Tuesday, November 11, 2008

Isn't It Strange?

During the pre-crisis market euphoria, M&A activity was robust. Multiples offered by buyers were rich, and premia to market prices of public companies sometimes took the breath away. Think about the many deals that were put on hold or which are no longer on the radar screen of the acquiring company's board. Does this make sense?

If an acquisition fills a legitimate strategic need, bankers are hired, spreadsheets are cast, fairness opinions abound, the acquisition is now teed up. Markets freeze and the deals wither. However, if all the reasons for looking at the acquisition were truly of strategic value, then all that should have changed--in many cases--is just price. Markets handle this issue all the time.

I remember some McKinsey research that said in market downturns, 60% of companies that made acquisitions in frothy markets choose to do nothing in a downturn. Isn't that strange?

Seller's expectations will be brought back down to earth. This is particularly true for private companies that are now facing a change in the capital gains regime from a new, activist administration in Washington. Weakened currencies of the buyers hamstring their ability to be indulgent with their owners money. If the strategic reasons are still there, come up with a new deal structure, or start with some form of partnership that leads to a deal later.

There are a number of microcap public companies that are profitable, with cash on their balance sheets that can earn higher valuations if their growth prospects are visibly enhanced. Acquisition targets for these companies are most likely private companies. It would seem that CEO's and their boards, instead of worrying about next quarter's earnings--which are probably going to worse than plan--should be looking at acquisitions.

Some key criteria for the acquisitions? A business with good long-term economics. A business that adds luster to the portfolio. Honest, trustworthy and committed management. A reasonable price.

Boards and management almost never talk about overpaying in a frothy market, and yet it is almost always the case that the acquirer does so. In these kinds of markets, there is some risk that prices continue to decline for targets, driven largely by macro issues that diminish the economic value of the target. Again, these are things that can be negotiated into a structure provided that both sides see the strategic benefits of the acquisition.

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