Author: dcdwek

Introduction

After a decade of post-financial crisis restructuring, 2018 is a year of general optimism around the world, despite financial market volatility and political uncertainty. Companies however need to be increasingly aware of the importance of digital disruption and to carefully consider the competitive environment within their industry to prepare for both innovation and rapid change.

Mergers, acquisitions, joint ventures and divestments both domestically and internationally are all possible in a business environment of low-interest rates and plentiful supply of funding for attractive transactions. We will explore the economic environment, the strategic options a business needs to consider regarding digital disruption and the financing opportunities available.

The Economic Landscape

There has been an active start to 2018 with growth in both the developed and the developing world accelerating for the first time since the financial crisis. The IMF recently increased its forecast of global GDP growth to 3.9% for both 2018 and 2019 from 3.1% in 2015 and 3.6% in 2017

The policy of quantitative easing by the major central banks is reversing with interest rates beginning to rise moderately. There are signs of increasing commodity prices and wages, albeit limited. Furthermore, stock markets continue to be very active and volatility has increased.

There remains a heavy debt burden across the world economies and this may impact the price of assets particularly if interest rates rise too quickly.

In the US, recent tax cuts, expected increase in Government spending and positive earnings from corporates continue to support the market although uncertainty with international trade relations persists. In Europe, stronger growth, employment prospects and a relatively stable political environment is improving confidence.

China continues to grow strongly with a debt overhang, over-capacity issues and the threat of a trade conflict with the US and Europe. However, growth is expected to slow during 2018 as the dollar remains weak.

In the UK, the uncertain political environment due to the divisions regarding Brexit as well as the increasing level of inequality has left the current Tory Government with no clear majority This may lead to an early general election with the potential for a tax and spend Labour Government. This uncertainty has led to slower UK growth than in Europe. Following Brexit in 2019 and a minimum 2-year transition period, we believe that with goodwill from both the Europeans and the British, a mutually beneficial trade and a services agreement can be eventually negotiated.

The recent rise of populism since 2016 in the US and the UK has, in large part, not been replicated in other major economies. With rising inequality, there remains a risk of nationalism spreading with forthcoming elections as in Italy. However, the improving economic environment in Europe should temper this trend.

The key global relationship going forward is between the US and China which will impact trade and potential conflict zones such as North Korea and the South China Sea. Overall, stability both economically and geopolitically will have a positive influence on global markets.

Digital Disruption

The pace of change within industries is accelerating and businesses need to carefully consider their strategies and respond effectively. The developments in big data analysis, cloud computing and artificial intelligence have already had a significant effect on a variety of industries. Innovations in mobility and sensors are likely to speed up growth and productivity and create new opportunities for consumers and entrepreneurs. Significant change is anticipated with workers in certain industries replaced by robots and forced to adapt to a new environment.

Digital disruption is now a universal phenomenon affecting all sectors including, energy, finance, government, healthcare, hotels, legal, music, newspapers, retail and transportation. Companies should carefully consider their strategic responses and their focus on customer service. This will avoid the fate of Kodak and Blockbuster, leaders in their respective industries, but failed to adapt to the new business environments and to anticipate the requirements of their clients. This led to their ultimate demise.

It is the ability to both measure and to analyse data from clients and to provide targeted products and services that will allow companies to enhance their product and service offerings and to retain a strong market presence.

Some of the crucial questions to consider are as follows:

1. How will technology impact my business? Blockchain will improve connectivity between different markets. In finance it will have a significant effect providing a ledger in the cloud and therefore an ability to execute multiple transactions simultaneously with the potential to disintermediate financial institutions.
2. How will logistics and customer service affect my business? As an illustration, mid-sized retail businesses are increasingly unable to compete with online stores benefitting from significantly lower overheads. Maplin a UK discount electrical retailer with 200 stores and over 40 years’ experience recently filed for administration.
3. How can I increase my understanding of customer requirements and enhance my competitive position? Data analysis techniques are improving rapidly and can be employed effectively to provide the necessary decision-making information.

A careful review of the competitive environment facing a company is required annually or in certain fast developing situations quarterly to carefully monitor the opportunities and threats to their businesses. In the US, the Amazon, Berkshire Hathaway and JP Morgan collaboration in the healthcare sector to reduce costs for their almost 1 million employees through new technology will lead to pressure on profits for middlemen in the healthcare supply chain.  This is leading to M&A activity in the sector. The car industry globally is also facing challenges from electrification and driverless cars plus the move away from diesel fuel. The major companies are reacting by acquiring technology, investing in relevant start-ups or merging with competitors as the business environment shifts. With rapidly evolving disruption the key strategic options are as follows:

a.    Expansion via Internal growth;

b.    Acquisition of companies and/or new technologies;

c.    Divestiture of legacy businesses;

d.    Joint venture or strategic alliance in new markets; and

e.    Reduced headcount in certain markets.

