2015 started as the Year of the Goat according to Chinese New Year, however many analysts now claim it finished as the Year of the Elephant – in reference to the volume of “elephant” or mega deals valued over US$10bn in the merger and acquisition (M&A) market. Indeed, 2015 was a record year for global M&A activity – annual volume surpassed US$5 trillion for the first time on record and eclipsed the previous peak of 2007 according to Dealogic.
We have witnessed a relative decline in deal-making since the start of 2016 but it remains firmly on the executive agenda with 23% of chief financial officers (CFOs) in US headquartered middle-market enterprises (MME) incorporating M&A into their 2016 growth strategy.
Many treasurers are now considering their role in the context of three notable trends that arose last year:
1. Year of the mega deal
The volume of M&A deals valued greater than US$10bn grew 80% year-on-year in 2015. While deals of this size do not typically impact MMEs (unless they are the target), it is important to consider the potential downstream implications.
Given the scrutiny deals of this sizes face, their valuation and synergy models frequently incorporate the disposal of non-core assets; subsidiaries or divisions of the target company that may not align with their long-term strategy. This can help allay concerns and drive confidence in the deal. In some cases, a planned disposal may also be a condition of boardroom or regulator support. As a result, we anticipate more carve-outs and spin-offs arising on the back of mega-deals, and these may prove appetising targets for MMEs.
Figure 1 below illustrates the year-to-date deal mix for US headquartered companies – as at June 2016 – and the relative Pareto principle this presents in term of lower value deals driving the majority of flow.
Consolidation impacting the supply chain and counterparty risk management
Treasurers need to be mindful of the potential impact mega-deals can have on their supply chain. For example, will client consolidation create unforeseen concentration risk on the company’s debtor book or jeopardise the favourable payment terms it has with a mid-sized supplier? Considering the current pace of deal flow we recommend keeping a close eye on the cash conversion cycle, and ensuring credit controllers and accounts payables/receivables (AP/AR) clerks know to escalate any debtor consolidation or changes in terms.
2. Year of the growth deal
Optimism and expectation is high, evidenced by a trend in “announcement effect” which has seen M&A announcements boost the stock price of both the buyer and seller. This traditionally benefits the target as markets anticipate a premium being paid for their shares, but investors now often reward acquirers’ moves to grow revenue and put capital to work. McKinsey research noted that the average Deal Value Added to market capitalisation for announced M&A deals with greater than or equal to US$5bn in deal value turned positive for the acquiring entity in 2014, and for the first time since 1998.
Mark Stephanz, head of middle market investment banking at Bank of America Merrill Lynch (BofA Merrill), says: “Owners of middle market companies should consider the low cost of debt, corporate functions consolidation and abundance of private equity firms when thinking of selling or buying companies, while never undermining the importance of post M&A operational integration.”
Heightened expectation surrounding high profile deals has trickled down to transactions of all sizes. Given that many acquisitive corporates are now experienced deal makers with in-house M&A teams and robust integration processes, investors expect to see greater synergies realised within shorter timeframes. As a result, mid-market treasurers need to be particularly astute given they may not have access to the same amount of resource and experience.
It is important to ensure expectations are realistic yet competitive, and to engage advisors early so efficient execution and integration can be planned. Seemingly small issues can present big risks, such as ensuring a smooth transfer of capital upon deal closure; negotiating the scope of a transition agreement; or ensuring the timely change of ownership and signatories on accounts. Done well, this is not a “side of desk job” and we increasingly see MMEs forming an integration programme office and assigning a treasury team member early in the process – either during pre-deal due diligence or upon announcement.
The relative nimbleness of an MME is an advantage, so structuring and resourcing these teams should be considered up front if M&A forms part of the corporate growth strategy. It is also important to ensure your own house is in order – a lean, consistent banking infrastructure and cash management solution will aid your ability to attain Day 1 control of new entities and accelerate post-deal integration.
3. Year of the cash deal
According to Bruno Poggi, EMEA head of Global Commercial Banking at BofA Merrill, favourable capital conditions continue to spur M&A momentum. “Sixty-six per cent of the middle-market CFOs in our 2016 CFO Outlook survey stated they intend to hold constant the percentage of free cash flow they allocate to acquisitions, while the average cash component of takeover bids and number of all cash transactions continue to rise,” he notes.
“This is particularly salient for international expansion where MMEs look to deploy offshore cash piles or capitalise on a strong US dollar (USD) and low borrowing costs. Treasurers are also cognisant that euro denominated deals can improve cost of capital given the current wide spread between USD and EUR high-yield rates.”
Cash is still king: M&A cash consideration (USD millions)
This trend has clear implications for treasury and tough questions need to be asked: How does this impact our balance sheet? Will this affect our credit rating or debt covenants? How do we satisfy regulatory cash confirmation requirements to evidence sufficient funding for the deal? How do we manage change in our currency mix? What happens if the deal fails to close? What staffing challenges does the deal pose?
Though executives have traditionally focused on getting the cost out of newly acquired entities, attention has pivoted to cash flow generation and top line growth. Where cash reserves are paid away or debt load increased to fund M&A, treasurers should manage working capital closely so they can react to changes in their forecasts or liquidity profile. It is worth noting that this vigilance on daily operations is easily compromised by integration efforts, which underscores the importance of allocating specific resource to these integration tasks.
The impact of a deal not completing was very evident in the first half of 2016: record break fees for aborted deals were paid out and US-targeted withdrawn M&A volume hit an all-time annual high. Treasurers should appraise this risk in the context of unexpected regulator or market reaction.
The takeaways for middle-market treasurers
Despite the various considerations raised it can be difficult for the treasurer to ask for help. Maintaining confidentiality is critical to the success of a deal, so deal teams are acutely focused on “need to know” to help mitigate against leaks that may incur premature scrutiny or competing bids. As a result, many companies now seek an M&A bank with significant balance sheet, global presence and a full product offering that includes cash management services. This helps minimise the number of external parties privy to the deal while retaining access to holistic advisory services, which is critical for MMEs that do not have this experience in-house.
Window of opportunity: average announced to closed cycle
Even if the treasury function is not involved at the outset of a deal, there is still a critical window of opportunity to prepare. For US-led acquisitions that completed during the last 18 months, the average period between the announced and closed dates of a deal was 82 days – and this extends to 103 days if the target was international.
It is critical that treasury departments consult their advisors early to assess the potential impact on working capital, scope the integration of cash and liquidity management structures, and identify opportunities to drive synergies for the expanded treasury function.
M&A events are an opportunity for the treasury function to come to the fore within an organisation. Careful planning and seeking out best practice advice early can help convert this challenge into a success – and to quickly tame the “elephant” in the room.
A significant amount of resources go into the actual calculation of forward cash flows, including both objective and subjective analysis of the cash flow statement, that a number of companies have brought sophisticated cash flow forecasting software to market to provide organisations with the ability to more quickly and easily assess cash flows.
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