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A senior figure in the investment community told the blog recently that companies’ views on the outlook for the economy seemed to vary according to their own financial position: “the stronger the balance sheet, the more realistic (and worse) the view on the economy”.
This analysis was confirmed at an interesting M&A Round Table organised last week by Pilko & Associates. Some key insights from the event were:
• Risk analysis. Many CFOs are organising up-front strategic reviews to better understand not only their own corporate risk profile, but also those of their major counter-parties (eg suppliers, customers etc)
• Scenario analysis is becoming much more common. Few people believe in a quick V-shaped recovery, and the risk of an L-shaped ‘lost decade’ is perceived to have increased (as seen by Japan in the 1990’s). The base case is increasingly a 3 – 5 year U/W-shaped downturn.
• Refinancing. A large number of businesses will need refinancing over the next couple of years. Banks like this type of business, due to the high fees involved. But their credit committees are being much more cautious than during the ‘boom years’. It now takes 12-18 months to achieve a refinancing, versus 6-9 months in 2006-7.
• Business analysis. Investors cannot now ‘flip’ businesses for a quick profit after 12-18 months, and instead need to be committed to running them for several years. They therefore need to understand the business’s fundamental drivers, and to evaluate its operational skills.
• M&A timescale. It is much harder to auction businesses via the use of a generic Information Memorandum and a timetabled sale process. Instead M&A is often a ‘one-on-one’ process, where finding a qualified buyer can require months of patient effort. And the total ‘package’ has to be right, to fit the buyers’ own strategic needs.
• The buyer’s process now starts by understanding the key drivers and issues for the business, and how its acquisition might fit with their overall strategy. They then develop realistic scenarios for the future outlook, as a means of highlighting key issues for testing during due diligence.
• Leverage. Lack of liquidity in financial markets means deals often require much higher equity levels (>50%). Equally, banks are more concerned about the strength of warranties and parent company guarantees, and how enforceable these might be in a continued downturn.
• Restructuring will need to bring in new investors, who will be focused on cash-flow risks, because of refinancing problems. This will benefit acquirors with capital, and a long-term view.
M&A activity is therefore much lower than in the past, as players adapt to the new environment. At the moment, a lot of deals are stalled due to sellers adopting a V-shaped outlook, and expecting a quick profits recovery, whilst buyers are worried about the potential impact on profits of a prolonged L-shaped downturn.
Today’s high levels of uncertainty also led participants to emphasise “the huge opportunity for high quality advice”. Major value could be added by those who had correctly foreseen the downturn, and could now describe the likely key issues ahead.