Above all, flexibility is required, to adapt to the new market opportunities and threats.

Financing

Notwithstanding the modest increase in uncertainty in the financial markets, there continues to be an abundance of financing available for attractive projects. Banks are lending although the loan to value ratios offered are less aggressive than during previous cycles. New challenger banks such as Virgin Bank or OakNorth have been opened to cater for small and medium-sized enterprises and have been able to capture an increasing market share. Financing remains available for cash generative businesses with attractive growth prospects.

Equity investment for earlier stage businesses is available particularly in the growth sectors of artificial intelligence, blockchain technology, cybersecurity, data analysis and health. Attractive tax breaks for investors and funds including Venture Capital Trust (VCT) and Enterprise Investment Schemes (EIS) in the UK. Businesses will need to satisfy certain criteria typically a technology focus and less than 7 or in some cases 10 years since the launch of the product or service. Furthermore, the opportunity to invest via crowdfunding platforms has attracted many investors to these sectors

For businesses with strong sales growth and approaching break-even there are increasing amounts of venture capital and private equity funds available. This has often delayed the requirement for these businesses to raise equity on the public market allowing the initial growth phase to occur with less onerous regulatory requirements.

For larger businesses and for equity buy-outs, financing is available through large funds with several billion dollars under management, the ability to raise equity and access the debt markets in scale. Co-investments with insurance companies, pension funds and sovereign wealth institutions provide access to additional funding sources.

There continue to be a large number of share buy-backs by companies as well as private equity funds de-listing companies. However, the public equity markets remain available for larger businesses, typically those with £50m plus of sales and a positive and growing level of earnings before interest and tax (EBITDA). The AIM market in the UK and NASDAQ in the US cater for the faster-growing businesses but the availability of private finance together with costs of listing and the regulatory requirements have delayed the number of companies accessing the public markets. For companies requiring the ability to raise large amounts of capital relatively quickly as well as providing a currency for acquisitions, the public equity markets remain available.

Conclusion

The economic environment has improved following the financial crisis and simultaneously there is an increasing amount of disruption in many industries. Senior management needs to be cognizant of these developments to ask the right questions and to prepare their businesses for the next decades.

 

At DC Dwek Corporate Finance, we have over thirty years’ experience and a solid track record advising domestic and international companies to analyse, review and execute the strategic opportunities for expansion or restructuring together with the necessary financing required through venture capital, private equity, debt and the public markets.

David Dwek
Managing Director
DC Dwek Corporate Finance Limited

DC Dwek Corporate Finance Limited is authorised and regulated by the Financial Conduct Authority

This information is provided for information purposes only

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Opportunities and Challenges for 2018

The decision by the UK population to leave the European Union on 23 June 2016 was a momentous event for the UK and also for Europe. Three months after the vote, no clear decisions have been taken as to the future relationship. There remain a number of key questions that will need answering:

Will there be a “soft”, a “hard” or an intermediate Brexit? Even after the recent Conservative Party conference this remains unclear.

Will the UK remain part of the customs union and will companies be able to trade as part of the single market for both goods and services?

Will regulated financial services firms in the UK be allowed to sell their services in Europe without additional regulation?

How will immigration into the UK both from within and outside Europe be organised?

How will trading with non-EU countries change?

What will be the long run implications for UK growth and for Sterling?

Will there be a significant change in foreign direct investment into the UK?

Will Europe use the UK negotiations as a catalyst for change?

All these questions and uncertainties need to be considered by businesses and financial institutions as the environment changes.

We will summarise the current options and consider the implications of Brexit on the business community and how preparations can be commenced so that companies are in the best position to take advantage of the opportunities and to manage the uncertainties.

The Brexit Options

There has been much discussion since the June vote on the type of Brexit that will be negotiated. For the UK, the future relationship with the EU centres on several key issues, the access to the single market, intra-EU immigration, sovereignty and the judicial process. For the EU, the 4 Freedoms of Movement of goods, services, people and capital within the Customs Union are fundamental as is the project of closer integration for all its members. Negotiating an agreement will require significant flexibility from both parties. The three options at present are;

1. Hard Brexit

When the UK invokes Article 50 a two year process commences to leave the EU. Two agreements are to be negotiated, the withdrawal agreement and the trade agreement. The withdrawal agreement focuses on the requirements for the UK to leave the EU and the future relationship framework with the EU. The EU would like the UK to finalise this agreement before commencing discussions on a trade agreement. The UK’s preference is to negotiate the two in parallel.

