Kurt Jacobs and Sam Metcalf look at what hands dealmakers in the Midlands have been dealt for early 2009, and how they’ll play them.
Midlands dealmakers were dealt a series of pretty duff hands in the latter part of 2008, made all the more painful after winning the jackpot in the spring with changes to capital gains tax (CGT) that set off a rush of transactions.
There was a series of busted flushes, folding and low stakes in the closing months, but what hands are the leading dealmakers in the region holding as they enter the new year, and how will our cardsharks play them in 2009? It’s time to deal…
The Banks’ Hand – Straight Flush
There seems to be a thick fog hanging over the banks.
Some of them admit they haven’t much of a clue how the markets will react.
As Tom Cawley from the Royal Bank of Scotland points out, opinions differ as to what 2009 will bring. He says: “There is a lot of pessimism about prospects for dealmaking in 2009, albeit there is a wide spread of opinion as to just how difficult the market might be.
“Debt leverage multiples have reduced and the economic climate has undoubtedly become more challenging, leaving many potential vendors unsure about whether this is a sensible time to bring a business to market and many buyers unsure about valuations – and ultimately the effect on returns – especially when looking at current trading numbers. In times such as these it’s not unusual to see funders focus on existing investments.”
Roger Hemming, of investment bank Rothschild, thinks the banks’ capacity for new deals may improve subsequent to their December balance sheet dates, but he is expecting banks to become more concerned on credit quality as the recession bites.
He adds: “For the time being the banks’ attention is pretty much restricted to the refinancings of existing valued customers. The landscape will change in 2009 with fewer banks in the market and limited debt available. Margins and costs will remain at their much higher levels in the less competitive environment. So, access to third-party debt advice will become more crucial as our own debt advisory team has witnessed.”
As prices fall, it seems, vendors will not generally be selling unless it is necessary. Liquidity will be the theme for 2009, or rather the lack of it.
Graham Young of HSBC says: “There is a considerable amount of corporate debt that will require refinancing in 2009, but with fewer banks in the market and secondary debt markets remaining thin, businesses will need to sell good quality assets to generate liquidity to fill the gap.
“This will be the primary driver of transactions through 2009 and their number will increase as we go through the year.”
Good news, then. And one aspect our banking experts are agreed on is that 2009 will be as good a time as any to snap up a bargain. Prices, they say, will become a little more realistic again.
Cawley says: “Many investors see a depressed market as a good time to buy, and in the mid-market debt continues to be available for businesses with good market positions and strong management teams.”
Young agrees that robust management will be key. "Looking back at the returns made by private equity since the last two recessions, the highest were made from the transactions undertaken during the recession years,” he says.
This time he thinks it is slightly different – since there will be less debt finance available the business will need to grow significantly to generate good equity returns, which switches the focus more than ever to quality management teams. He continues: “There will be some bargains available, but it is crucial that compromises are not made on the quality of management.”
Hemmings also believes people’s expectations are now somewhat lower than they have been for some years.
He says: “We have seen a gap develop between the price expectations of buyers and vendors, with vendors, in many cases, still seeking prices that were relevant only at the market’s peak last year. This gap is beginning to close and this should help mergers and acquisitions activity in 2009.”
The advisers’ hand – Full House
Many advisers are looking back to the time before the changes in CGT limits as a time of bounty, where deals roamed free in the streets and when we all had enough to eat.
“There’s been a slowdown in the levels of deal activity in the Midlands market in the past six to nine months, which, in comparison with how the market was in the lead-up to April 2008’s CGT deadline, is a stark contrast to what we’re seeing now,” says Mark Gibson of Cobbetts.
Advisers expect this decline may well continue for some time for three main reasons: banks’ appetite for lending; vendors’ expectations on price in a shrinking economy and reluctance from buyers to spend on acquisitions.
However, some are more optimistic.
Simon Bursell at Dains says: “It’s no secret that most people are predicting a quieter year in the dealmaking markets in 2009. However, there are significant opportunities for corporates particularly. Having early discussions with floundering competitors can lead to fruitful merger talks or even a sale of assets through a prepackaged administration.”
Andrew Madden from Geldards thinks the focus will move away from the banking sector in 2009, saying: “All the signs are that businesses across all sectors are feeling the effects of the lack of liquidity and re-pricing of debt.
“We will continue to see redundancies as businesses reshape for lower demand. This will continue to impact on business confidence, particularly in the retail and housing sectors, and inevitably a number of businesses will fail.”
Paradoxically, says Madden, this will in turn fuel some corporate activity as businesses going into administration are sold on, so expect corporate recovery teams to have a busy year.
If, as many believe, the deals are still out there to be done, where will the finance come from if the banks are sitting on their cash?
Paul Ray of Browne Jacobson thinks the money is out there all right. “Cash-rich corporates, individuals with liquid assets and serial entrepreneurs who are in the market for buying businesses in administration will be the big winners. Asset-rich businesses offering lenders the comfort of collateral will find it easier to raise the necessary funds through assetbased lending,” he says.
Funding is already a big issue for many businesses and looks set to become more challenging. As credit conditions tighten, it is becoming harder to secure the debt financing needed to fund a transaction. Private equity deals in particular have become scarcer as a result of the lack of debt in the market.
However, for those businesses that have funding facilities, says Gordon Newlands of Ernst & Young, there have been, and will continue to be, good acquisition opportunities.
He says: “A number of the deals we advised on in the East Midlands during 2008 – such as Next’s acquisition of Lipsy – involved businesses that weren’t reliant on raising external finance.”
Newlands also agrees that those corporates with capital could be the winners in 2009. He thinks that, with less activity from private equity houses, there will be opportunities for the region’s cash-rich corporates to pursue their acquisition strategies with less competition in the market.
This trend was evident during Melrose’s recent acquisition of FKI – a international engineering group based in Loughborough – which completed in July 2008. Despite some rumoured interest, there were no formal bids from a private equity house.
Gibson also thinks that those with cash will be looking to go on the acquisition trail.
“I foresee activity for some of the larger companies – those with available cash and acquisition warchests – will likely be able to capitalise on the current economic status,” he says.
“Businesses like these will recognise the strength of their position and begin to pick up some bargains as bolt-ons to their existing business operations.”
The venture capitalists’ hand – Royal Flush
Buyers will be opportunistic in 2009: that’s the message from the private equity houses, and with that will come the need to buy (and leverage) at sensible levels that will drive down the overall pricing of deals.
Paul Franks, of Gresham Private Equity, says: “I expect by the end of quarter one in 2009 realism will set in and deal volumes can then recover.
“It feels a very, very different market but one that will absolutely generate good buying opportunities – patience and selectivity will be key in identifying and completing the best deals.”
Nick Leitch of Endless is hedging his bets: “Until we feel the bottom has been reached, I think it is difficult to build an investment case around a future that is so challenging.
“The markets are in such a state of flux that it is difficult to forecast anything right now. One thing is for sure, we have to start from a very low expectation base.”
Franks thinks the second half of 2009 will improve: He says; “Against the backdrop of a weakening economy, it is reasonable to assume deal flow will fall from the strong volumes in 2008.
That is not the full picture, however. Deal volumes in 2008 were really only strong in the first half, boosted to some extent by the changes to CGT in April 2008. The second half of 2008 slowed in deal volumes. I expect there will be a similar level of transactions in 2009 with a potential pick-up probably in the second half of the year.”
Also in: January 2009
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