Post on 03-Jan-2016
description
transcript
Life After the Perfect Storm — Selling Privately Owned Businesses in Today’s Market
Bill EastwoodDoering & Eastwood, Ltd
May 16, 2003
Doering & Eastwood, Ltd 2
Total Transaction Value(in millions)
$0
$300
$600
$900
$1,200
$1,500
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
The U.S. M&A Market Peaked in Terms of Transaction Value in 1999 at $1.4 Trillion, After Eight Consecutive Years of Unprecedented Growth
Virtually All of the Drivers of M&A Activity Were Operating During the Latter Half of the 1990s
Source: Mergerstat
Overview -- Long Term M&A Market
Doering & Eastwood, Ltd 3
Overview -- Long Term M&A Market
Transaction Volume Composition
71.0% 70.7% 67.6% 69.4%76.5% 79.0%
20.7% 20.4% 21.7% 20.7%16.2%
15.9%
8.3% 8.9% 10.7% 10.0% 7.3% 5.1%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1997 1998 1999 2000 2001 2002
Under $100 MM $100MM - $500MM Above $500MM
Middle Market M&A Activity May Be Somewhat More Resilient Than Large Deal Activity
Doering & Eastwood, Ltd 4
The Perfect Storm -- Obvious Parts November 2000 — November 2002
• Poor Earnings• Rapidly Falling Stock Prices
– No Longer Currency for Acquisitions
• Recession/Slow Growth Economy• Excess Capacity• Geo-political Events
– 9/11– Iraq– Korea
Doering & Eastwood, Ltd 5
The Perfect Storm -- Obvious Parts November 2000 — November 2002
• Loss of Credibility in Financial Statements and Corporate Management
• Attitude That Acquisitions Do Not Increase Stockholder Value– World Com — MCI – Tyco — CIT– ATT — TCI Cable– Qwest — U.S. West– Lucent — Ascend– AOL — Time Warner
Doering & Eastwood, Ltd 6
The Perfect Storm -- Less Obvious Parts November 2000 — November 2002
• Falling Interest Rates and Stock Prices Make Returns From Proceeds of a Business Sale Much Less Attractive
• Entrepreneurs Evaluating Sale of Business Need Proceeds to Last the Remainder of Their Life– In 1999 Projecting 15% Stock Returns and 7.5% Fixed Income
Returns, Lifestyle and Income Level Needs Were Much Easier to Satisfy Than In 2002 With Negative Stock Market Returns and 1% Money Market Rates
• For Private Equity Funds, the Public Market Is No Longer a Reliable Exit Strategy
Doering & Eastwood, Ltd 7
The Perfect Storm -- Less Obvious Parts November 2000 — November 2002
• Banks’ Risk Tolerance For Acquisition Financing Reduced– Average Equity Requirements to Obtain Financing
Increased From 25% to 40-50% of the Purchase Price
• Most Private Equity Acquisition Criteria Is Based on Return on Equity (“ROE”) of 25-35%Example: Pre Fall 2000 Post Fall 2002
Acquisition Price 1,000 1,000Debt 750 550Equity 250 450Total Funding 1,000 1,000
Doering & Eastwood, Ltd 8
The Perfect Storm -- Less Obvious Parts November 2000 — November 2002
7.0%
9.7%
13.4%
20.7%22.0%
25.2%26.2%
23.7%22.9%
3.3%
30.0%
3.5%
31.6%
4.1%
35.7%
3.9%
37.8%
5.5%
40.6%
2.7%
40.0%
4.2%
41.0%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
1987 1988 1989 1990 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 4Q02
Average Equity Contribution to Leveraged Buyouts 1987 - 4th Q 2002
Rollover Equity Contributed Equity
Source: Leveraged Buyouts
Doering & Eastwood, Ltd 9
The Perfect Storm -- Less Obvious Parts November 2000 — November 2002
• For a Private Equity Group with a 25% Hurdle Rate, Reduced Bank Financing Make the ROE Below the Threshold, Now a Deal is Not Doable Without Price Adjustments or Owner Financing
EBIT = Earnings Before Interest and Taxes Interest at 7.5%PBT = Profit Before Tax PAT = Profit After Tax at 37% Tax RateROE = Return on Equity = PAT/EquityEBITDA = Earnings Before Interest, Taxes, Depreciation and Amortization
