I just spoke at the Wisconsin Institute of Certified Public Accountants Spring Conference and the general sentiment was cautious optimism for the next 12 months. Several attendees mentioned they only see distressed companies selling and at 0.5x revenues. Another mentioned his firm has lots of cash and no debt but they are hesitant to part with it. All-in-all I think many are taking a wait and see attitude – which for the middle is okay, but the strong companies and weak companies may wait too long. Long enough that their moment will have passed.
M & A News
On this blog previously, David discussed some of the issues surrounding the AOL-Time Warner merger. Given that the ten year anniversary of the merger was recently marked, I wanted to re-visit the ill-fated deal to explore it a little more in-depth.
AOL and Time Warner merged to create the “world’s first Internet-age media and communications company” for an all-stock combined value of $350 billion. The merger announcement stated that the new company “will be uniquely positioned to speed the development of the interactive medium and the growth of all its businesses. It will provide an important new broadband distribution platform for AOL’s interactive services and drive subscriber growth through cross-marketing with Time Warner’s pre-eminent brands”… which doesn’t include the laundry list of growth opportunities captured in the remainder of the announcement covering everything from music to telephony.
Instead of delivering on these ambitious promises, the merger imploded, translating into about $100B in lost shareholder value. The new company was plagued by many issues such as: short-term thinking, bad technology, bungled product development, and a risk-averse culture more prone to imitation than innovation. Most importantly the vision and passion the deal champions Jerry Levin and Steve Case established in 2000 were not effectively translated and executed by their people.
Yes, there were external pressures such as regulators and Wall street that increased merger difficulties – but I believe it all comes back to a clear vision that sets the strategic direction that the rest of the organization can understand and execute against. To that point – AOL’s original vision was “to build a global medium as central to people’s lives as the telephone or television… and even more valuable”. The company accomplished this vision prior to the merger. Eventually they replaced the statement in 2006: “to serve the world’s most engaged community”, which is nondescript and applicable to many businesses.
Recently, Jerry Levin, former CEO of AOL-Time Warner, and Steve Case, co-founder of AOL were on CNBC reflecting on the merger (see the video below). Levin apologized for the merger, “I presided over the worst deal of the century… I’m really very sorry about the pain and suffering and loss this has caused.” Levin and Case’s observations included:
- Leaders need to be compassionate and understanding of the significant tension due to a merger’s disruptive nature and cultural differences
- AOL TW was to be a ‘supermarket’ but instead was a ‘mall’
- Vision is nothing without execution in which people are key
- Too much focus on internal politics and wall street instead of customer needs
According to the Wall Street Journal, November 2009 was the biggest month in over a year for deals involving consumer products and food and drinks firms, with $12.54 billion in acquisitions. And it doesn’t look like this momentum will be stopped. Kettle Chips, Just for Men and Grecian Formula hair-coloring products, Aqua Velva cologne, Brylcreem hair gel, Vagisil feminine products and Ambi Pur brand are all reported to be on the block. It is interesting to me that such well known brand name companies would sell in a down market. I believe the consumer product industry continues to have seismic changes as younger people are less tied to brands, while at the same time distribution channels like Wal-Mart have strengthening power over their suppliers and continue to expand their private label products. I anticipate more product consolidation as companies like P&G have to remain relevant to their customers and maintain some economies of scale. Perhaps at the end we will have some consumer product companies “too big to fail.”
Our buy-side clients at Capstone are seeing the same trend that a recent Reuters article reported: “Companies are making moves to divest assets that are not essential to their operations, while stronger firms, nudged on by their boards and shareholders, are looking to grow and position themselves for the recovery.” This leads to numerous “orphan” non-core product lines and/or business units. This is resulting in increased deal flow, with more silent auctions and calls coming in from around the globe. Further, JPMorgan noted: “We are seeing a pickup in serious strategic discussions that would give us more optimism for 2010.” Capstone’s pipeline is strong and growing as proactive external growth requirements are driving leaders to “come out of the woodwork” looking for strategic assets that will offset their deficits on the organic growth side as they refine their 2010 budget forecasts. Do you need to fill a gap? Consider that technologies and product lines are “on the market”.
The M&A statistics for the third quarter of 2009 are in and show the vast majority of the deals getting done are strategic. The economic crisis and concerns over deal financing continued to significantly hold down the number and value of deals when compared to the same period last year. Today, a Wall Street Journal article by Peter Lattman reports that leverage is out and equity is in. Although these numbers are grim, there is reason for hope. A number of big name deals, such as Kraft-Cadbury and Disney-Marvel, have injected the market with some much needed optimism. These types of deals are evidence that strategic deals are going to lead the way to recovery with private equity to follow – not the other way around.
