Key Note Speech to Cass M&A 30.9.15
Good afternoon ladies and gentlemen, it is
a great pleasure for me to be back at my
alma mater again, some 25 years after
graduating with an MBA in Finance and
Banking.
My qualifications for being here are largely
down to the fact that I owed Scott
(evidently); that I have recently been
installed as the Master of the International
Bankers Livery Company (more on that in
a moment) and that after 43 years as a
banker, most recently completing 25 years
as a Vice Chairman in the Corporate and
Investment banking business at Citibank, I
might have some perspectives on the
M&A market.
Just quickly then on the Worshipful
Company of International Bankers – as
some of you may know, Livery Companies
were founded in the Middle Ages in the
UK (and other countries) to regulate
industries and to provide a structure for
apprenteships. Our livery company was
only founded in 2000 when membership
was extended from members of the
Commonwealth and EU, to all
nationalities. All livery companies have
the same core aims, namely, Charity,
Education, Fellowship and Promoting the
Profession. If you are interested in
learning more, please google international
bankers – one word dot org dot UK or by
all means contact me…...
OK – back to M&A…..
My talk is in 2 parts – firstly I thought it
would be interesting to look at some past
deals by way of introduction and example,
before moving onto the specific
conundrum set for me by Scot around the
question of private equity vs strategic or
trade buyer.
I’ve chosen as my initial example, the first
hostile deal in the UK – partly because my
wife’s grandfather was a prime mover in
the tale but also because it probably
marked the beginning of the modern age
in M&A – certainly in the UK.
The contest between the Aluminum
Company of America (known as Alcoa)
and Reynolds Metals Company with its
British ally Tube Investments Ltd (or TI)
for a stake in the British Aluminum
Company, became know as the Aluminum
War (not to be confused with the Russian
Aluminum Wars of the 1990’s when
several people in the industry were
assassinated every week – the 1950’s
version was hotly contested as we’ll see
but did not become physically violent –
although a close run thing at times, I
believe!).
Perhaps it would be helpful to have a little
context first on the industrial dynamics of
the aluminum industry – reflecting the
technical and economic situation in the
development of the product.
Aluminum production was always volatile
largely because of the very large
investment needed for new plant
development (similar to the steel
industry).
During the Second World War, demand
rose sharply primarily due to aircraft
industry demand. Immediately afterwards,
the aluminum industry found it had too
much capacity for peace-time demands.
However, it spent a lot of time and
ingenuity finding new uses for its products;
namely in packaging, vehicle construction
and house building. The result was that
from 1947 onwards producers found
themselves unable to satisfy the demands
of post-war growth. This led to substantial
investment in new plant to the extent that
10 years later by 1957, supply had again
exceeded demand – with producers
working at 80% capacity. Not only was
the US aircraft industry in the doldrums
but also it seemed likely that the US
Government, that had been stockpiling
surplus aluminum, would stop buying the
following year. Having said that, there
was confidence in the future as engineers
demonstrated the advantages of
lightweight alloys.
Alcoa had been the monopoly aluminum
producer in the US until the war.
Since then Reynolds and Kaiser
Aluminum and Chemical Corporation had
both grown to nearly the size of Alcoa.
The other large producers were the
Aluminum Company of Canada (Alcan),
the British Aluminum Company and the
Russians.
The American producers looked at this
competition with growing unease and, the
fear and greed that drives capitalism and
hence M&A, meant that there was an
opportunity to restructure the industry.
Battle commenced in late 1958 when
Reynolds and Alcoa tried to gain control of
British Aluminum, the largest UK producer
and one that had just completed a new
plant in Canada that would fit well with
Reynolds expansion plans.
An important side issue was the role of the
merchant banks, as investment banks
were then known. Lazard’s and Hambros
acted as joint advisors to British Aluminum
whilst Reynolds was advised by two upstart banks SG Warburg and Schroders!
Reynolds was advised by Warburg to
cooperate with a British firm, Tube
Investments or TI, to mollify public opinion
in the UK. TI was by this time a leading
industrial group headed by my wife’s
grandfather, Sir Ivan Steadeford.
On the advice of their banks, Reynolds
and TI began acquiring shares in British
Aluminum through nominees, as was
allowed at the time – and by Oct 1958
they held 10% of the target without its
knowledge.
Stedeford met with the Chairman and MD
of British Aluminum a few days later and
told them he’s like to have “an association
for future development”. He was turned
down as they were already negotiating
with another party – Alcoa.
When Stedeford returned a few days later
with a definitive and attractive offer, he
was not only rejected - but the Chairman
refused to put the offer to shareholders.