Pre Fall 2000 Post Fall 2000EBIT 180 180Interest 56 41PBT 124 139PAT 78 87ROE 31% 19%Debt 750 550Equity 250 450Equity % 25% 45%
Doering & Eastwood, Ltd 10
The Perfect Storm -- Less Obvious Parts November 2000 - November 2002
• Owners’ Failure to Accept Current Value of Business – During 1998-2000, Owner Had an Offer or a Friend in
the Business Had an Offer 8-10 Times EBIT
– Today’s Market 5-7 Times EBIT for Owner’s Industry
– With Earnings Down 10%, Owner’s Business Only Worth 60% of Perceived Prior Value
– Even Though Business Fundamentally Continues to Degenerate, Owner Waits Until the Market Returns to Prior Valuation
Doering & Eastwood, Ltd 11
The Perfect Storm -- Less Obvious Parts November 2000 - November 2002
• Principal Types Of Businesses Sold During the Perfect Storm– Outstanding Business With a Competitive Advantage
and a Growth Story
– Businesses in Industries That Benefited From Consolidation (Costs and Pricing Power)
• Banks
• Cable Television
• Oil and Gas
– Distress — Must Sell Business
Doering & Eastwood, Ltd 12
The Perfect Storm -- Less Obvious Parts November 2000 - November 2002
• Owners Who Accepted Realistic Prices– Buyers Stretch to Make Transaction Attractive, Often
Including Seller Paper
– Doering and Eastwood, Ltd. Is a Member of IMAP (“International Network of M&A Partners”), Which Completed 217 Transactions With Total Value in Excess of $4 Billion in 2002
Doering & Eastwood, Ltd 13
What Is Happening After The Perfect Storm
• The Good News– Private Equity Firms Have Hundreds of Billions in
Equity Capital• Financial Times in April 2 Article Estimates That the Largest
450 Private Equity Firms Had Over $250 Billion in Committed Funds
– Assuming a 40% Equity Requirement, Capacity to Complete $650 Billion in Acquisitions
• Private Equity Groups Acquire Questdex Phone Directory Business for $5 Billion+
• Increased Role in Middle Market Transactions• Pressure to Invest or Return Proceeds to Investors• Interest Rates Are at All Time Lows• Prices Are More Reasonable
Doering & Eastwood, Ltd 14
What Is Happening After The Perfect Storm
• The Good News– Strategic Buyers Are Acquiring Companies in Their
Industry• First Data Announces $7 Billion Acquisition of Concord —
Both in Credit Card Merchant Processors• Comcast Cable Acquires AT&T Cable Properties• Numerous Regional Bank Mergers • Acquisition Discussions Increasing Dramatically Between
Potential Buyers and Sellers (Source: Business Week, April 21 P.82-83)
• Large Companies Are Looking at Smaller Company Add-ons to Grow Without Huge Risks
Doering & Eastwood, Ltd 15
What Is Happening After The Perfect Storm
• The Good News– Private Business Owners Have Become More Realistic
in Value Expectations• Aging Baby Boomer Population Is Under Increasing Time
Pressure to Sell and Enjoy Retirement
– Banks and Financial Institutions Are Cautiously Increasing Commitment to Buyout Loans
– Buyers and Sellers Are Becoming Flexible and Creative - Seller Financing, Retained Equity, Earnouts
Doering & Eastwood, Ltd 16
What Is Happening After The Perfect Storm
• The Bad News – Perfect Storm Conditions Continue in Varying Degrees
• Tenuous Economy
• Rising Unemployment and “Spent Out” Consumers
• Continued Accounting and Management Credibility Issues (Healthsouth)
• Poor Potential Returns to Sellers With Business Sales Proceeds
• Buyers VERY CAUTIOUS
Doering & Eastwood, Ltd 17
What Is Happening After The Perfect Storm
• Slight Increase in the Deal Closings in the Middle Market