Two years is a very short period to negotiate such complex agreements and the likelihood is unless an extension is agreed with all the member states of the EU, the UK would leave the EU without an agreed trading arrangement for goods and services. A transition period can also be considered before the formal exit from the EU. Trading for goods can continue as the UK is a member of the World Trade Organisation and the relevant tariffs would be applied.

Services, especially financial services is a more complex area as at present there is an agreement that a regulated UK firm can sell its services throughout Europe based on its UK regulation, the “passporting” rights. However, at the current time there is not the freedom to sell all financial services throughout the EU and any future agreement would need to take this into account. It would be detrimental to the whole of Europe if the UK’s role as Europe’s premier financial centre is compromised. There are alternatives following a Hard Brexit that may be considered or negotiated, including setting up a subsidiary and obtaining regulation in another EU country such as Ireland or Cyprus and then continuing to sell financial services within the EU. There will be solutions to every eventuality and businesses will need to take decisions once the political landscape becomes clearer.

Following withdrawal after two years, the UK’s sovereignty would be increased with a Hard Brexit. Controls on immigration could be re-imposed which would allow firms to hire talent globally rather than primarily from the EU. Bureaucracy and cost of hiring will have to be factored into the process.

The freedom of movement of capital is a global rather than a European issue and therefore the Brexit negotiations are unlikely to impact this freedom.

2. Soft Brexit

Retaining access to the single market for goods and services whilst agreeing an “emergency brake” on the number of immigrants entering the UK is the option most favoured by a significant proportion of the business community. However, the current positions of the EU and the UK differ on the freedom of movement of people within EU states. Any change to this important Freedom would require a unanimous vote of the 27 EU States and at present there is no clear agreement on this issue.

3. The Norway, Switzerland or Canada Models

Other countries outside the EU have varying arrangements regarding the sale of goods and services within the EU, the acceptance of freedom of movement of people, the contribution to the EU budget and importantly the acceptance of EU Regulations with limited or no ability to shape the legislation. The British Government will aim to negotiate a UK agreement which will be specific to its unique circumstances and will encompass elements of all the existing relationship models.

4. Alternative Relationships with the EU

a. Continental Partnership

The Brexit negotiations provide an opportunity for Europe to restructure. One option requires the EU to formally acknowledge that there is a two speed Europe. The partnership would provide a shallower relationship than full EU membership, but would be closer than a simple free trade agreement. For example there would be access to the single market, the ability to participate in the negotiation of relevant single market EU laws and the continued close cooperation on security and foreign policy. In return, there would be a continued contribution to the EU budget, exclusion from the free movement of labour and from further political integration. This continental partnership could be expanded to other countries within Europe that do not want to have full EU integration but require access to the single market.

b. Joining the European Banking Union

The City of London has a powerful voice within Europe and retaining passporting rights for UK based financial institutions is a key issue. One alternative to consider is for the UK to become a member of the European Banking Union without being a member of the EU. This will provide regulatory commitments, but importantly will allow passporting and if agreed, the free movement of banking labour across the EU. Regulatory and legal hurdles would need to be overcome. However there is a clear danger for both the UK and for Europe if there is no agreement: within 5-10 years significant financial business that is currently handled in the UK will migrate away from Europe to other financial centres including New York, Hong Kong and Singapore. This scenario will be to the detriment of the whole of the EU.

How should companies respond to Brexit?

This short review indicates the level of uncertainty that continues to surround the post-Brexit situation. Even when Article 50 is invoked, there will be a minimum of two years before the UK exits the EU and potentially many years before the trading agreements are finalised. Transition arrangements are also being discussed and may lengthen the process of disengagement from the EU, although may provide a longer period of certainty.

An agreement will be reached eventually. It will not satisfy all parties, but it will be workable.

