that the comeback is widespread over the whole market. There’s going to be a divide. At the high end — which I characterize as transactions of $10B and up — we’ll continue to see a healthy amount of activity. It’s Hewlett Packard buying EDS. It’s Anheuser-Busch getting bought by Inbev. It’s Microsoft trying to buy Yahoo.  Many of those big companies recognize that they will only continue to grow by adding strategic components to their business. They’re looking to get immediate expansion in either brands or — even more important — global penetration, which is partly what we saw on the Inbev deal. 

The other area where we will see continued growth is at the lower end of the market. These are transactions under $1B in size. Here people are trying to fill their market gaps, buying competitors that have gotten weaker. In particular within that sector, watch for transactions under $100m  — I predict the strongest activity within this range. The primary reason is their access to credit, or perhaps more significantly their ability to do without it.  In many cases privately held companies of this size can buy for cash out of their operating income. Or they can use equity positions they’re going to put into the business. Either way, the transactions are proving much easier to get financed.

So this is what I see as the major divide — greater than $10B, less than a billion. In my next post I’ll talk about the missing middle: transactions from $1B to $10B.

Technorati Tags: acquisitions, equity market, m-and-a, mergers