• Ability to Sell Varies Greatly Depending Upon Company and Industry
• Committed Sellers Are Succeeding By:– Maintaining or Growing Earnings
– Managing Their Business Well
– Flexibility in Deal Terms
Doering & Eastwood, Ltd 18
Value of Privately Owned Businesses
• Types of Valuation– Fair Market Value -- Estates, Gifts, Disputes
– Market Value -- What the Business Will Bring If Sold
• Real Market Value Determined When Offers Are Received
• Most Valuations Are Earnings Multiple Based (Example 5 Times EBIT)
Doering & Eastwood, Ltd 19
Value of Privately Owned Businesses
• Specialized Industries May Have Different Valuation Rules of Thumb– Computer Software — Multiple of Sales
– Banks — Multiple of Book Value
– Cable Companies — Price Per Subscriber
Doering & Eastwood, Ltd 20
Value of Privately Owned Businesses
• Market Valuation Approaches:– Highest Value —“Strategic” or Investment Value
– Median Value —“Stand Alone” Value
– Lowest Value — Liquidation Value
• Market Comparable — Used for This Presentation• Recasting Earnings• EBIT Multiple — Most Common Measuring Rod;
3 to 7 Times EBIT — 6 to 12 Price Earnings Multiple
Doering & Eastwood, Ltd 21
Value of Privately Owned Businesses
• Factors That Differentiate a 3 Multiple Business From a 7 (an “A” Business From a “C” Business):– Industry
– Size
– Growth in Sales
– Earnings — Growth and Consistency
– Balance Sheet Strength
– Perceived Competitive Advantage — Brands, Patents, Technology, Costs
– Margin As Percent of Sales
– Strength and Continuity of Management
Doering & Eastwood, Ltd 22
Value of Privately Owned Businesses
• Exceptions to the 3 to 7 EBIT Rule:– Each Buyer Will Have a Different Criteria for
Valuation
– Examples:• Private Equity Firms Evaluate Based on Projected ROE
• Food Brand Purchaser May Project Savings in Costs From Adding a Brand to Its Existing Distribution System
• Cable Company Computes Savings From Purchase of Programs
Doering & Eastwood, Ltd 23
Value of Privately Owned BusinessesQuantitative Study By IMAP
A 59 Member Middle Market Intermediary Group With Offices in 25 Countries
Proprietary vs. Non-Proprietary Manufacturers — NAFTA
Doering & Eastwood, Ltd 24
Value of Privately Owned BusinessesQuantitative Study By IMAP
Multiples of EBIT — 2002 Transactions
Doering & Eastwood, Ltd 25
When Should A Business Be Sold?
• With Expert’s Assistance, Objectively Analyze Business’s Sales Prospects– When the Business Is Performing Well
– When There Are Good Prospective Buyers Within a Reasonable Time
– When the Owner Is Committed to Spending the Time and Money to Market the Business Properly
Doering & Eastwood, Ltd 26
When Should A Business Be Sold?
– When the Condition of Financial Records Is Sound• Are the Statements Audited?
• Possibility of Restatement in Due Diligence
– When Contingent Liabilities Are Limited and Estimable
• Warranty Claims
• Environmental
• Employee Issues
• Litigation
Doering & Eastwood, Ltd 27
Who Are The Buyers?
• Strategic Buyers– A Buyer in the Same Business As the Seller (May Also
Be an Extension of Existing Business)
– Examples:• First Data Buys Concord Credit Card and ATM Processing
• Wells Fargo Acquires First National Bank of Lincoln
Doering & Eastwood, Ltd 28
Who Are The Buyers?
• Financial Buyers — (“Private Equity Funds & Leverage Buyout Groups”)– Use Equity Provided by Institutions, Pension Funds,
Insurance Companies and Other Investors
– Borrow Money to Increase the Return
– Examples:• Carlyle and Welsh Carson Acquire QwestDex (Telephone
Directory)
• Texas Pacific Acquires Burger King
Doering & Eastwood, Ltd 29
Who Are The Buyers?