The key approach for UK based companies and financial institutions is to continue developing their businesses. Scenario planning and impact assessment analysis on a business given the above options for the UK is important and Boards of Directors of small, medium and large companies need to be asking the relevant questions and carrying out the necessary analysis. These include:

1. Identification of the key business uncertainties:

a. Tariffs
Leaving the Single Market may result in tariffs for UK goods entering the EU. This could amount to between 1% and 10% of the value of the product. VAT will also need to be added and can be reclaimed. Extra bureaucracy is inevitable. For a business, the key considerations will surround product pricing. With a significant European market, acquiring a European presence will be beneficial.

b. Currency Implications
Sterling has fallen around 10% against both the Euro and the US Dollar since the Brexit vote. This can assist exporters as products will be cheaper for international purchasers. However, if there is significant import content with the product, these imports will raise the price of the final product that will be exported. The company will then have to decide whether to alter the price or the product margin, based on the competitive environment. Currency hedging is also possible, but normally for relatively short periods. An overseas subsidiary that is Euro or Dollar based will generate local currency costs and will act as a natural hedge.

c. Employee Hiring
The free movement of labour within the EU has been of great importance particularly for fast growing companies requiring manpower. Also the City, with its focus on international financial services has been a major attraction for European employees. The imposition of visa requirements on European nationals will increase the bureaucracy of the hiring process. Reciprocal arrangements will be negotiated for UK nationals wishing to work in Europe. On the other hand, it will also broaden the market for talent allowing non-EU labour with improved access to the UK.

d. Re-Location
Relocating all or part of a business to mainland Europe can be considered in order to simplify the trading process. This will depend on the amount of European business that is carried out. Different legal and regulatory requirements will need to be taken into account including labour and taxation laws in individual countries. Europe is not homogeneous and therefore careful consideration of the markets to enter is key.

e. Additional or Reduced Regulation
Clearly if the UK leaves the single market with no formal agreement with the EU then selling goods and services will lead to extra bureaucracy. In the financial sector it may be necessary to obtain additional regulation in addition to the FCA in order to sell financial services within Europe. As discussed previously, a deal will be struck, but contingencies need to be considered.

2. Understand the different scenarios in key markets particularly if there is a long period of uncertainty:

a. Within the UK
How will UK business be affected if there is a slowdown in growth and less foreign direct investment from overseas? Conversely, a more open UK market with lower regulation and taxation may lead to increased investment from foreign companies. In either scenario the competitive environment must be considered and international expansion into alternative markets reviewed.

b. Within the EU
How to maintain and increase trading in EU markets with the increased bureaucracy and regulation. More staff may need to be hired and also overseas offices or alliances formed.

c. Opportunities outside of the EU.
New trading relationships with Asia, the US, Latin America as well as the EU can be considered. Trading will be fundamental to the UK. The opportunity to forge relationships outside of the restrictions of the EU trading bloc can present exciting growth opportunities for companies.

3. Determine how to succeed under each of the scenarios and consider the strategic option:

a. Flexibility, to adapt to the new market opportunities and threats.

b. Expansion via Internal growth.

c. Reducing headcount in certain markets.

d. Acquisition.

e. Divestiture.

f. Joint venture.

g. Strategic alliance.

4. Review every quarter the scenarios to ensure that the company will be responsive to the      changing situation.

The following flow chart summarises some of the key strategic and financial options:

Strategic Options

Conclusion

In periods of uncertainty preparation is critical. Throughout the extended Brexit negotiations there will be continuous rumours and speculation and this will have an effect on the financial markets. It is therefore important for companies to consider their strategic options carefully so that they can react to both the opportunities and the uncertainties as a result of the Brexit vote. The UK has for centuries been a trading nation. We will continue to grow and to adapt to the new environment. The City of London is very powerful in Europe and globally. An agreement that meets the business requirements for both goods and services will be reached eventually. It will not be a deal that will satisfy all parties, but the UK will make it work and will continue to grow and prosper.

These are the personal views of David Dwek, Managing Director of DC Dwek Corporate Finance Limited

There are attractive opportunities for management teams to purchase their companies from larger organisations, in particular where the business has become non-core. This appeals to vendors as business continuity is ensured, with the potential to retain some upside through an equity holding.

Below, we provide a review of the process, the funding options and the key elements required for a successful transaction.

Key features for a successful MBO

Buyouts originated in the 1970s as large organisations restructured and disposed of non-core activities. Existing, or new, management teams backed by financiers rapidly became an important component of the disposal process.

Across the business spectrum, several factors are required for a successful buyout. These are:

• A quality business with predictable cash flows and growth potential. In particular, can a management team demonstrate that the development of the existing business has been constrained due to the ownership structure?
  A high quality management team with a motivated leader . Does the team need to be enhanced in the marketing or finance area, or is there the right balance of skills?
• Committed financial investors for both debt and equity . A buyout requires a strong partnership between all parties to overcome inevitable hurdles.
• An appropriate financial structure in terms of debt, equity, working capital and capital expenditure . A balance must be found between the attraction of leverage from an equity return perspective and achieving a realistic business plan. The failure of the Le Meridien hotel group buyout was due, in part, to the overambitious growth projections and the large amount of debt on the balance sheet. This became more evident after September 11 2001 , which resulted in a sharp downturn in the tourism industry.
• A clear exit route, either via a trade sale or a flotation, within a ‘3 to 7’ year time frame. The timing depends on the sector and on business performance. A clear exit goal has the benefit of focusing the management team on the task to be accomplished.

