Owner management
Now might be a good time for owner-managers to consider that buyout
We've buyouts on the brain
Stung by hard times, corporate financiers are unlikely to declare a recovery until they have deals coming out of their ears. but Anthony Harrington finds one or two signs of optimism
It seems to be a time of mixed messages as far as buyouts are concerned. Some think the market is continuing its flat streak, some think it is starting to move. Where there is unanimity, however, is on the fact that things have been very slow for what now seems like a very long time.
After that kind of a lull, everyone is a touch reluctant to talk about an upturn before the pace quickens to the point where it is blatantly obvious that the dull times are over. Nevertheless, there are optimistic voices about. Gareth O'Hara, corporate partner at the Wilkes Partnership, which recently completed a £38m MBO of Industrial Washing Machines, reckons that his firm has been busier than most. However, as he modestly admits, this could be down to luck, as much as to anything else.
John Farnsworth, a partner at Smith Cooper Corporate Finance, reckons that there is a great deal going on that is still in the preparatory stages around the country, and that could give something of a boost to the first or second quarter 2003 buyout figures. "There was a marked fall-off in activity levels through 2001, and this was not corrected in 2002. However, we saw a significant recovery in the last quarter of 2002, and our take on things is that there are still a good number of opportunities coming through. My inclination would be to say that the upturn is in all probability being maintained," he comments.
Part of the problem right now, he points out, is that the market is still in a fairly jittery, nervous state. "Although we have a great climate for buyouts, in terms of low interest rates and low inflation, the feelgood factor is just not there yet. So getting deals off the ground and bringing them to fruition when they do get started is much more difficult. There is a definite tendency for more transactions to fall by the wayside at present," he comments.
Part of the reason for this is the self-fulfilling cycle of doubt and nerves that tends to take hold when economic conditions hit a prolonged difficult spell. "There is a tendency to be more careful when times are hard, and increased time in a transaction is always dangerous. People look harder at everything and this creates its own problems," he says. Add three more months to a deal cycle and it is amazing how many fresh problems potential buyers and their advisers can find to fret over.
Peter Naylor, investment director at Gresham, reckons that part of the problem is simply the fact that quality deals are hard to find right now. "The whole industry is hungry for good deals. Competition is really tough when one comes along and it is all about differentiating your service from everyone else's," he comments.
In his view this is a great time for enterprising management to start putting wheels in motion to get a buyout off the ground. "We think that there will be a number of deals coming through over the next 12 months," he says.
These deals will be driven by the usual motives, namely corporates wanting to restructure their portfolios and owner-managers looking for an exit. What encourages Naylor particularly is the fact that his firm is seeing a very welcome move towards realistic valuations on the part of sellers. "In our experience there are now a good number of vendors who have put any thought of a possible sudden upswing in the economy out of their mind. As a consequence, they are now prepared to sell at a realistic valuation that is much closer to what buyers are prepared to pay," he says.
"We think we are about to enter a very good period for investing, which will be followed by a change in the economic cycle that, in turn, will make it a good time for corporates to start divesting themselves of non-core business," he says.
Not surprisingly in these difficult times, when many companies are finding it hard to predict business volumes for even the next quarter, buyers are looking for far more due diligence to be done. At the same time, Naylor points out that one way for advisers and VCs to differentiate themselves is to push due diligence hard, to try to give vendors and MBO teams more certainty about the transaction.
Grant Thornton corporate finance partner Mustafa Abdulhusein is also optimistic about the opportunities for MBO activity. "We are seeing quite a bit of interest. Vendors are finding it very difficult to find trade buyers and this has created a great opportunity for MBO teams to take the initiative," he says. He expects to see substantial activity through 2003 in the £35m to £350m mid-market arena.
However, he is not particularly impressed yet with any startling realism on the part of sellers. "Basically, they still want too much. Too many of them are still living on memories of the boom years," he says.
This price gap need not be a deal breaker though, Abdulhusein points out, if the vendor is prepared to accept a vendor-assisted MBO. "In order to solve the price gap, we are seeing vendors increasingly willing to take some equity stake in the new, post-MBO company. That way round they get a certain amount of cash now, and the ability to share in the up-side later," he says.
He points out that Grant Thornton did a deal in October 2002 involving WR Refrigeration. The MBO team took a 75 per cent stake in the company and the vendor took a 25 per cent stake. The whole deal was done with senior debt, with no venture capitalist involved.