A story in the news last week caught my eye – U.S. antitrust enforcers are planning to revamp merger guidelines. This isn’t surprising news – there have been expectations for quite awhile that the Obama administration was going to take a closer look at large corporate mergers. It also won’t affect the vast majority of you (or our clients) – antitrust enforcement generally only relates to the biggest of the deals (like the potential Kraft – Cadbury transaction mentioned in the article). What stood out to me, though, was at the bottom of the page:
The move to revamp the guidelines… comes as tentative signs emerge that the mergers and acquisitions market is recovering… In the three months from June to August, global M&A rose 29 percent compared to the preceding three months. In the second quarter, M&A was up 15.2 percent compared with the first quarter…
This has been exactly what we have been seeing with our clients in recent months. Deals are getting done in new ways: more creative deal structures are being used and more options are on the table. Deals are viewed as strategic partnerships to make two companies stronger and help them weather the storm together. Is increased government scrutiny actually an indication that we are finally starting to see clear skies in the distance?
Three recent deals are being heralded as “the revival” of the M&A market. Although the linked article captures some of the larger buy-side deals (for example Disney’s $4 billion purchase of Marvel) that are now beginning to emerge, we here at Capstone are seeing a similar trend in the area of the market where we mainly focus: smaller to mid-size ($25 to $200 million) transactions. Firms are beginning to react to the apparent improvement in economic conditions (according to some indicators, but not all – see today’s unemployment numbers), and wish to capitalize on lower prices and expectations before a full recovery occurs.
PWC released its second quarter report on M&A activity in the industrial products sector. Two items from the report stood out for me. First, M&A activity in the second quarter actually rose compared to the first quarter of 2009 (although still down significantly compared to last year). This could be a sign that some of the fear that has gripped the marketplace is beginning to subside. Second, the following quote struck me:
Strategic buyers continued to act as the main investors in the majority of deals in all segments of the industrial products industry as financial investors remained on the sidelines because of continued tight credit markets and a lack of liquidity.
Cash continues to be king. Companies that have cash are using it to snap up weak competition and make strategic moves to strengthen themselves for the future. They are making small, targeted acquisitions to calibrate their business.
At Capstone, we are continuing to push our clients to be active buyers in this market. Our mantra remains: “If not now, when?”
There was an excellent profile in last weekend’s Wall Street Journal of Cisco Systems and its CEO, John Chambers. Cisco is a company that “gets it”. In some of the most difficult economic conditions of our lifetime, Cisco is not hiding its head in the sand. Here is Chambers’ philosophy:
Even in this downturn, we intend to be the most aggressive we’ve ever been.
That is saying something for Cisco. Since Chambers took over as CEO in 1995, Cisco has been a bold acquirer. As the article says:
Cisco’s growth plan has combined audacity in acquisitions and attacking new markets with strict, even ruthless control over costs.
The result of this growth plan? I could lay it out in words, but you know that a picture says it better – look at Cisco’s performance against the major stock indices since 1990:
Pretty impressive. Being aggressive during down times and constantly calibrating with targeted acquisitions have paid off big time for Cisco and its investors.
It seems that in the world of private equity, middle-market funds are enjoying the greatest success in this bleak deal-making landscape. The main reason given:
…small and middle-market firms are getting the attention of the PE shops because they can be had without piling on gobs of debt
Right now, they are also considered a relative “bargain” in the marketplace. Despite the uncertainty surrounding the economy, there are still deals to be had. PE funds with cash and who deal with smaller to mid-size banks not burdened by the troubles of the larger institutions are see opportunity – and are pouncing.
Back in December, I noted (and agreed with) one author’s proclamation that in the current economy, the balance of power in M&A has shifted from sellers to buyers. The main reason: With the credit market in a crunch, cash is king, and cash-rich companies hold a distinct advantage.
As these survey results show, this trend is continuing. I believe this is true in the US as well. Buyers are looking to protect themselves from a sour deal by adding in more escrows and earn-outs, along with more items covered in reps and warranties. Due diligence has become more thorough.
Good companies are choosing to sit on the sidelines rather than risk a bad deal. Grade ‘A’ sellers are also waiting for better days, if they can, or aren’t compromising. Cash is king and the king makes the rules.
I recently appeared on Jacobson & Katz: Inside Maine Business to discuss the current state of the mergers and acquisitions market, as well as the Capstone approach to the M&A process.
