The ‘Sokrat’ investment group presents its view on the relevance of real opportunities for owners of companies that are experiencing financial difficulties, as well as investors with free capital.
A cloudless past...
According to experts, the 2005-2007 period was very successful for M&A transactions, both in terms of the quantity and volume of transactions. In 2005, the M&A market exhibited record growth. The privatization of steel giant “Krivorozhstal” alone accounted for a total of $4.8 billion. The unequivocal leader in 2006-2008 in terms of M&A transactions was the banking sector. Banks benefited from strong demand among overseas players, which is explained by the rampant growth of nominal incomes and, consequently, the commencement of a rapid increase in consumption. In addition, banks embarked on a path of gradual development of retail networks, which fueled credit programs available to the population. Clear prospects for retail credit greatly boosted prices of the banking business.
In 2007, the volume of transactions rose to nearly $8 billion, which is 98% more than experienced in 2006. At the same time, the average size of a transaction increased to $86 million. The majority of transactions fell into the $10-200 million segment.
In the first 10 months of 2008, more than 50 transactions were concluded, worth a total of $8.6 billion. In this process, the more interesting sectors were retail, construction materials, agriculture, and the machinery and metallurgy industries. The basic volume was made up of big deals, as about 40% of all transactions occurred in the $10-200 million segment.
The changes have also affected and redistributed power in the negotiation process. While the spring ball was still controlled by sellers, who could select the kind of investors to whom they would sell their business more profitably, today the situation is already firmly in the hands of buyers who actively shoot down the prices of the respective businesses, motivated by the global financial crisis and the total reduction in the cost of business worldwide.
The global financial crisis has made adjustments in the development of the country’s entire economy. Low bank liquidity and a sharp decline in lending, falling world prices for metal, and the devaluation of the currency have instantly affected the economic situation. Banks, real estate developers and metallurgy were the first hit. The decline in production in these sectors means increasing unemployment and falling sales in related industries. Problems are now beginning in the shipping/transport and energy sectors. This will be followed by chemistry and machine-building/mechanical engineering. High prices and low employment have reduced income growth, as well as cooling the appetite of consumers. Resultantly, we see a slowdown in the sales growth of selected consumption-oriented companies.
The retail and food production industry is already feeling pressure from the crisis. The lack of working capital, which was previously covered through loans, together with weakening consumer demand and a high debt load, has forced many owners of consumer goods enterprises to adjust their investment, financial and marketing plans. The inability to fully service obligations and repay debts, as well as the lack of bank refinancing, only added fuel to the fire. Put options on issued corporate bonds are also dampening the mood of many owners of Ukrainian enterprises.
Most companies are still operating on budgets drawn up for this year based on the previous year’s results. Last year, the future seemed more certain and growth brought double-digit figures, but no serious drop in demand was even considered. Today, the bright prospects of business have not been dispelled. Owners are beginning to fundamentally address the problems that have arisen by reducing production and personnel, undertaking a full-scale economization of resources, reviewing budgets, and suspending the implementation of investment programs.
In the midst of the economic crisis, many owners are thinking about sale of business. Moreover, this tendency is fueled by the fact that the capitalization of many public companies is deteriorating before our eyes, though 1-2 EBITDA (operating profit) transaction multiples are already not as frightening as they were two months ago.
The future is pessimistic ... What if this is the case?
First and foremost, you must understand that the results and expectations of last year may not be the basis for projections, as we are beginning to live with new realities. It’s best to remember how your business was 2-3 years ago, and plan on the basis of those figures. Next, you need to sternly assess the situation: what sales volume is achievable in a pessimistic scenario, the level of your debt burden and how it differs from the optimal capital structure, how the value of the company has changed and what the prospects are for credit financing, as well as determining the degree of liquidity of stocks and the likelihood of repayment of debts owed. After such an analysis of the capabilities and current state of the company, an action plan for the future should be developed. If the business has adequate solvency, a liquidity reserve and a stable cash flow source, then the company will be able to overcome the crisis relatively easily. For companies that are characterized by high levels of debt burden, an unstable income and low liquidity, the refusal of banks to refinance loans or corporate bonds can mean significant problems.
It is also worth considering the option of selling shares (not necessarily a controlling stake) in the business. The capital raised will provide the company the opportunity to repay debt, fund working capital, and continue to retain its market share. The new infusion of resources could strengthen its competitive position and enable the company to more confidently face the future. Even in the event of the company’s complete sale, the shareholder is left with liquid cash on hand, which, accordingly, may then be profitably invested in depreciated securities, gold and other assets or else in the acquisition of other businesses.
Today – Already too late or still too early?