Detailed planning and positioning of the MBO opportunity is required at the outset. It is essential at the earliest opportunity for the management team to state its intentions to the vendors to ensure transparency, and for the MBO team to be considered seriously in the sale process.

The key objective for the management team during the ‘4 to 8′ month sale process is that the business’ performance continues to improve.

Planning

At an early stage, the senior members of the MBO team need to develop the new business plan. Typically, it differs from the business strategy agreed with the present shareholders, in particular regarding the growth and exit strategies. The plan provides the basis for discussions with potential equity and debt providers and is instrumental in providing the confidence required to invest in the project. At this stage, a financial advisor can provide the management team with assistance on developing the plan, and can give guidance on positioning it effectively for external financiers.

The planning process also clarifies the resource requirements including the key personnel and the amount of finance needed for working capital and for capital expenditure purposes. A typical plan includes a review of the business and the market opportunity from both a domestic and an international perspective. An analysis of the competitive environment and the marketing and distribution strategy is also required, together with the current and prospective customer base.

The growth opportunities and strengths of the management team are highlighted in the plan. However, it is equally important to emphasise the risks and the actions to be taken to mitigate those risks. The plan needs to be backed up by ‘3 to 5’ year financial projections and the relevant assumptions.

Finally, structuring the business for a future potential exit needs to be considered at an early stage. An example of a rapid exit was Homebase, the UK DIY store chain. Sainsbury’s sold the business to a private equity sponsored management team in early 2001. The business was then restructured and sold in November 2002 to GUS. This was a very profitable deal for both the management and for their financiers. The management benefited from Sainsbury’s desire to dispose of the business rapidly and from the upturn in the retail market. A focused strategy led to a sharp improvement in business performance prior to the eventual disposal to GUS.

Structuring the Capital

Whilst no two transactions are identical, there are several key components to the capital structure of a MBO. There are a number of layers of finance with returns commensurate to the risks of providing the funding. The key components can include:

• Senior debt . This is provided by a bank or a syndicate of banks. It has the highest ranking capital in the balance sheet and consequently the lowest servicing costs. The interest rate charged depends on the maturity of the debt, the agreed covenants and the risk profile of the business. A balance has to be struck between the amount of debt and the serviceability,particularly in a downturn. For a business with a stable cash flow, a 50%leverage is comfortable. This percentage can be increased especially when there is a large asset base.
• Mezzanine debt . This is subordinate to the senior debt and ranks higher than equity. It provides a higher return to reflect the increased risk. This debt may have a portion of equity warrants attached in order to improve the risk return profile for the lender. Typically 10-15%of the capital is in the form of mezzanine debt.
• Preferred equity or loan notes . This is provided by private equity investors and/or institutions.This class of capital ranks before equity and is typically convertible into ordinary shares.
• Ordinary equity . Management usually holds this class of equity. It is the highest risk, but provides the largest potential return.Management would tend to hold 15-25% of the ordinary equity at the outset with ratchets based on reaching agreed milestones. The vendor may also retain some of the upside in the MBO in the form of ordinary equity or loan notes.

Based on the business plan, the first step is to determine with the lenders the maximum level of senior debt that the company can accommodate comfortably. The other elements of the capital structure would be negotiated individually, but as part of the overall financing package.

Due Diligence Process

One of the main attractions to a vendor selling a business to the management team is the reduced level of due diligence required by the purchasers rather than a sale to an external party. This speeds up the execution process. Similarly,the level of warranties and indemnities provided by the vendors is typically lower, as the management team has a better understanding of the business than an external purchaser.

However, prior to agreeing to finance a transaction, banks and institutions conduct a thorough due diligence both on the business plan and the management team. A review of the financials, legal, tax and operational issues is undertaken by a team incorporating lawyers, accountants and, possibly, consultants. A holistic view of results from the due diligence process needs to be taken after which the negotiations can be finalised with the vendors.

No business venture is riskless, but an effective due diligence process can highlight the key issues that need to be addressed.