You can view Part One here:
And Part Two, here:
To see other episodes of Jacobson & Katz: Inside Maine Business, visit www.insidemainebusiness.tv
I recently read an article through DealBook indicating that the Obama administration will increase antitrust enforcement during its tenure, raising the anxieties of many on Wall Street.
In the big picture, I don’t think this increased oversight will have much impact on middle-market deals – after all, it’s usually only the really big deals that could have monopoly implications.
What stuck out for me in the article, though, was the following statement:
Economic downturns tend to force executives to find ways to reduce costs…
Merging with a rival, and reaping the synergies that come from eliminating duplicative functions, is a crucial component of any manager’s recession survival tool kit…
It’s my belief that while cost-cutting is one way to deal with a tough economic situation, it can only help you tread water for so long.
Proactive growth proponents look at a complementary acquisition or new market entry opportunity as a chance to increase revenue and cross-sell – leading to more significant growth in the long run.
I often find that the cost-cutting aspects of these deals are a way to get more conservative finance colleagues to sign off on the deal. The benefits are real and helpful, but cannot by themselves lead to sustainable growth.
Although many executives are just trying to weather the current storm, I believe that those that are bold with their growth moves will come out significantly stronger once it passes.
Why do stock market investors sell when prices collapse and buy when prices soar? Why do real estate owners display the same irrational behavior? The math is hardly difficult. It’s better to buy when valuations are low and sell when they are high. Yet human nature seems to require that we run with the market cycles instead of against them.
It’s easy to see how that plays out in M&A. The other day, one of our clients said to me: “We’re retrenching like everyone else”. Well that’s honest, but hardly inspiring. My response is: If you have a plan for growth, stick to it, irrespective of the market. After all, a good financial advisor would say no less about your plan for retirement. Stand by your strategy through good times and bad.
I understand the real world of company dynamics makes this easier said than done. In any organization, there will be a handful of people with the vision to see that M&A is often the fastest track to growth. But in times of economic anxiety, they will be told that their ideas are far too risky, that all we should be doing is focusing on cutting costs and getting by.
In reality, the long-term winners will be those that are seizing on the extraordinary opportunities this current period is producing. They will be more proactive than ever, not just looking for bargains but seeing the chance to expand in existing markets and penetrate new ones by joining force with other players who are now more motivated than ever to contemplate some form of union.
In my last post I commented on the opportunity that has risen in the mid-market with the concentration of investment banking focus on major deals. There’s a chance for third-party advisors like Capstone to do more than fill the vacuum recent events have created.
However, it’s important to understand what the gap really is — and actually always has been.
The problem with investment bankers is their hunger for the deal. It’s a healthy instinct in itself, but in the world of mid-market M&A where I operate it needs to be held in check by a broader perspective. The Capstone “road map” for acquisitions comprises three major components of which “Build The Deal” is only one — the third and last. The first two components are “Build The Foundations”, which establishes the strategic objective, and “Build The Relationship”, which sets the stage for successful negotiations.
Investment bankers by training and inclination tend to rush to stage three, “Build The Deal”, without giving adequate attention to “Build The Foundations” and “Build The Relationships.” If you want one reason why 77% of M&A transactions end in failure, this is it.
To win at this game, you must know exactly why you are making an acquisition. As I’ve written elsewhere, successful M&A deals are driven by ONE clearly defined reason. Arriving at that one reason takes a process of strategic analysis.
As soon as you have your strategic objective, and a clearly defined path to achieving it, you’ll begin exploring possibilities with a number of target companies. There is a tremendous amount of skill required in this process of courtship, which may be going on simultaneously with several potential acquisitions at the same time.
M&A consultants to the mid-market who help their clients through these two challenging stages will have far more success with third stage, closing the deal, than most investment bankers. I know this for sure, because the success rate of Capstone’s deals is so far above the average.
This is a period of enormous change in the financial, business and worlds. With change comes opportunity for creativity and leadership. Who do you see rising to the challenge? I’d welcome your comments on this.
Your objective is growth, and it would be easy to deduce from this that the bigger your purchase, the better. Not so. You’ve heard the familiar question, “How do you eat an elephant?” with the equally familiar answer “One bite at a time.” That’s the mindset that works best when strategizing your external growth.
It is dangerous to try to expand too far too fast and to make a quantum leap by acquiring a company much bigger than your own. A series of small acquisitions will give you a better chance that each one will tightly fit the need it is supposed to meet. Your acquisitions will also be easier to integrate and assimilate into your company’s culture.