So, Stedeford went public with his offer
that was at a 30% premium to the Alcoa
bid!
Headlines exploded over the front pages
of the press and the management and
advisors of British Aluminum were angrily
criticized for not consulting their
shareholders. The board really hadn’t
come to terms with the way shareholdings
had graduated to major institutions that
were increasingly concerned with return
on investment rather than protecting the,
perceived, national interest.
Needless to say Reynolds and TI carried
the day and jointly acquired British
Aluminum but not before much
metaphorical blood had been spilt.
I include it partly because of family
interest; partly because it was a seminal
moment in being the first hostile deal – at
least in Europe – but also to demonstrate
the emergence of investment banks as
major catalysts and players. Also a good
example I think to enable us to see the
clear industrial logic of the transaction in a
wider economic context…….
Moving swiftly along, the 1980’s saw the
emergence of multi-billion dollar M&A
deals, the largest being the famous or
infamous “barbarians at the gate” - highly
contested acquisition of RJR Nabisco by
the private equity firm KKR. The cost at
$25 billion, was roughly twice the size of
other mega-deals of the time such as
Chevron’s purchase of Gulf Oil; Kraft by
Philip Morris and Squibb by Bristol Myers.
The Nabisco deal stood out not only
because of its size (at the time) but also
because it was the first deal of this size by
an investment company rather than a
trade buyer – and one using leverage
rather than stock to complete the
acquisition.
Around the same time, conglomerates
such as the UK/US Hanson Trust were
using similar leverage and asset stripping
techniques to acquire assets that could be
managed in a more aggressive way to
produce significant financial returns.
Which reminds me of a story I was told
about a transaction Citibank financed at
about this time.
Hanson had acquired a retail newspapershops business as part of the acquisition
of, Imperial Tobacco I recall. It sold the
business in a management buy-out – the
current corporate finance fad at the time.
Citi financed it on the basis of a plan to
squeeze working capital ----- this from a
business being sold by the UK’s leading
proponents of squeezing assets!
Needless to say, it went bust very soon
afterwards. A great example of the
financiers not looking at the wider picture!
The mild recession of 1990 allied to the
collapse of the junk bond market led to the
unraveling of a number of high profile
leveraged deals. WPP being a good
example – if one that came right in the
end. Martin Sorrell, having recently left
Saatchi & Saatchi as CFO, acquired a
small listed company called Wire and
Plastic Products that made shopping
trollies. With funding from JP Morgan,
Bankers Trust and Citibank he
transformed WPP into a highly leveraged
acquisition vehicle to acquire marketing
company assets – most significantly
J Walter Thompson and then Ogilvy &
Mather.
Marketing budgets were pared to the bone
during the early 90’s and it took a number
of years for WPP to emerge from
restructuring before roaring back to
become the colossus we know today.
Martin learnt several valuable M&A
lessons – don’t over-extend on leverage;
earn-outs are a good way of ensuring you
get what you pay for; and a maniacal
focus on cash ensures you don’t run short
of liquidity!.........
In the 1990s, the markets became
enthralled with consolidating deals known
as roll-ups. Fragmented industries – like
marketing services and advertising – were
consolidated in a strategy to combine
smaller companies into a national
business to enjoy economies of scale both
in terms of costs and revenues.
Other examples were funeral businesses,
printing, office products and floral
products.
One that I was close to was BET which
tried to roll-up the office services business
in the UK by acquiring thousands of mom
& pop small businesses to form a major
FTSE-sized company.
It ran into indigestion issues as it sought
to manage all these deals, struggled to
integrate the businesses and when it did
found that although they were in a good
position then to bid for nationwide
contracts, found that they could always be
undercut on a local basis by minimum
wage small owner-managed operators. It
was eventually absorbed into Rentokil.
As the 90s progressed, the forces of
economic growth and the pursuit of
globalization affected all economies as
companies sought to service global
markets. By 1999, the value of deals in
Europe was almost as large as that of the
US, where starting in 1996 the dollar value
and volume of deals had increased
dramatically.
Furthermore, the end of the 90s also saw
the emergence of M&A in Asia as many
Asian economies began to open up, giving
rise to sell-off and acquisition
opportunities……
The end of the millennium coincided with
another recession, and the technology
company bust, but by 2004 M&A demand
had begun to increase significantly. In
part this was fuelled by demand from
private equity, aided by a period of low
interest rates and combined with a long
bull run in the property and stock markets.
How could one go wrong?!
