THE ART OF DEAL MAK­ING

With a clear sense of déjà vu the global mar­kets com­menced 2016 with a re­turn to ex­treme volatil­ity. By Ni­cholas Assef

Business First - - FEATURE -

Whilst we of course hope that this neg­a­tive en­vi­ron­ment is short lived, the CEO and Board of Di­rec­tors al­ways need to live by the old adage of ‘hope for the best, plan for the worst’.

As such it is use­ful to re­flect on a num­ber of the fac­tors that took place dur­ing the GFC, and, with the ben­e­fit of hind­sight, how best to po­si­tion for the main­te­nance of share­holder value if this volatil­ity con­tin­ues.

Valu­a­tions Be­come Ir­ra­tional

The me­dia love a bad news story, and tur­bu­lent mar­kets bring am­pli­fied ‘alarmist’ me­dia com­ment.

Com­pa­nies see their valu­a­tions trade in wide ranges, which of­ten make tra­di­tional val­u­a­tion ap­proaches dif­fi­cult. For Re­search An­a­lysts cov­er­ing sec­tors the task is dif­fi­cult as the base in­put as­sump­tions many use for their DCF mod­els are of­ten ‘fluid’. For the CEO & Board it is dif­fi­cult to ig­nore share price ac­tion – of­ten feel­ing as a help­less pas­sen­ger on rough seas.

As noted be­low – the CEO must be­come an evan­ge­list at these times with all stake­hold­ers – in­ter­nal and ex­ter­nal. Stress­ing the pos­i­tive dif­fer­en­tia­tors as to why their com­pany is the ‘in­vest­ment of choice’ within its sec­tor. In­creased time and care needs to be taken on the de­vel­op­ment of in­vestor pre­sen­ta­tions and var­i­ous stock mar­ket re­leases— qual­ity over quan­tity.

Board & Man­age­ment Paral­y­sis

Dur­ing the GFC many pub­lic com­pany Boards de­cided that no ac­tion was the best ac­tion. Un­for­tu­nately this ‘no ac­tion’ po­si­tion is ac­tu­ally a de­ci­sion of paral­y­sis. Com­par­isons such as “we are do­ing the same as our com­peti­tors” do not win the ap­plause of in­sti­tu­tional in­vestors or the in­vest­ing com­mu­nity at large.

Con­ser­vatism should be re­placed with flex­i­bil­ity and the on­go­ing search for in­no­va­tion and ex­cel­lence.

On­go­ing pos­i­tive com­mu­ni­ca­tion with stake­hold­ers of mean­ing­ful de­vel­op­ments is manda­tory. More shoe leather will be worn out in the process. Ex­plore all op­tions to gen­er­ate pos­i­tive share­holder value.

As­tute Boards and CEOs also know that now is the time to op­por­tunis­ti­cally strike – when valu­a­tions are low and the al­ter­na­tives for that in­ter­est­ing ac­qui­si­tion tar­get are few.

Strong and de­ci­sive lead­er­ship will not make the mar­kets set­tle, but it will en­sure that the CEO’s com­pany, its em­ploy­ees and stake­hold­ers are con­fi­dent that their Board and Se­nior Man­age­ment are com­mit­ted to find­ing a way through—and not be­ing the prover­bial feather blow­ing in the wind.

Higher Offshore Led M& A Ac­tiv­ity

Cur­rency fluc­tu­a­tion am­pli­fies the val­u­a­tion ad­van­tages of­ten en­joyed by Bid­ders that op­er­ate in larger, more liq­uid cap­i­tal mar­kets. Those Bid­ders of­ten have higher trad­ing val­u­a­tion met­rics for a va­ri­ety of rea­sons. Suf­fice to say they have a real strate­gic ad­van­tage.

We have seen a ma­te­rial in­crease in offshore in­quiry as the Aus­tralian dol­lar has fallen. We ex­pect this trend to con­tinue – and the ad­van­tage of those Bid­ders to be am­pli­fied by the volatil­ity.

For the CEO / Board un­der pres­sure it is im­por­tant to en­sure that they can mar­ket to in­ter­na­tional suit­ors who may look for es­tab­lished beach­heads in coun­tries such as Aus­tralia to launch into Asia. As­tute Boards are proac­tively en­cour­ag­ing in­ter­na­tional strate­gic al­liances to not only gain ac­cess to new mar­kets at try­ing times (and hope­fully gen­er­ate for­eign cur­rency cash­flows) but also to keep wired in to re­gions from where a Bid­der may emerge.