This principle makes all the more sense when you combine it with my “rule # 1” — have a single reason to buy. Making several highly focused acquisitions will get you further, with more safety, than trying to meet multiple goals with one huge purchase.
I was struck by Matthew Karnitschnig’s excellent article in yesterday’s Wall Street Journal. His opening line was perhaps an overstatement — “M&A is almost dead”. But the gist of his piece is right on the money.
Mr Karnitschnig’s theme is the one I have been pounding in this blog for the past few weeks. In the world of M&A, cash is king. He points out the shift of power from sellers to buyers, and the extraordinary advantage held by cash-rich companies right now.
Despite that advantage, even the cash-rich players are mostly sitting on the sidelines right now. Nevertheless, those that come out to buy are able to seize on significant opportunities that weakened companies present. The article also points out the rise in PIPEs (private investment in public enterprises), and makes an accurate observation that in the current climate, even where cash is available buyers are shifting their preference to stock purchases. Why? To hang on to the cash, of course.
One other very striking comment: “With growth unclear, buyers are more focused on what companies are earning now than what they may earn in the future.” That is no doubt true, but it’s an alarming truth. If you are considering a purchase, this is a trap you must make every effort to avoid.
One reason the deals we put together at Capstone are so frequently successful is that we are adamant about one principle: strategize your acquisitions in terms of future demand.
If you want to read a decent book on M&A, be prepared to spend $70 or $80, and set aside several days to plough through a heavy-duty tome for business students. There are exceptions, but for the average business reader there’s remarkably little to guide you through our world of deals.
So I’m writing a book. And it won’t be 500 pages long, or cost $70! The working title is “A CEO’s Guide To M&A” and its really for the kind of people I do business with — leaders of substantial companies and divisions in the mid-market sector.
M&A has a peculiar aura in the business world. On the one hand, there’s the fascination of massive corporations eating each other alive. On the other hand, there’s all that dreary academic literature. The subject seems simultaneously glamorous and impenetrably dull.
In reality, most acquisitions are not multinational mega-deals. Every year, hundreds of transactions are consummated between companies below the $1 billion revenue level, the majority privately owned. You will rarely read about these deals in the business press, and by definition a private transaction yields less public information. Yet this activity is absolutely essential to a healthy economy.
One thing I’ll be emphasizing in my book: the true function of an acquisition is not just growth, but recalibration. Buying another company will change yours, for better or worse depending on how strategic your approach. By the same token, M&A as a whole serves to recalibrate entire industries. It’s one of the market’s most effective mechanisms for self-correction and positive evolution.
That’s why I’m hoping my work will interest the general reader, as well as CEOs. The better you understand acquisitions, the better you understand business itself.
I was asked the other day what can be learned from the possible merger of GM and Chrysler. Specifically, what might this union of giants teach the M&A market lower down the food chain?
As I’ve said elsewhere, this is a time when corporate mergers can appeal to those struggling with a hostile economic climate. Reducing competitive pressure, cutting costs, gaining market share… All seem like good outcomes when two players in the same market consider forming a single new entity.
My concern about the GM-Chrysler engagement is that it models a marriage based on weakness. Both companies are in trouble, and in my experience two failures don’t make a success. The underlying problem is that mergers of this kind are driven by an agenda to cut costs. No company grew rich on that agenda alone. To win the business game, you have to keep developing new products or finding new markets — or both.
On the positive side, a merger of this kind can buy you time. That may be good enough reason for the auto makers to tie the knot. But only if they immediately launch a proactive campaign of true innovation in products and/or marketing.
And that should be happening anyway.
When it comes to funding acquisitions, banks are still holding tight to their money — unless you count the special case of banks buying other banks, which is causing quite a stir in the wake of the government bailout. The fact is, this is still a tough time for M&A, especially in what I have called “the wedge”: M&A transactions between $1bn and $10bn. Smaller deals continue under the radar, and the mating season of the behemoths never ends. Witness the prospect of GM and Chrysler merging.
In the wedge, a huge area of M&A activity, private equity is being told to wait. Banks aren’t playing and neither are the battered hedge funds. So we can expect a hold on most LBOs (leveraged buyouts) until at least the early part of next year. However, not all private equity firms are taking this lying down. They are turning away from traditional sources and seeking capital elsewhere — specifically, the public markets.
The result: we’re seeing renewed interest in SPACs, or Special Purpose Acquisition Companies. These are basically IPOs launched purely for the purpose of buying companies. How quickly this trend will increase is an open question, but it’s certainly a development to watch over the coming months.