Rocky road

Multiples up for the right businesses

Competition will keep prices up in some deal sizes

While most talk about decreasing multiples, and anxiously await vendor price expectations to fall in line with those deemed appropriate by private equity backers, some feel high prices will still be paid in certain circumstances.

"We've seen more than 100 opportunities in the last year," says David Menton, managing partner at Synova Capital, a small buyout house that has raised more than £70m for a first close in December 2007 and currently has enough on the table to reach its £100m imminently. "But of these 100, I can count on my hands how many look interesting, and on one hand how many we would actually follow up."

While this is not surprising - there are often more people looking for capital than houses willing to give it - the difference now is that the options are far more limited than ever, with the banks and public markets closed for business. "With more banks likely to be nationalised in 2009, their focus will be on lending capital to small businesses and on homeowner loans. Leverage for private equity will be way down the line. However, the lower end of the mid-market, where we invest, tends to rely more on corporate lending from the banks rather than the leverage teams," cautions Philip Shapiro, managing partner at Synova. This rings true with the cutbacks the leverage teams have announced, with many slashing numbers by up to 80%, to single digits.

Basic economics of supply and demand tell a story of hefty multiples for some businesses at the larger end of the mid-market. According to figures from Synova, around 64 deals were done in 2007 with an EV of £50-100m, in an extremely competitive segment of the mid-market with over forty funds looking to invest. This was down two thirds to just 21 deals in 2008. The drop is similarly stark in the £30-50m EV range (from 58 to 22 deals). Finally, a drop of around 50% in the lower mid-market (111 deals in 2007 down to 63 in 2008 for EV £10-30m) still delivers a significant number of investment opportunities given there are far fewer funds seeking to deploy capital, allowing multiples to continue to decrease.(c) 2000 Crain Communications Inc.

BANKS YANK BACK

2009 will be the year of loan-to-own

Banks are likely to consider pulling clauses as companies breach covenants. "I have no doubt that banks will be at the forefront of activity next year," says Andrew Masraf, partner at Pinsent Masons. "Banks are likely to look to charge fees for waivers and covenant re-sets and amending the margin rates for companies which have breached covenants but are viewed as strong enough to pull through. The size of these fees may themselves put pressure on cashflows."

There is also likely to be a (large) increase in debt-for-equity deals: Wyevale and its main creditor HBOS may prove the beginning of a big wave. With banks not really geared up to manage equity stakes, large shareholdings may need to be re-homed. This may prove an opportunity for new GPs to enter at discounted rates - effectively a bank-intermediated secondary buyout with little or no upside for the original vendor.

Masraf explains that such changes of ownership may trigger change-of-control clauses in underlying contracts, giving rights to counter-parties. "The change of control through the banks taking equity stakes could give rise to potential consolidation issues for the banks and governance issues for them. How will they monitor their investments? If they appoint directors to the boards of investee companies, how will they approach directors' duties and liabilities and conflict issues?"

IT'S ALL ABOUT TURNAROUNDS

Many beef up restructuring teams fpr 2009

"I've had to re-budget three times in as many months - the shareholders keep wanting me to re-forecast based on different downturn possibilities." It's a familiar situation to many, and one a managing director of a PE-backed business recently shared with your editor.

It is no surprise that turnarounds and restructurings will become increasingly apparent in 2009 - recent figures suggest that one in three private equity-backed firms are failing to meet targets; anecdotal evidence suggests this figure is actually much higher (the results simply aren't out yet). Multiple arbitrage in a growth market guaranteed returns, but now it is all about downside risk and cost controls. There is much evidence that the Big 4 are shifting people into their restructuring practice; SEB in the Nordics has recently lost two people; both to become heads of banking at local buyout firms (new roles). Marsh recently appointed someone to its business continuity management team (a fancy word for ensuring cohesion during times of change).

A CEE GP last month told your editor he had had five meetings in four days with his underlying portfolio companies to slash unnecessary expenditure. Many are doing this worldwide - but do you go it alone or call in the big guns?

"A lot of companies are moving from amber zones into red ones," says Malcolm McKenzie, managing director of Alvarez & Marsal (A&M), a restructuring and performance improvement specialist. Since their founding in the mid 1980s in New York, the firm reckons it has achieved a 95% success rate for increasing EBITDA in the companies it takes on - and attributes the losses to that they are invited in too late, when the company is on a steep downward spiral after spending a fair while in what A&M call the 'red zone'. Their success has been such that despite the boom years, the business saw its European practice grow from 40 people three years ago to 200 today - with that number expected to approach 300 by the end of 2009.

Clearly they envisage a lot of amber- and red-zone companies coming their way. "It's no longer just about multiple arbitrage - now it is about transformational investing," says Colie Spink, also a managing director at A&M.

FORGETTING THE PAST

Track records matter less than your next investment

Many GPs will be facing a dilemma with investee companies held in committed funds as to whether to reserve the remaining capital in the fund to prop up those that may hit bumps in the road, or to take advantage of current multiples to fund add-on, value-enhancing acquisitions for the better performing companies. "Capital rationing is inevitable, particularly given the lack of visibility of 2009 trading forecasts," says Charlie Green of Candover.

So GPs are likely to lay low for the beginning of 2009 (some may keep heads down for longer), both for fear of rocking the LP boat (LPs are not keen to see more drawdowns and will scrutinise new deals very closely), as well as a fear of investing in an asset that may be cheap but may prove tough to handle (a disaster for all). This will be the case for most GPs, across all sizes.

"In these markets I suspect early 2009 will be a time for GPs to work out the sectors and sub-sectors on which they want to focus, and then for them to look to buy in the second half of the year," says Green. This cautious approach is largely down to the uncertainty surrounding the true bottom of the market - why buy today if it is going to be cheaper in six months' time?

"If a company trades flat or slightly down in its first year, it is very hard to generate a good IRR, as well as being tough to explain to LPs," Green explains. Such a 'mistake' would make LPs fume. "Given how uncertain the markets are, LPs are as likely to define you by the quality of one new deal as they are by a great track record reaching back over many, many years."

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Send to  

• Topics
• Industry
• UK / Ireland