Corporate Governance

Whether the company is private or public, the directors’ responsibility is to ensure that any strategic transaction involving the transfer of ownership is carried out in the shareholders’ best interests. The involvement of the management team as a potential purchaser of the business creates the potential for a conflict of interest between their fiduciary duties to investors, who want the highest price for their shares, and the larger profits that the executives stand to make the lower the price of the buyout.

In these situations, the role of non-executive directors is crucial to ensure that objective decisions are being taken that will be in the interest of all shareholders. An example was the public to private transaction of Debenhams, the UK department store group, in mid 2003. Permira, the private equity investor submitted a bid on the condition that it could work with the management team. The intention was to deter rival bidders. The initial bid was recommended by the board, but to deflect criticism, the directors of the company were extremely keen to have another party enter the bidding to demonstrate that the process was transparent. This led to a payment of £1m per week from the company to the Texas Pacific and CVC consortium to prepare a rival bid. TPG won the battle and the management team was forced to resign. This highlights the importance of a transparent process, particularly in a public situation. It is also clear that there are always risks for the management team in aligning itself with one particular investor group.

Conclusion

Careful preparation, a well developed business plan, the formation of theright team and a transparent process are all critical for a successful MBO.

The time is now right for companies to consider divesting non-core businesses with the incumbent management team a serious contender.
The views expressed in this newsletter are those of DC Dwek Corporate Finance Limited and are provided for information purposes only.

Generating revenue growth for companies is more challenging to accomplish than cost cutting through a restructuring process. Acquisitions are therefore often perceived by senior management teams to be a more certain method of achieving their growth objectives. Whilst there is a greater willingness to complete deals, there remains a degree of uncertainty in the market as a large proportion of acquisitions fail to generate shareholder value for the acquirer. This is due to a combination of:

• Lack of realisable synergies;
• Unrealistic expectations, particularly regarding revenue potential;
• Too high a price paid and value transfer to the selling shareholder; and
• Ineffective integration planning and execution.

Many companies have been able to acquire successfully, to integrate diverse businesses and to generate value for all their stakeholders. Shareholders of both private and public companies are becoming more vociferous. Therefore, management teams must have a realistic plan to achieve the acquisition benefits. The recent bid battle between Disney and Comcast emphasises the current scepticism of shareholders on potential synergies. With the valuation of Comcast in decline following the announcement of the bid, the management team decided to withdraw their offer for Disney having failed to convince shareholders of the benefits.

Our aim in this newsletter is to review the key aspects required for successful transactions. Senior management, in particular, need to take a holistic approach to the entire acquisition and integration process. Careful planning is essential from the outset with one combined execution team.

Implementing a successful acquisition strategy

A clear strategic rationale is the first step to ensure a successful acquisition. The chances of success are significantly enhanced when the following are taken into consideration:

• Business synergies, where an acquiring company’s core competences are accentuated;
• Increasing revenues, particularly through access to additional markets both for existing and new products;
• Consolidating the business sector with a focus on the potential for cost savings; and
• Stronger barriers to entry from new entrants.

There have been countless examples of destruction of shareholder value by companies through diversification into unrelated business areas. For example, AT&T made an expensive, and ultimately, unsuccessful move into the cable television industry from the telephony sector in the late 1990’s. This failure was a result of the diversification into a business sector too far from their core competence magnified by the fall in the valuation of related companies.

The initial approach

Once an acquisition strategy has been agreed by the company, a small team is assembled including specialist business development, financial and operational personnel. Financial advisors should be appointed as early as possible to work with the team in researching and approaching potential targets, or merger partners, with the initial intention of selecting a short list of one to three candidates for more advanced discussion and negotiation. The advisors act as a catalyst to the process and their experience in completing similar transactions is crucial in overcoming the hurdles.

At this stage, creative discussions can take place between the parties at a senior level on growth strategies and on the vision for the combined business.

It is tempting at an early stage to focus on the price of the transaction; however, it is crucial to build momentum for the deal, for personal relations to strengthen and for all parties to believe in the strategic rationale, prior to moving to the next phase.

The due diligence process

Due diligence is the most time consuming and least creative part of the M&A process. Whilst fact checking is important and lends credibility to the management team, it is crucial to incorporate due diligence into the integration planning and to keep the same team involved throughout the transaction.

Due diligence can be separated into a number of areas depending on the complexity of the business. The main areas of focus are: accounting, legal, commercial, systems and human resources including pensions. The review will also provide the opportunity to deepen the understanding of the operating managers in the business.

A significant amount of time must be spent on commercial due diligence. Discussions with key customers and suppliers, joint venture partners and with competitors provide invaluable information on the prospects for the business. Often these more commercially sensitive discussions are permitted only after exclusivity has been granted to one party.