– Funds Raised Over $800 Billion From 1997-2002• Hundreds of Billions Left for Investment
– Thousands of Buyout Funds With Billions in Capital Can Generally Borrow 1-2 Times Equity to Buy a Company
Doering & Eastwood, Ltd 30
Who Are The Buyers?
– Many Different Types of Buyout Funds• Each Has a Profile of Types of Investments Pursued by Size
and Industry
– Some Look to Consolidate a Niche Industry• Example — Hicks, Muse Radio Stations
• Almost All Have a Limited Ownership Time Horizon (5 Years Average) to Sell the Company
– Most Encourage Management to Own Part of the Company (5% — 20%)
Doering & Eastwood, Ltd 31
Who Are The Buyers?
– Look for 25% — 35% Return on Equity
– Have Different Minimum EBIT Thresholds• Some Acquire Only Very Large Companies
– KKR
– Hicks, Muse
• $5 Million, $2 Million (Most Common), $1 Million
• Most Consider Even Smaller “Add-ons” That Complement an Existing Business
Doering & Eastwood, Ltd 32
Who Are The Buyers?
• Private Investors– Local Entrepreneur Buys Printing Business
Doering & Eastwood, Ltd 33
Financing Sources
• Strategic Buyer — Cash Flow From Operations; Existing Bank Lines; or Project Specific Financing
• Private Equity Funds:– Equity 30-50%– Loans — Banks and Other Financial Institutions
• Asset Based Loans– Revolver — Accounts Receivable, Inventory– Term Loan — Fixed Assets
• Cash Flow Based Loans • Mezzanine Debt• Seller Financing
Doering & Eastwood, Ltd 34
Structure of the Deal Affects Value
• C Corporation With Value Substantially in Excess of Equity Brings Less Than Comparable Company (Subchapter S, LLC) That Can Sell Assets Without “Double Taxation” in Middle Market Transactions
• Licenses, Leases, Inherited Liabilities and Other Contracts
Doering & Eastwood, Ltd 35
Structure of the Deal Affects Value
• Currency– Cash Is King
– Seller Financing Brings Higher Price• With Bank Financing More Difficult and More Expensive to
Obtain, Importance of Seller Financing Is Increasing — Particularly on Deals Valued Under $20 Million
– Stock Swap — Tax Deferral and Liquidity Consideration, Negative Stock Market Risks
Doering & Eastwood, Ltd 36
The Marketing Process
• Prepare Business for Sale– Dressing Up Prior to Sales Effort
– Maintain Management Continuity
– Utilize Pass Through Entity (Sub S, LLC)
– Identify and Resolve Litigation, Intellectual Property, Environmental and Other Contingent Liabilities
– Determine Reliance on Key Customers or Suppliers
– Identify Personnel Issues
– Obtain Audited Financial Statements
Doering & Eastwood, Ltd 37
The Marketing Process
• Offering for Sale– The Team Is Critical – Lawyer, Accountant, Trusted
Financial Adviser, and Investment Banker– Determine Advisability of a Merger and Acquisition
Professional • Business Value Less Than $1 Million, Usually Not Advisable• Business With Less Than One-half Million EBIT
– If M&A Professional Desirable, Evaluation and Choice Is Critical
Doering & Eastwood, Ltd 38
The Marketing Process
• Communication Among Team Members Critical• Be Aware of Deal Snipers
Doering & Eastwood, Ltd 39
The Marketing Process
• Business Sales Strategy– Prepare a Business Summary or Offering Memorandum
and Teaser– Identify Potential Buyers– Open Negotiation Process:
• With One Purchaser at a Time• To a Few Prospects (“Selective Marketing”)• With a Controlled Auction to All Qualified Prospects
Doering & Eastwood, Ltd 40
The Marketing Process
• Major Legal Documentation– Confidentiality Agreement – Letter Of Intent– Due Diligence– Definitive Agreement and Closing
• Management Must Concentrate on Running the Business
Doering & Eastwood, Ltd 41
Conclusions
• Successful Businesses Are Marketable• A Marathon, Not a Sprint• Seller Must Be Realistic About Price and Timing• Having a Trusted Team Critical• Do Not Ignore Running the Business. If Business
Falters, All Other Work Is Wasted