Bal­ance Sheet Health Can Change Quickly

CEOs and their Boards need to be acutely aware of the debt covenants in­side their debt fa­cil­ity agree­ments, and how mar­ket volatil­ity might af­fect them. Many fa­cil­ity agree­ments are not linked to things such as share price and mar­ket cap­i­tal­i­sa­tion – but some are.

There is noth­ing more prob­lem­atic for the CEO/ Board to dis­cover sud­denly that there is a tech­ni­cal prob­lem with ex­ist­ing debt pack­ages – and any clar­i­fy­ing an­nounce­ment to the stock mar­ket of a prob­lem will likely be met with ex­treme neg­a­tiv­ity. Ad­di­tion­ally, with in­creased coun­ter­party risk a sen­si­ble as­sump­tion, cash­flow can be placed un­der pres­sure with lit­tle no­tice.

Although it is not what CEOs and Boards want to hear, non core as­set di­vest­ments, eq­uity place­ments and debt re­fi­nanc­ings early can en­sure healthy Bal­ance Sheets are main­tained through this tur­bu­lence – and can even al­low ex­pan­sion op­por­tu­ni­ties to be moved upon when they un­doubt­edly present

I re­call one CFO dur­ing the GFC not­ing to me that he was ‘spoilt for choice’ for deals as they had po­si­tioned well, and po­si­tioned early. With a lowly geared Bal­ance Sheet and cash in the bank many beat a path to his door look­ing for a res­cue deal.

The longer the volatil­ity the more dif­fi­cult it is for small and mid­dle mar­ket com­pa­nies to ef­fect eq­uity ini­tia­tives at de­cent valu­a­tions (dis­counts to at­tract cap­i­tal be­come deeper). Pri­ori­tis­ing the health of the Bal­ance Sheet is al­ways a safe op­tion to nav­i­gate through volatil­ity.

Cash­flow King—Coun­ter­party Risk Up

CEOs and CFOs need to be on guard about the sta­bil­ity of both their cash­flows and coun­ter­par­ties (clients) with whom they deal. Dur­ing the GFC many good com­pa­nies quickly found them­selves un­der pres­sure when it be­came clear that par­ties with whom they dealt were them­selves stum­bling. With soft com­mod­ity prices and stretched project fi­nanc­ing, the Re­sources sec­tor in par­tic­u­lar be­comes one where vig­i­lance needs to be lifted even fur­ther on coun­ter­party re­la­tion­ships.

An ea­gle eye on debtors needs to be main­tained dur­ing volatil­ity to en­sure that cash­flow sta­bil­ity is main­tained. It can be pru­dent to re­fine var­i­ous op­er­a­tional as­pects of the Com­pany such as re­fin­ing credit terms to en­sure the risk pro­file of in­bound cash­flows does not in­crease.

In­no­va­tive fi­nanc­ing and re­fi­nanc­ing

Com­mer­cial banks of­ten be­come more con­ser­va­tive in deal­ing with both ex­ist­ing clients and new loans. For those pub­lic com­pa­nies with loan ma­tur­ing across 2016 and early 2017 get­ting started on the re­fi­nanc­ing early is crit­i­cal.

M& A fi­nanc­ing can be­come ef­fec­tively more ex­pen­sive as a re­sult of lower loan val­u­a­tion met­rics be­ing im­posed – with the eq­uity to be pro­vided by the Bid­der in­creas­ing, and of­ten as a re­sult mak­ing the prospect of an ac­cept­able fi­nan­cial re­turn more dif­fi­cult to achieve.

Offshore lenders, for­eign bond is­suers, mez­za­nine debt funds and multi-faceted lenders (in­clud­ing hedge funds) en­tered the mar­ket dur­ing the GFC, and we ex­pect to see this trend lift again. There are mul­ti­ple al­ter­nate sources of fi­nanc­ing to the tra­di­tional banks, and the CEO and CFO need to un­der­stand the flex­i­bil­ity of al­ter­na­tives to prop­erly ad­vise their Board.

