Is it just me, or is the sound of whistling getting louder in here?Helen Thomas from FT Alphaville told us earlier this week that the market mavens at UBS have declared the imminent health of the mergers and acquisitions market. Apparently, these Pollyannas took a gander at previous disruptions to the global financial markets—like the US savings and loan crisis and the implosion of Long-Term Capital Management—and have concluded there is no reason to speculate that this time things will be other than just peachy.
Sure, the sudden freeze in the credit markets has put the kibosh on free money masquerading as "covenant lite" debt, and the maximum feasible deal size for prospective LBOs has plunged over 80% to seven billion smacke(u)roos, but all else is for the best in this best of all possible worlds, according to our lederhosen-wearing pals. To what is their optimism due? Well, to the faithful corporate M&A buyer, of course, who they are sure is even now sprinting up to take the baton on the next leg of the global M&A steeplechase.
Now of course it is true that corporate buyers continue to account for the substantial majority of the M&A deal volume, as they have done from time immemorial. There was a time, not too long ago, when private equity accounted for less than 10% of the annual deal volume in the market, and it has only been over the past several years that it has peeked noticeably into double digits. A casual reader of the financial press might be forgiven for believing—based upon the column inches devoted to chronicling in nauseating detail the deal making, compensation, and social peccadillos of various and sundry PE plutocrats—that corporations have been taking a very long nap in the M&A coma ward over the past few years, but it is not true.
That being said, long experience and personal knowledge of many corporate dealmakers has left me with little reason to suppose that hordes of the same are chomping at the bit to preserve the frenzied dealmaking pace witnessed earlier this year. A little sober reflection on your part, Dear Reader, will surely lead you to the same conclusion. For what CEO, CFO, or even corporate development officer would feel compelled to leap into action and start spewing above-market bids left and right simply because a few drunken sailors (PE firms, natch) have left the field?
While it transpired, the credit market love fest which turned every second year Associate at Carlyle and KKR into Genghis Khan Jr. had little effect on the dealmaking proclivities of Corporate America or Europe, other than making them shake their wooly heads in wonder at the insane multiples said Associates and their betters committed to pay the delighted sellers. Now that the ersatz financial wunderkinder have toddled off to the nursery to play with smaller companies—or with none at all—your average workaday CEO is trying to calculate a decent interval of mourning before he or she launches a substantially lower offer for the juicy little acquisition target he or she has been eyeing these many moons.
But here we come to the crux of the matter. In order for M&A nooky to take place, there must be an agreement between consenting adults, and most of the potential sellers I am aware of are claiming to suffer from nasty headaches. Pourquoi? Well, wouldn't you have second thoughts, Dear Reader, about giving up the good thing if your paramour suddenly changed the dinner venue for your date from Le Cirque to Applebee's? Sure you would. The dramatic recent compression of valuation multiples offered has had a distinct chilling effect on the ardor of most potential sellers, for the simple fact that most potential sellers do not have to sell. For the average CEO, it is much better to remain in the C-suite, collecting juicy option reloads and undemanding performance bonuses than to settle for a golden parachute calculated on a less than stratospheric takeout multiple.
There is a similar and well documented "seller strike" syndrome in the residential housing market, where sellers refuse to acknowledge a market-wide reduction in the price level and insist on listing their property at the value implied by what their neighbor Bob realized three months ago. The effect in the housing and the M&A market is the same: the property languishes on the market indefinitely, until the seller pulls the listing in disgust or capitulates to offer it at the new, lower market price.
I would that it were not so, but we investment bankers as a class do little to dissuade potential sellers from behaving in this fashion. In order to win the assignment to sell a business, an investment banker must usually be exceedingly optimistic about both the potential value achievable in a sale and the speed with which the potential buyers can line the seller's pockets with moolah. (While most sellers give the pitching i-bankers some rigamarole about the importance of certain "soft" factors, like preserving jobs and such, there are only three things a potential seller is really concerned about in awarding a sale mandate: value, value, and value.)
After he has won the assignment, the investment banker's job largely consists of (1) persuading potential buyers against all contrary evidence that this property above all others is truly worth a king's ransom and (2) reassuring the seller that an unhinged buyer is mere days away from lobbing in an offer priced at the highest multiple ever recorded in M&A history. Once the final bids are in—usually falling pathetically short of the target value the i-banker told his client was in the bag—said intermediary must switch rapidly to spin and close mode, in which he simultaneously staves off both buyer's and seller's remorse until the final check changes hands in the closing ceremony. In short, a successful sell-side investment banker must have the patience of Job, the constitution of an ox, the self-delusion of a real estate broker, and the cast-iron cheer of a Frank Capra movie.
It is hard to fake such a persona, and unwise to turn it off in public, which is why we are now getting treated with articles like the one published today in the FT. After describing the ineluctable evidence of a dramatic slowdown in deal activity, the reporters regale us with a veritable parade of M&A honchos who tell anyone who will listen that the good times are coming back, in spades. As an industry insider, I tell you in confidence that they do this in part to preserve as much of the M&A department's bonus pool as possible against the inevitable cuts coming down from the executive suites of Wall Street. But they also do it because they realize that—unlike private equity, which depends on the ready availability of attractive debt finance to make their buyouts work—for corporate buyers confidence is the lifeblood and driver of strategic M&A activity. No confidence, no deals. No deals, no Testarossa.
So now you understand. The M&A market is subject to the same relentless march of progress as the rest of society.
In Ancient Egypt, there was only one Cleopatra. Nowadays, Wall Street is full of Queens o' de Nile.
© 2007 The Epicurean Dealmaker. All rights reserved.