Whilst the devil is in the detail and the information gathered is critical to the decision on whether to proceed with the transaction, senior management must also take a more strategic view of the opportunity and use the acquired facts in the negotiations.

Pricing and final negotiations

The majority of acquisitions over the last 20-30 years have not created value for acquiring shareholders. There are many reasons for this phenomenon including the irrational exuberance as to the strategic importance of the deal, weak integration and simply paying too much for the business. In the excitement of the endless opportunities that an acquisition brings, it is essential to have a disciplined approach to the valuation of the business and to be able to walk away from a transaction at the appropriate time. There are several valuation methods that are employed including discounted cash flow, earnings and operating profit multiples as well as analysing comparable transactions.

The intrinsic value of the business is the net present value of expected future cash flows independent of any acquisition. This is the stand alone value and the basis for negotiations. Any price paid above the intrinsic value represents a premium to be shared between the target company and the acquirer’s shareholders. This premium includes a market premium and the potential synergy value. These synergies comprise of revenue enhancements, cost savings including financial engineering and tax benefits as well as process improvements.

The recent pharmaceutical acquisition of Aventis by Sanofi-Synthelabo of France highlights the transfer of value between shareholders. After three months of heated negotiations, at the eleventh hour, Aventis convinced Novartis, a potential white knight, to enter into negotiations. This resulted in Sanofi raising its bid by 14% to win control of Aventis. The higher price paid intensifies the pressure on the Sanofi management team to make the acquisition work. This transaction also highlights the importance of having alternative options such as a white knight in the final negotiations to achieve the best outcome for the selling shareholders.

Achieving closure

Once terms have been agreed and the final agreement signed, there is typically a one to three month period before all the documentation is completed and the approvals received. A surprising number of deals fall apart at this stage and whilst there may be legitimate reasons such as a material adverse change in the business, it is also vital for the acquirers to sell the deal to the company’s stakeholders and to maintain the momentum to ensure there is rapid closure.

Integration

Effective acquirers, such as GE, have perfected their ability to integrate companies rapidly into their organisation. The key elements in a successful integration are as follows:

• Begin the integration process before the deal is signed with a combined due diligence and business integration team.
• Dedicate a full time individual with decision making powers to manage the entire process.
• Ensure constant communication to minimise the loss of morale. Reaching to the second tier of management as fast as possible and clarifying their positions reduces the possibility of significant defections.
• Focus on a rapid integration process. There needs to be clear decision making authority from day one. A 100 day plan is required and tough decisions, particularly on personnel issues, have to be taken at the outset. Paralysis in decision making must be avoided.
• Integrate not only the business operations but also the corporate culture. This is particularly important in cross border mergers.
• Poor integration planning and execution is one of the major reasons for value destruction in mergers and acquisitions and senior management must devote all the necessary resources to overcome the hurdles.

Conclusion

Successfully acquiring and integrating businesses only occurs through a disciplined process and experience. A clear strategic rationale is required at the outset with identifiable synergies in combining the businesses.

A combined acquisition and integration team is required, which is supplemented by the necessary advisors to provide an independent view. Thorough due diligence must be undertaken which is critical both to the final negotiations and to the integration.

It is important to note, in the excitement of the deal, that often more value can be generated for shareholders by walking away from a transaction than by pursuing a merger or acquisition of limited strategic benefit.

In any case, courage and tenacity are required to become an accomplished acquirer.

The views expressed in this newsletter are those of DC Dwek Corporate Finance Limited and are provided for information purposes only.

The decision to stay private or to remain public is one of the most critical in the life of a company. The availability of a variety of financing options from the private equity and banking sectors has provided both large and small businesses with an alternative to a formal listing on one of the main stock exchanges.

Many companies are also considering de-listing from the stock exchanges through public to private transactions. There is often a belief that the market is undervaluing their business prospects or that life outside the public gaze is less onerous.

However, the public markets, at the appropriate time, provide excellent liquidity for investors and facilitate the use of company shares for fund raising, acquisitions and strategic purposes.

In our latest newsletter, we explore the options of staying private or remaining public. The ultimate decision for the company rests with the option that facilitates the growth in shareholder and stakeholder value.

Why do companies want to go public?