Liq­uid­ity In Trad­ing Vol­umes

For Mid Mar­ket and Small Cap pub­lic com­pa­nies volatil­ity can lead to rapid illiquidity in their share trad­ing ac­tiv­ity. An in­cred­i­bly frus­trat­ing sit­u­a­tion for the CEO and Board.

The ‘flight to liq­uid­ity’ of­ten means that both in­sti­tu­tional and re­tail share­hold­ers ro­tate their port­fo­lios to In­dex rated com­pa­nies where liq­uid­ity con­tin­ues dur­ing tur­bu­lent trad­ing con­di­tions.

This shift in fo­cus also can have a knock on ef­fect for mar­ket par­tic­i­pants such as stock­bro­kers, who change the fo­cus in the way they change the ser­vic­ing of their clients from spec­u­la­tive to con­ser­va­tive.

CEOs need to be in­no­va­tive in their ap­proaches to en­sure ex­ist­ing share­holder sup­port is main­tained, and for po­ten­tial new share­hold­ers that the Com­pany is high­lighted as be­ing an ‘op­por­tu­nity of choice’ de­spite ir­ra­tional valu­a­tions and low liq­uid­ity. Place­ments and other eq­uity cap­i­tal mar­kets ini­tia­tives should be con­sid­ered where strong ap­petite from a party is ex­pressed. Di­lu­tion should be a sec­ondary con­sid­er­a­tion to Bal­ance Sheet health and at­tract­ing new in­vest­ment be­fore it is needed.

It is not dif­fi­cult to re­flect on the share prices of qual­ity play­ers dur­ing the GFC and to see the im­pres­sive re­turns made by those that sup­ported qual­ity man­age­ment teams dur­ing those times.

Sell­ers & Pri­vate Eq­uity

De­clin­ing valu­a­tions and illiquidity are ideal mar­ket con­di­tions for Short Seller Funds, Ac­tivists and PIPE play­ers (Pub­lic In­vest­ment By Pri­vate Eq­uity). The ma­jor­ity of Board Mem­bers and CEOs of pub­lic com­pa­nies have not had ex­pe­ri­ence in deal­ing with these mar­ket par­tic­i­pants – and tur­bu­lent mar­kets can be a tough time for the first les­son

PIPE play­ers have the op­por­tu­nity to take pub­lic com­pa­nies pri­vate at heav­ily dis­counted valu­a­tions to those in nor­mal trad­ing con­di­tions.

Ac­tivists and short sell­ers can also take the shape of ‘wolf packs’ and in­for­mally (not form­ing le­gal ‘as­so­ci­a­tions’) gang up on CEOs and Boards to at­tempt to force change. Re­spond­ing to such dis­rup­tors is time con­sum­ing, ex­pen­sive and dis­tract­ing – re­duc­ing the time the CEO and Board have for op­ti­mis­ing ef­forts to man­age and grow sh are holder value. Board and CEO paral­y­sis are the ideal con­di­tions for ‘dis­rup­tors’ to flour­ish.

If one of these play­ers turns up get ex­pe­ri­enced ad­vice—quickly...

The good news is that if the CEO and Board are flex­i­ble, in­no­va­tive and pro ac­tive in nav­i­gat­ing the tur­bu­lent mar­ket the like­li­hood of a dis­rup­tor ar­riv­ing will be dra­mat­i­cally re­duced – they will look for other eas­ier tar­gets. Ex­pe­ri­enced ad­vce in han­dling these play­ers is in­valu­able.

Merg­ers of ne­ces­sity

In this en­vi­ron­ment merger for ne­ces­sity can be a ra­tio­nal out­come and for the CEO and Board flex­i­bil­ity in think­ing in this area can pay div­i­dends. The longer the volatil­ity the more dif­fi­cult it is for small and mid­dle mar­ket com­pa­nies to ef­fect eq­uity ini­tia­tives at de­cent valu­a­tions (dis­counts to at­tract cap­i­tal be­come deeper). Be­ing the ini­tia­tor as op­posed to the re­spon­dent to a Merger Pro­posal is pref­er­en­tial.

It is not dif­fi­cult to re­flect on the share prices of qual­ity play­ers dur­ing the GFC and to see the im­pres­sive re­turns made by those that sup­ported qual­ity man­age­ment teams and Com­pa­nies dur­ing those times.

