Where to from here?

The unpredictable nature of the current market has produced a wide divergence of opinion as to where it is heading. In recent weeks Carlyle's managing director David Rubinstein has been quoted as saying that the 'Platinum Age' of private equity is still to come and he expects a comeback of the attractive returns LPs had become accustomed to in recent years. On the other hand, Guy Hands of Terra Firma stated that the current unwinding of pre-credit crunch inflated debt and asset values would create a sustained period of slow growth and a decline in wealth in Western countries.

So, who is right? Well, there is no way to argue with Rubinstein, where there was a way down there will inevitably be a way back up. However Hands, who focuses on the macro-climate, is citing important problems that the industry has to overcome in order to return to form. In the deal game, the importance of corporate finance is growing as the one place where information converges.

Auction? What auction?

There should be no doubt that an auction process is still possible. The how-to, however, has changed significantly. The difficulties private equity houses are having raising debt has resulted in some corporate financiers asking themselves whether they should include private equity in an auction process at all. Debt, for example, was the main reason why RBS excluded private equity from bidding for its insurance arm and it is also the main reason why the industry currently has so little expectation for the large buyout segment and is more confident about the mid-market.

"In our experience many auction processes are proving to be demanding. In a number of instances, we have seen the preferred bidder dropping out of the auction process within a short time of having been granted preferred status only for other competing bidders' interest also to fall away," states Will Rosen, a partner at DLA Piper.

Corporate financiers also have to deal with vendor expectations, many of which have not yet adjusted to pricing re-alignments, as Patrick Groarke, a partner at Livingstone Partners, explains: "We had high valuations driven by debt multiples in recent years. The debt multiples have now come off by about 2x and many vendors won't accept that yet. However, there seems to be a sense of realism kicking in now."

Groarke says that vendors must understand the buyer's changed position: "They need the time to do thorough due diligence and to raise the debt. We are, in fact, spending a lot more time much earlier in the process working on the bank issues."

As a corporate financier, now is the time to put networking skills into use. With buyers falling away because of unrealistic vendor expectations and banks cautious, it makes sense to invest time and to test the market. "You'll end up with a pre-qualified field of bidders and, if you also look after the relationship between vendors and buyers and make buyers feel special, you can maintain interest, competitive tension and an effective auction process," states Alex White, a corporate finance partner at BDO Stoy Hayward.

Chris Williams, a partner at Cobalt Corporate Finance takes it one step further. "There has to be a good fit between target and acquirer, but it comes down to good merger analysis and smart presentation," he says. "On one deal we moved the lowest bidder up to the highest by dragging the buyer into our view of the merger benefits. It took six months, but everyone was excited about the result" he says.

The return of the trade buyers?

The time is ripe for trade buyers to make a comeback. With private equity houses having difficulties getting a deal financed in time, trade buyers may profit because they can afford to pay more and generate lower returns over a longer period. "There are few processes out there that evoke only interest from private equity," states Rosen.

Williams believes that private equity has lost its advantage over trade buyers because recent success was driven by cheap debt, saying: "That advantage has gone. Trade buyers should be able to outbid private equity. They can extract strategic value out of a combination with the target, while private equity can only improve performance of the business for sale."

Jacques Callaghan, head of financial sponsor coverage at Hawkpoint takes a different view: "Although trade buyers are more confident about competing with private equity buyers in auctions due to the current credit markets, there is a significant amount of private equity looking to be invested and some firms, depending on the asset, are still out-bidding trade by over-equitising the deal."

White points to the amount of cash still uninvested as reason for optimism for private equity buyers: "Small and medium quoted trade buyers who need to raise equity are struggling to do so. Conversely private equity portfolio companies still have access to equity and I expect to see more bolt-ons over the next year."

Time to buy-and-build?

When it comes to sectors, industry players take differing approaches. Many are concentrating on the oil & gas industry and related services, while others are focusing on businesses with good contracts, for example with the government, such as education. For White, buy-and-build strategies, particularly in the support services sector, may be profitable in the current market. However, he also warns: "When it comes to exits, you do not necessarily get multiple arbitrage because you are bigger. There should be a strategic rationale for bolt-ons and not just a pursuit of scale for scale's sake."

While some private equity houses make it their specialty to buy-and-build and are clearly comfortable in doing so, Williams suggests that there might be a risk attached: "With each deal you are repeating the integration risks and constantly reshuffling management, it needs a lot of planning, tough appraisal of each deal and great deal management."

When it comes to buy-and-build, the issue of debt is again on the table. Will a bank lend money to someone who is putting all his eggs in one basket? "Some private equity firms' portfolio companies are finding it difficult to achieve their buy-and-build plans due to the reluctance of the incumbent banks to provide additional funding on comparable terms. Our debt advisory practice is seeing increased demand to structure creative solutions to overcome the issue," Callaghan says.

Where to go?

Risk averse lenders, competition from trade buyers, hedge funds and sovereign wealth funds and uncertain economic conditions are all testing the resilience of the industry. Corporate financiers are felling the strain of less competitive processes and are having to be creative to generate interest and claim maximum value. Those corporate financiers with well-established relationships and the ability to innovate will be best equipped to weather the storm.

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