EMI was one of the world’s great music
companies, alongside Universal, Warner
and Sony. It had run the usual gamut of
horizontal, vertical and conglomerate
activity over the previous century; was
acquired by Thorn (an electrical
engineering business) in 1979 then
demerged in 1996.
It had 2 businesses: recorded music that
ran Capital Studios in LA and Abbey Road
studios in London and it owned the rights
to such iconic artists as the Beatles,
Robbie Williams, Pink Floyd, the Spice
Girls (it was a while ago now!!).
It was a global player if a little weak in the
US compared to its peers. In its other
business – Music Publishing, it was a
world leader - holding and administering
music rights on behalf of songwriters.
In 2007 it employs 6,300 people in some
50 countries and has a market cap of
around £2.3 billion. Revenues are £1.75
billion with EBITDA margins of around
10%. 60% of EBITDA came from the
publishing arm and these were high
quality stable revenues.
The recorded music business was being
hit by technological and cultural changes
as the business migrated to digital
platforms - and revenues were under
severe pressure.
Net debt, at this time, totals just over £1
billion giving the company a fairly racy
leverage ratio of around 6 times – so its
bankers are concerned about their loans,
if somewhat mollified by the perceived
value of the music publishing assets –by
themselves thought to be worth over £1
billion and easily securitisable.
For the last 10 years EMI had been the
subject of repeated failed attempts to
merge with Warner Music (which was
strong in the US) and would bring the
combined entity to the same size and
market presence as Sony and Universal.
However, regulators had always opposed
this concentration of market power and
the bids had foundered.
In late 2006, EMI had been approached
by several private equity firms. So,
Citibank, Deutsche Bank and Greenhill
were retained by EMI as financial advisors
to consider a sale. Futhermore, Citi and
DB were also cleared to provide financing
to potential bidders, provided appropriate
Chinese walls were instituted to avoid
conflicts of interest.
Early in 2007 EMI issued 2 profit warnings
and indicated that a likely breach of
banking financial covenants would follow
on the next testing date – lenders were
comforted by the on-going sale process.
In May 2007, Citi signed commitment
papers to provide 100% of the financing
for Terra Firms (Guy Hand’s private equity
vehicle) to make a public bid for EMI. It
was expected that DB, Barclays Capital
and Bank of Scotland would join the
financing group imminently.
What could go wrong?
In July 2007, Bear Stearns liquidated two
hedge funds invested in mortgage-backed
securities.
In August, the EMI bid goes unconditional
and funding is made available by Citi in 2
tranches - £1.5 billion to fund music
publishing, with an exciting leverage of 13
times; and £1.2 billion to fund the
recorded music business at what turned
out to be 30 times, as EBITDA dipped
post closing.
In September 2007 there was a run on a
little known building society called
Northern Rock. Needless to say no
further commitments of financing were
forthcoming and Citi was stuck with the
total financing of over £2.7billion.
2008 goes past in a blur as EMI’s financial
situation deteriorates…….In September
Lehmann files for bankruptcy, Merrill
Lunch is acquired by BoA and AIG is
rescued by the US taxpayer. The year
ends with 3-month treasury bills yielding
minus 0.01% and 2-year treasuries
yielding below 1%.
Early in 2011, EMI is placed into
administration and becomes a wholly
owned subsidiary of that well-known
rapping and hip-hop band known as
Citibank.
The businesses are recapitalized and
Music Publishing sold for around £1.4
billion to a Sony-led consortium; and
Recorded Music, to the now Vivendiowned, Universal Music Group, for around
£1.2 billion.
A combination of over-payment for assets
that were in free-fall in a fast changing
technological environment; a lack of due
diligence and over-aggressive funding in
what was imminently to become the
financial crisis, all took their toll on the
deal - with a good dollop of hubris all
round!
So what does all this history tell us about
the M&A market in general and in
particular the continuous tension between
private equity and strategic or trade
buyers?
Claudia Zeisberger and Jan Vild in a
recent paper entitled Strategic Buyers vs.
Private Equity Buyers in an Investment
Process suggested the following thoughts:
On fundraising, whilst unlike strategic
buyers, PE firms have the challenge of
external fundraising – this may also likely
increase financial discipline on those
firms.
On deal sourcing, strategic investors have
the benefit of best knowing the
sector/target. Conversely, PE firms tend
therefore to go in for more rigorous
analysis (of which more later).
It follows that on due diligence corporate
buyers tend to look at the big picture
(most notorious example being Lloyds
acquisition of Bank of Scotland!) whereas
the PE firms will take a longer and deeper
review in most cases (which may put them
at a disadvantage in deal closing).
