Acquisitions: Getting a Fair Deal in Today's Economy
- Published: October 01, 2002, By George Spilka, George Spilka & Assoc.
Middle-market acquisitions are transactions ranging in price from $1 million-$200 million. Many executives mistakenly believe that external economic conditions significantly impact the timing and pricing of these deals. This is a gross misconception. Economic conditions should have little, if any, impact on middle-market transaction prices as long as a strategic buyer is located.
A selling owner should not allow a large corporate acquirer to cite bad economic conditions as justification for a substandard transaction offer. Instead, the owner should demand a deal similarly priced to one under optimal economic conditions.
Acquirers are always trying to “steal” a seller's company. This psychology is a logical outgrowth of the capitalistic system and exists whether economic times are good, fair, or bad.
Large acquirers — by their very size and acquisitive nature — are usually more familiar with the acquisition process than a selling owner. This, combined with the vast financial clout of multinational companies, enables them to approach the prospective seller in an arrogant manner, demanding unreasonably low transactions prices. This is the norm. Unfortunately, most sellers fall prey to this approach and accept the norm.
The Issue of Volatility
The pricing of large corporate acquisitions, which have transaction prices in excess of $200 million, tends to be quite volatile and to mirror changes in the stock market. On the other hand, there is minimal volatility in the pricing of middle-market acquisitions.
As the upside on pricing of middle-market deals during good economic times is not significant, the downside volatility of middle-market transaction pricing during bad economic conditions also should be insignificant. However, large acquirers try to use bad economic times as the rationale for substandard offers. This is complete hogwash!
Middle-market transaction prices should be determined by the expected future earnings (cash flow) and the risk in achieving those earnings from the business foundation given an acquirer. The expected future earnings used in developing an acquisition price will more than likely be based on the projected earnings flow through the next business cycle. Therefore, the pricing of a deal should not be affected significantly based on what point in the business cycle a company is sold.
A strategic acquirer will determine an affordable transaction price based on the expected incremental future earnings produced by the combination of the two companies. To the extent strong synergistic benefits are produced by the deal, the combined future earnings of the companies will exceed the total of both operating separately. This enables the payment of a higher premium price by a strategic acquirer, while still generating an attractive return on investment.
An owner of a middle-market company should avoid selling to a private equity firm (financial buyer) that brings no synergy to the deal. Without synergistic benefits, the optimum acquisition price can't be paid.
In addition, financial buyers are known to be very risk-adverse. They must generate extremely high returns on their transactions to keep the flow of institutional money into their funds. These funds guarantee their future existence.
As financial buyers usually bring no synergistic benefits to the deal and typically very little in the way of additional management skills, the sole way they can produce high returns for their institutional investors is through buying at vastly discounted prices. Their prevalence reflects that few middle-market advisors are willing to commit the considerable time or develop the necessary expertise to locate domestic and foreign strategic players willing to complete a fully priced deal.
Fix Your Foundation
When a seller proceeds to the market, its business foundation should be in solid shape. This will have a substantial impact on attaining a premium price. A selling owner should have an acquisition advisory firm review its business foundation before proceeding with the sale. If there are any deficiencies in the foundation that would impact the transaction price, an advisor can recommend the necessary changes.
For a manufacturer, considerations in evaluating a seller's business foundation include the following:
- strength of the market niche
- the ability to control the customer base over a long period of time
- the capability of being a cost-efficient producer
- a modern plant and equipment
- the strength of the management group.
For a distribution firm, the following might be considerations:
- the quality of the product lines; the capability of management
- the sales force's control of the customer base
- the capability to maintain strong pricing
- the operation of a cost-efficient warehouse
- and the ability to procure goods at a price competitive with the company's large national competitors.
5 KEY POINTS
Here are the key points a selling owner should remember to consummate a fully priced deal during an economic downturn.
- Locate a Strategic Buyer
A strategic acquirer will be interested in obtaining your market niche to get the full synergistic benefits of the consolidation of the two companies. They will be interested in the intermediate and long-term benefits from the acquisition. As the short-term earnings and outlook should be not of paramount importance to them, they are less likely to allow current economic conditions to be the justification for a substandard offer.
- Investigate Foreign Acquirers
If you are advised by an acquisition advisory firm that is knowledgeable in utilizing the capabilities of the Internet in the search process, a vast array of foreign candidates becomes available to acquire your company.
One of the benefits presented by foreign acquirers is that their interest in a US acquisition is usually to obtain a strategic position in this country. Therefore, it is almost incumbent on them not to fixate on short-term performance as a serious deal-pricing consideration.
- Consider the Consolidation Factor
With the rapid consolidation that has taken place in many industries, the number of domestic acquirers has been reduced greatly. In some of these industries, this has made the major national acquirers brazenly aggressive in demanding substandard pricing for deals.
In these industries, a seller must remain patient and be tough and wait until one acquirer breaks from the pack and pays a fair price.
- Absence of Upside Volatility
As previously discussed, the pricing of middle-market deals never increases dramatically during good economic times or buoyant stock market conditions. During these conditions, the increase in middle-market deal pricing is extremely muted compared to large corporate deals.
Correspondingly, a middle-market seller never gets the benefit of a market top and, therefore, should never accept a reduced price during bad economic conditions.
- Reduced Earnings During Bad Times
During prolonged good economic times, many acquirers want to discount the value of recent earnings by those that will be realized during bad economic times. After an economic downturn/recession ends, these same acquirers want to price a middle-market company solely on the earnings realized during bad economic times. Don't let this happen when the economic downturn that started in the first quarter of 2001 ends.
The concept to remember is that middle-market deal pricing is dictated not by historical earnings but by expected future earnings and the risk in achieving those earnings from the business foundation given an acquirer. This, in fact, is the value of your business niche and should govern deal pricing during any economic conditions.
A large acquirer should not be allowed to take advantage of bad economic conditions to justify a substandard transaction price. Insist that your company be priced at a value that reflects the strength of your business foundation. Your niche is what a strategic acquirer really wants. It dictates the future earnings potential that can be realized from the acquisition. Correspondingly, it should determine the transaction price.
George Spilka is president of George Spilka & Assoc., a merger and acquisition consulting firm specializing in middle-market, closely held corporations. Castle Town Sq. South, Ste. 301, 4284 Rte. 8, Allison Pk., PA 15101; 412/486-8189; fax: 412/486-3697; This email address is being protected from spambots. You need JavaScript enabled to view it.; georgespilka.com.
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