Higher qual­ity deal mak­ing

War­ren Buf­fett is fa­mous for his say­ing in his 2004 Berk­shire Hath­away Chair­man’s let­ter: “In­vestors should re­mem­ber that ex­cite­ment and ex­penses are their enemies. And if they in­sist on try­ing to time their par­tic­i­pa­tion in equities, they should try to be

‘Pri­ori­tis­ing the health of the Bal­ance Sheet is al­ways a safe op­tion to nav­i­gate through volatil­ity.’

fear­ful when oth­ers are greedy and greedy only when oth­ers are fear­ful”.

Tur­bu­lent mar­kets are a rich hunt­ing ground for as­tute Bid­ders, and savvy man­age­ment teams that see the op­por­tu­nity of Pub­lic to Pri­vate trans­ac­tions. Paral­y­sis should be re­placed with that sense of op­por­tu­nity to drive share­holder value with a com­pelling trans­ac­tion or trans­ac­tions.

Key Take Away For CEOs & Boards of Di­rec­tors

Volatile mar­ket con­di­tions pass. For the as­tute CEO and Board the op­por­tu­nity is to un­der­stand how to both main­tain and max­imise share­holder value in try­ing mar­ket con­di­tions that are try­ing for all com­pa­nies.

Three key learn­ings from the GFC pe­riod that should be front of mind are: • Bal­ance Sheet gear­ing can have a di­rect im­pact on the eq­uity val­u­a­tion of the Com­pany. Eq­uity value can be driven down ir­ra­tionally where it is per­ceived that there is ei­ther too much or poorly struc­tured debt (in­clud­ing near term re­fi­nanc­ing re­quire­ments). • Cer­tain mar­ket par­tic­i­pants flour­ish in these con­di­tions. CEOs and Boards need to have spe­cific strate­gic plans to deal with Ac­tivists, Short Sell­ers and op­por­tunis­tic Takeover Pro­pos­als— in par­tic­u­lar where pre­sented by Pri­vate Eq­uity play­ers who are on the whole both pa­tient and so­phis­ti­cated • Op­por­tu­nity knocks. Main­tain­ing flex­i­bil­ity and be­ing pro ac­tive pays div­i­dends. The deal that may be a ‘com­pany maker’ is likely within reach at a com­pelling val­u­a­tion and at­trac­tive terms. Ex­pan­sion with strate­gic al­liances (both do­mes­ti­cally and cross bor­der) should be con­sid­ered and pur­sued. Be on the front foot. Plan how to grow stronger and ex­e­cute those plans. Hope­fully these mar­ket con­di­tions will set­tle in the com­ing months, but in the event they don’t then for the CEO and Board un­der­stand­ing both the chal­lenges that will come and hav­ing de­ci­sive pos­i­tive ac­tion plans to deal with those po­ten­tial chal­lenges is a pru­dent and log­i­cal in­vest­ment of time.

Start to­day. Get a jump on your com­peti­tors that will likely as­sume the po­si­tion of paral­y­sis.

About the au­thor Ni­cholas Assef LLB (Hons) LLM MBA Ni­cholas’ ca­reer has spanned the le­gal pro­fes­sion, academia and the cor­po­rate world for over 25 years

For­merly an at­tor­ney with Allen Allen & Hem­s­ley’s cor­po­rate prac­tice in Syd­ney, Aus­tralia his ca­reer evolved to in­vest­ment bank­ing af­ter com­ple­tion of his MBA at the world ranked Si­mon Busi­ness School at the Univer­sity of Rochester (New York). Whilst in the USA Ni­cholas also had the op­por­tu­nity to un­der­take study at Har­vard Busi­ness School. In academia Ni­cholas has been on staff at both Mac­quarie Univer­sity’s Ap­plied Fi­nance Cen­tre and Bond Univer­sity’s Law School.

Ni­cholas works across the Aus­tralian and South East Asian mar­kets, spe­cial­is­ing in M& A, share­holder value driven ini­tia­tives, cor­po­rate per­for­mance and com­plex com­mer­cial ne­go­ti­a­tions. He has also had ex­ten­sive spe­cific ex­pe­ri­ence deal­ing with Ac­tivist in­vestors (act­ing both for them, and against them).

He is the founder of Lin­coln Crowne.

Newspapers in English

Newspapers from Australia

© PressReader. All rights reserved.