When valuing a target, strategic buyers
will normally focus on preparing DCF
models to enable them to identify the
biggest value impact synergies, whereas
the PE firm will use an LBO model which
by leveraging the transaction increases
their IRR.
It is often felt that strategic buyers show a
lack of financial discipline relying on
optimistic cost synergies to support what
are thought of as must win strategic deals!
PE firms’ repeated experience in
structuring and negotiating deals often
gives them an advantage in closing
transactions as long as they avoid putting
noses out of joint!
In most cases, strategic buyers will be
looking to fully integrate the acquired
target as quickly as possible to realise
planned synergies. However, it is
estimated that a high proportion of M&A
transactions falter due to poor execution
often due to culture clashes. PE firms
likely avoid this issue as the target
continues to stand alone as a business.
Again PE firms’ vast experience in postacquisition execution tends to stand out.
Finally, the ability of strategic buyers to
think longer-term than the IRR-focused PE
firms can benefit the former by ensuring
investment over a longer period.
Let’s review some of these issues in
practice by looking at the position of a
specific seller of a business and his
experience. Paul Spiegelman sold his
business BerylHealth to a strategic buyer
a couple of years ago. He gives 6 reasons
why he chose a strategic buyer over a
sale to private equity:
Firstly, he found that PE firms were
focused on short-term financial returns
that could force decisions NOT in the best
interests of the company whereas the
strategic buyer wanted to build for the long
term and perhaps more importantly
therefore was very patient in the way it
went about its negotiations. This is
always going to be a big positive point for
strategic acquirors as PE funds by their
very nature usually run for 10 years and
average holding of assets will tend to be
5-7 years.
Secondly, the acquirer sent a large team
to do due diligence at the target but were
reasonable and fair whereas his
experience of PE was that there was a
distrustful view taken of numbers and
projections which set a more negative
tone to negotiations. This is not all that
surprising given that PE firms will not
usually have cost synergies to soften the
blow of projections missing targets.
Thirdly, he just failed to find an emotional
fit with the expensive tastes of the PE
employees with fancy cars, expensive
expense accounts and so on. Hard to
debate such a visceral issue.
Fourthly, on a similar theme, he just didn’t
trust the PE team to stick with the
company if it didn’t hit its financial goals.
He found the strategic buyer team much
more humble I their approach believing
they could learn much from the target.
Fifthly, and similarly he simply LIKED the
people at the strategic buyer – they had a
caring attitude to their workers.
Sixth and lastly – and key – was that he
was looking for a partner who could help
him achieve his dreams – beyond the
price issues.
All of this is, I think, interesting in that it is
predicated on a view from someone who
is staying in the business post acquisition
– much more likely to be the case when
you sell to Private Equity in practice.
Let’s turn to another live situation where,
not unusually, a PE-owned company is
approaching an IPO when a strategic
buyer suggests a merger. (As you all
know “merger” is just code for an
acquisition – it just sounds friendlier and
more consensual!) The management of
the target would clearly prefer to be
running their own company, rather than to
run the high risk of being “let go” by a new
parent. The PE owners will have a more
objective evaluation to make as to
whether the expected future NPV of the
asset exceeds the strategic buyer’s offer.
Not easy to determine and will have to be
considered within the context of its
existing portfolio.
In summary, selling to a strategic buyer
will tend to mean the following:
1)
the owner or owners are selling out
and are unlikely to be involved in the
company going forward.
2)
You are most likely to get the best
price for your company from a
strategic buyer, as it is likely that the
acquirer will be able to extract cost
and add revenue synergies from
combing the target with its existing
business.
3)
Most selling owners will see that
the management is taken care of
either by having them absorbed into
the new combine and/or by cash or
equity on close.
Conversely, private equity will likely keep
on the existing management and
potentially the owners and will empower
management with control and/or strong
incentives to meet financial targets and
hence returns for the PE fund.
Of course, this is to suggest that it is
simple decision to choose between these
two exits, whereas, in reality, there are
other options available to raise capital and
there are numerous variants in terms of
structures to raise capital. However, the
seller has to establish his or her priorities
between cash and legacy.
Finally, it is estimated that PE firms are
currently sitting on an estimated $3.6
trillion of assets under management
including a third of that in cash to be
invested. Public companies are holding
even larger cash balances. Debt is still
cheap by historical terms and is likely to
remain so even given a likely move up
over the next year or so. Public
companies have spent the last several
years cutting costs but investors want
growth so CEOs are under pressure to do
M&A. With that as a backdrop, M&A this
year and next is likely to continue to grow
at a fast pace….comfort for investment
bankers and prospective investment
bankers and M&A research directors…
Thank you for your attention.