Prepare to be shocked by valuations

As values for mainstream businesses plunge, some vendors could be in for a nasty shock if they are still holding out for last year’s prices. Marc Barber reports

As values for mainstream businesses plunge, some vendors could be in for a nasty shock if they are still holding out for last year’s prices. Marc Barber reports

As values for mainstream businesses plunge, some vendors could be in for a nasty shock if they are still holding out for last year’s prices. Marc Barber reports

What a difference a year makes. Twelve months ago, vendors were desperate to find a
buyer to get taper relief on a sale after the introduction of a capital gains tax rate
of 18 per cent. Today, anyone looking to sell has a host of different and far more challenging problems to face.

Richard Glasson, CEO of marketing agency Gyro International, says: “People who have missed the boat of the last three to four years need a pretty good reason to sell at the moment, either because they can see their business model is running out of steam or they are staring in trepidation at their cash flow.”

That’s not a particularly attractive proposition for acquirers when protecting cash flow and margins are the main priorities. Mark Wignall, chief executive of Matrix Private Equity, observes: “The reason that so few deals are being completed, and why the pipeline is so thin for everybody at the moment, is that sellers aren’t selling unless they’re distressed.”

Well runs dry
The lack of debt financing from banks has seen the funding for mergers and acquisitions virtually dry up.

Graham Cunning, regional director of Scotland for acquisition finance at Clydesdale Bank, observes that deals are happening, albeit with a far greater degree of caution.

“To be honest, I think the way a deal is being done now is how it should’ve been before. Perhaps that’s why we’ve got money and other [banks] don’t,” he says breezily.

“A bank and a private equity house have to sit down and conduct an assessment before an initial offer of funding. It probably adds an extra ten or 20 per cent on the time to do a deal.”

Using multiples of profit to price a business has always been a less-than-exact science and Cunning notes standard ratios have taken a tumble. “Typically, for deals up to £50 million, you’re probably only going to see three times earning before income, tax, depreciation and amortisation (EBITDA). It depends on the sector, but you would have been looking at four or five times EBITDA last year.”

Open for business

Chris Williams, a partner at Cobalt Corporate Finance, which specialises in mid-market technology, media and telecoms companies, comments that “deal volumes are down dramatically. I would say that they will remain so for at least another six months and probably for the whole of 2009.”

For good businesses with strong intellectual property rights and technology, Williams says deals remain on the table, especially as “there are a
lot of corporates with good balance sheets in every sector who can acquire smaller businesses”.

For the latter type of fast-growth company, surrounded by corporate suitors, “standard EBITDA multiples or price-to-earnings (p/e) ratios have never been relevant other than as a background context. If a company creates a new technology that unlocks a market worth £1 billion to a Microsoft-type organisation, it’s never been about a ratio”.

When it comes to less revolutionary types of businesses, Williams also warns against looking at earnings multiples to get a sense of value within a sector. “I think it’s one of the worst times in history to use a p/e ratio,” he states. “The pace of change in the market has been so fast, we do not have perfect information.”

Deal pipeline

Steve Rebbettes, operations director at BCMS Corporate, which specialises
in selling privately owned businesses, says that he’s seen deal volumes remain steady and that pricing is yet to change significantly.

“In the last eight weeks we have done £33 million worth of deals in the SME sector, that’s pretty healthy and on a similar level to last year when we completed 11 deals in the same period compared to nine this year. But, that said, average deal values have increased.”

According to Rebbettes, these are not distressed deals from predatory buyers or specific to a sector. “Anybody who is going after a weak business is probably not that wise,” he states. “It’s the stronger businesses that are more in demand.”

Specialising in the mid-market, Rebbettes claims the number of companies looking to buy has increased, with interest coming from cash-rich businesses and high-net-worth individuals. He isn’t surprised by the upsurge in demand.

“If you think about it, if you’re a large company and you’re losing market share or customers, a quick way to regain that is to make an acquisition. In an odd way, there can be a spike during a recession in sector-to-sector acquisitions.”

Interestingly, he insists that valuations haven’t dropped: “Market forces are kicking in. If you have more buyers than sellers, that has an upward impact
on price.” A company, which is making a profit and has three or four companies looking to buy it, will always go for a decent amount. “Ideally, we want companies with strong balance sheets who can buy outright. We don’t mind some of it being in paper, provided the bulk of it is in cash.”

New strategies
Adrian Alexander, a partner at professional services firm Mazars, observes that there
is less “room for gamesmanship” when negotiating a deal, and that now is
“the time for realism”.

He says: “If you had a deal conceived pre-September or October, holding the price and structure has been difficult. People on all sides need to take a deep breath and figure a way to do it. If someone was slightly reluctant or half-hearted, then a deal falls apart very quickly.”

Assuming interest in a deal remains, then the structure may be altered. “So what would have been an all-cash deal now involves a loan note,” he comments, noting that he fully expects a rise in strategic alliances, joint ventures and, like Gyro’s Glasson, mergers with no cash exchanging hands, so that overheads are cut and equity shared. “Egos will have to be put to one side,” adds Alexander.

Nick Britton

Nick Britton

Nick was the Managing Editor for when it was owned by Vitesse Media, before moving on to become Head of Investment Group and Editor at What Investment and thence to Head of Intermediary...

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