There are many reasons for companies to seek a listing on a major stock exchange and in the appropriate circumstances these far outweigh the associated regulatory and related costs. These are:

• Capital for growth. Fast growing companies are often constrained from rapidly raising funding in the private markets. Public companies can raise funds efficiently from equity investors through rights issues and the sale of shares to domestic and international investors. Similarly, once a company is listed and has developed a diverse investor base, it opens possibilities to access the domestic and international bond markets. The hybrid securities markets are also available and provide a variety of options such as convertible securities.
• A currency for acquisitions. When a company is public, shares can be used for acquisition purposes as the stock market provides both liquidity and a clear valuation of the business. The shares can be exchanged for those of a target company or funds can be raised from investors to pay for a specific transaction.
• An opportunity to exit the business. For the shareholders in a private company and for employees with stock options, a stock market listing provides a market valuation for their equity holdings. It also provides the opportunity to sell all or part of their shares and to exercise their options.
  This is of particular importance to short-medium term financial investors looking to exit all or part of their investments. However, it is normal practice when a company obtains its primary listing for existing shareholders and particularly for management to be locked-in and prevented from selling their shares for a short period.
• Prestige and peer pressure. Companies on attaining a certain size in an industry and where the leading players are all listed on major stock exchanges often feel that it is necessary to join the “club” of their listed peers. A listed company can also attract talented management and employees in an industry helped by the resulting transparency of the business prospects.

Becoming a public company is an important milestone in the development of many businesses. Being under public scrutiny requires more rigorous regulatory and governance procedures. In addition, a company must be prepared for the enhanced financial reporting requirements and the resulting analyst and investor attention. However, these procedures can be very effective in professionalising and in providing a strong platform for the development of a business.

Why are many companies looking to revert to private status?

Notwithstanding the many positive benefits of a public listing, there are a number of public companies or large private companies that have eschewed the public markets and have remained private. The main reasons are as follows:

• The availability of alternative sources of capital. The phenomenal growth of the private equity market over the past few years provides an almost limitless amount of equity capital for companies with the requisite growth prospects. There are an increasing number of the private equity groups managing funds of several billion dollars combined with an increased capacity of the banking community to provide significant leverage for transactions. This has provided a realistic option for companies with small, medium and large market capitalisations to revert to private status.
• Undervaluation by the public sector. There are certain sectors which at times become unfavourable for institutional investors. This is often the case for companies which are complex to value, including holding and property companies. The market often values such businesses at a discount to the net assets and provides an investor group with the opportunity to purchase the assets at an attractive price.
• One classic example is the Virgin Group in the mid-1980’s. Richard Branson, the flamboyant entrepreneur, wanted to raise funding to develop his airline, music and related businesses and he therefore floated part of his group on the London Stock Exchange. The group’s share price underperformed the market and two years later Richard Branson took the company private, citing that the investor community was short-term focused and misunderstood the growth prospects for his businesses.He has since grown his group internationally in a variety of sectors, including budget and long haul airlines, train operations and mobile phone networks.The group has typically raised finance through individual transactions such as the sale of the music business to Thorn-EMI, the formation of a $600m joint venture between Virgin Atlantic and Singapore Airlines or through the flotation of  Virgin Blue, the budget Australian airline.
  Ability to restructure a business outside the public eye. An undervalued business or a business in need of restructuring can be taken private and reorganised without the quarterly reporting requirements and the associated analyst and media attention.
  Management and investor incentives. Taking a company private, restructuring it and then concluding a sale of the business either in the private or public markets can be very profitable for the management teams and their financial backers.Institutional investors are however aware of the upside potential in a successful public to private transaction and are consequently demanding a higher premium for the initial sale. They are also often sceptical about the upside potential when a company returns to the public market following a restructuring. Notwithstanding these reservations, there remain significant incentives for a successful public to private transaction.
  Whilst strong corporate governance is required for all companies, a private company has a reduced regulatory, media and analyst burden as compared to a public company. However, private equity investors and bankers are rigorous in their monitoring role of their investments and the management team are set strict performance targets. Successful exits are very well rewarded with management teams typically awarded 10-20% of the equity in the business.

Conclusion

With the availability today of almost limitless amounts of capital, large and small companies with solid growth prospects have a wide range of options in deciding on their public or private status. The regulatory burdens of running a public company today have become onerous and this is prompting a number of companies to consider the attractive option of private status. Whilst the governance and professional requirements are the same whether a business is private or public, the ability to restructure and refocus outside the public eye is a tempting option and provides the management team and the shareholders with strong potential financial incentives.

Selecting and executing the appropriate strategy to support a business throughout its development cycle requires the necessary management expertise, combined with sound financial advice.
The views expressed in this newsletter are those of DC Dwek Corporate Finance Limited and are provided for information purposes only.