Abdulhusein argues that this arrangement actually makes a great deal of sense for vendors. After all, what are they going to do with their money today? Bank interest is negligible and the equity markets look like a certain loss. With those investment options looking decidedly less than compelling, the prospect of backing an established management team that the vendor knows well, in a business and market that they understand, looks very attractive, he points out.
Obviously this kind of deal is more compelling to a vendor that has been hands off the business for a while. Where the vendor has had a substantial and controlling influence in driving day-to-day activities forward, they may well have some question marks over the capacity of the management team to run the show on their own.
Abdulhusein reckons that there are two major factors holding the market back at present. The first is the understandable caution in the VC community following the technology and telecoms market crash, while the second comes down to the general uncertainty in the global market. "We see VCs being particularly challenged through the course of this year in achieving exits from some of the more mature elements in their portfolios. Yet they will need to make sales to turn their money around and satisfy their clients," he says.
Robson Rhodes partner Martyn Pilley says that his firm's MBO portfolio has been growing steadily since the autumn of 2002. One additional stream of MBO activity he's seen is US corporates looking to sell UK subsidiaries. "What we have found is that a number of US companies who were in an expansionist phase three years ago have now clearly taken a decision to retreat back to their core markets. They are selling UK and European businesses that they regard as part of their expansionist phase. With not too many trade buyers about, an MBO offers them an excellent way of achieving their exit," he says.
Farnsworth adds a cautionary note, however. He points out that if one looks at the statistics for buyouts and particularly at the exits from buyouts, they are enough to give management teams considerable food for thought. "There were 259 exits from buyouts in 2002. By far the biggest single category of exit was into receivership!" he warns. Some 114 MBOs ended in receivership last year as opposed to just 71 trade sales. Secondary MBOs were another category.
Despite these somewhat grim statistics, Farnsworth remains confident that MBOs will be the dominant flavour of 2003. "Big corporates have had their share price pounded by the markets. Their ability to do trade deals based on their paper has suffered and this is having a ripple effect down the food chain. Hence the recovery in MBOs."
He points out too that there were some 60 secondary buyouts through 2002. This compares very well to just over 30 the previous year.
If MBOs are doing well, pure MBI deals (management buy-ins), remain distinctly out of favour. VC sentiment, influenced it must be said by the poor track record of MBIs over time, is solidly in favour of retaining the existing management team, wherever possible rather than backing a purely external team to come in and run the show.
"This does not preclude the idea of an incumbent management team being bolstered by a player or two from outside," Farnsworth notes. Often, where the MBO team has an insufficient track record to give the necessary level of confidence to a funder (be it a bank or a VC), the funder will recommend an external candidate to the noard. This is the classic BIMBO deal (buy-in, management buyout).
"BIMBOs are also a good way for an owner/founder to exit even if the internal team has not yet grown to the point where they can safely take the business forward on their own."
Naylor agrees. "We like to supplement the internal team and encourage them to approach the business in a slightly different way, if that is appropriate," he says. This will usually be done by introducing the internal team to a good non-executive director or chairman.
Music to their ears
Deloitte & Touche Birmingham's corporate finance team recently completed an MBO deal worth £340m, selling the musical instrument division of Boosey & Hawkes to the private equity firm Rutland Fund Management.
Rutland has taken an 85 percent stake in the new company, called the Music Group, with the management team retaining 15 percent. Senior debt was provided by the Royal Bank of Scotland. Rutland plans to carry out an operational restructuring of the new company, with improved financial and operating controls and a close focus on manufacturing efficiency. The ability to generate operational improvements was seen as key to the deal's success by all the parties.
It came out in the wash
When Carl Hollier and his father sold Industrial Washing Machines to Warner Howard of the US in May 1999, one of their primary reasons was the feeling that being part of a bigger group would benefit their company.
The idea was that a large parent would provide new investment and add weight and fresh ideas to the company, helping it to grow. In fact, however, although Warner Howard had moved into the washing machine arena with this purchase, subsequent events and the global economy led the Warner Board to decide that the business was now not strategic to its future interests.
Accordingly Hollier retained the Wilkes Partnership to look into an MBO with the aim of reacquiring the company. Funding was provided by Tony Massey of HSBC Bank, Solihull, and the corporate finance side of the deal was handled by the Birmingham-based firm, Invex Partners, led by Peter Bull.
While no figures have been disclosed, Hollier is on record as saying that he believes he got a great deal on both the sale and the purchase. Gareth Hunt from the Wilkes Partnership handled both transactions. "This was a first for me, both selling and then buying back the same business," he says.
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