It pays to already have an exit strategy from business now, while the buyer is willing to assume the risks and pays decent money for its assets. Despite the crisis, the financial condition of many companies is good enough and, while sales plans may not be realized completely, they are still being fulfilled and the company is still ending the year with a profit. But owners are always looking to the future and understand that the consequences of the economic crisis, one way or another, are affecting all sectors of the economy. Therefore, the decision to sell at today's value may be the most far-sighted course of action. The business will be of interest to the buyer, even during times of economic crisis, if it demonstrated good growth and profitability in the pre-crisis period and if there will be demand for its products or services in the future.
However, if you start selling at a time when the company is already unable to repay its debts and fund its working capital, production has nearly ceased, and sales are rapidly losing market share, then selling those assets will be problematic. The preparation for and commencement of the sale should begin much earlier, when the problem has only just emerged, but has not yet led to dramatic damage to the value of the business. At that time, the circle of buyers and the price of shares will be greater, while the situation for the selling company may still be remedied.
In a crisis period, the optimal buyer is usually not a strategic investor (whose requirements usually include many formal parameters, long due diligence, and an in-depth analysis of the business), but rather are so-called “distress funds” (funds that specialize in acquiring businesses that are experiencing financial difficulties). They require less time for decision-making. However, even in their case, at least 1-1 ½ months are required for an assessment of the situation and the actual deal.
According to our estimates, private equity funds may also become more active players on the market. Many of them have earned substantial equity previously. Some attracted resources directly before the crisis and are ready to use them for profitable investment in this crisis period. The fall in stock markets makes financial investment more profitable if one has an understanding of the market “bottom”. Since the market is not quite sure that the “bearish trend” (declining tendency) is over just yet, investors are waiting and are in no rush to invest in listed securities. At the same time, direct investment is becoming very popular. Therefore, private equity funds are quickly being filled and are, with great interest, looking at various sectors of the economy.
These players are interested in the potential growth of cash flow and prospects for a profitable exit from investment in the future. This is exemplified by Horizon Capital, which formed a fund worth $390 million for investment in Ukraine, Moldova and Belarus. Private equity funds do not simply enter a company, but also monitor its operations, and are involved in designing and implementing development strategies. Therefore, they are paying particular attention to the production of consumer goods, the financial sector, agriculture and the food industry. Horizon Capital is not the only fund that is considering opportunities for investing in the country's economy during this crisis period. As soon as next year, many foreign private equity funds and hedge funds will be buying a whole series of depreciating assets, as well as investing in various businesses.
2009 - Year of the buyer?
Experts believe that next year will be “the harvest” for a large number of small and large M&A transactions in various sectors of the economy. Most of these transactions will be of a “crisis” nature. Many transactions will be driven by desperation or will occur in aims of selling part of the business in order to attract additional capital. We expect that the market volume will be approximately $8 billion, that the average transaction size will be reduced, and that the number of transactions will increase significantly. The array of industries will be rather wide-ranging.
In such a system, the Investment Bank (financial advisor) plays an important role. It is via the investment bank that the demands of the investor and the sellers’ offer are realized. Its specialists maintain daily contact with different categories of investors and are able to respond quickly and effectively to find a buyer or partner for the business, conduct a valuation and analysis of the company, and negotiate and formalize the deal.
The specifics of M&A transactions differ from those of a private shares placement or an Initial Public Offering (IPO). Work on the M&A market involves a more subtle understanding of the market, a unique audience of investors, and various options for investing in companies. The most important part is a contact with potential investors. Typically, an owner of a Ukrainian company is very familiar with the owners of competing firms that are aware of clients interested in that particular industry. An investment bank is potentially much broader in terms of provided services, since it is a group of both strategic and financial investors who reach beyond the scope of Ukraine. It is important that the investment bank is aware of exactly which investors are currently ready to buy and what the requirements are for the potential objects of such transactions. The investment bank plays an especially great role in communicating with foreign buyers (investors) – a task that requires an understanding of customer attitudes, knowledge of their evaluation methods, internal decision-making processes, and the ability to carry out international negotiations.
Investment banks’ expertise is also invaluable to clients, as they have information on companies that have already expressed willingness to consider a proposal to acquire a business, as well as an extensive array of financial information regarding companies’ activities and that of their owners. This permits a sufficiently reliable identification of the most successful businesses, an assessment of which companies are closest to deciding to sell, and what performance may be expected for such companies in the crisis and post-crisis period.
2009 will undoubtedly be the year of the buyer, since it is namely money that will be most in deficit. 2009 will be the year when business empires collapse and others new ones are created. Therefore, the crisis should not only be seen as a problem, but also as a great opportunity to deploy and profitably build capital.
Press Service of the ‘Sokrat’ investment group
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