Bid Considerations in a Sell-Side Process
When an investment bank represents a potential buyer in a sale process, both parties are very motivated to be the winning bidder. However, the investment bank is more incentivised to bid to win as they are paid on a success fee whereas the potential buyer has a variety of other reasons – and may quite fairly decide to walk away at a certain price.
Nonetheless, the investment bank and potential buyer still have to extensively evaluate what price to bid at in order to make an informed decision that is sufficient to beat the other parties – but not necessarily on price alone.
In the most simplistic, laymans example, someone looking to sell their house may not necessarily want to sell to the person who puts in the highest offer, but also someone with financing secured (bank has already signed off on mortgage, great professional job). Likewise, investment banks will consider financing as well as thousands of other things as businesses are inherently more complicated cash flow streams than a house.
In this article, we discuss a simple example where a privately owned firm is up for sale.
Value Perspectives for the Client
The client will have a view for what the company is worth and will run their own numbers but will also expect to get input from their investment banker.
If the client is a strategic buyer, like a coffee shop buying a coffee shop, they are looking at the intrinsic value of the coffee shop up for grabs to them. So this will factor in cost and revenue synergies (with a big focus on cost synergies because you cannot really accurately predict revenue synergies). Cost synergies include firing the old company’s head office, firing front line staff and scheduling more efficiently, getting bulk discounts on buying coffee beans, centralizing a baked goods division amongst other things.
The investment banks will run this and give perspectives to payments in terms of multiples, cash flow and earnings accretion and hypothetical rates of returns with and without layering on debt. Investment banks will also look at what financing will be required as well as how they can provide that financing. Keep in mind, investment banks love providing the financing as the fees on DCM issuance, ECM issuance and the corporate banking bridge loans by far outstrip the M&A fees.
For private equity or financial sponsors, they will have their own view and models and will want to check the investment bank’s outputs to see that they are not out to lunch in terms of their thinking. Then it comes down to how much money the bank can give them via bank debt or issuance in high yield markets to juice their returns.
Estimating Competitor Bids
This will depend on who the financial advisor/investment banker thinks is possibly in the process.
Investment bankers will communicate this to the client by putting together a buyer list. So for instance, the prospective competitors in the bid process for Carls Jr. could be horizontal – Burger King (QSR), McDonalds, Wendy’s; vertical – a major beef supplier or a major cheese farm company; or financial (private equity firms).
From those names, investment bankers will highlight who the main bidders are in each category. Theoretically, strategic buyers should be able to pay a higher price – however, they may not always be able to secure financing needed and may opt to use stock as a form of consideration which will be less attractive to all-cash offers from private equity.
Sometimes the most natural buyer will not be in the process. Investment bankers will know this from both insider knowledge and public information. For example, if Carls Jr has the best geographic and product line fit with Burger King but Burger King is currently highly leveraged and actually in divestiture mode, the investment bank can be reasonably confident that they will not bid.
So for whatever bidders are leftover, the bank will look at what value the target firm is to the potential competitor buyer as well as how likely they are to be serious with their bid. A lot of firms are just in the process for competitive information and throw out silly bids, while a lot of bidders pull out at the last second. Banks may discount these other bidders in the process.
Ability to Pay Analysis
When they are left with the real contenders after stripping out the pretenders, they are able to start doing ability to pay analysis. For public companies, this could include accretion dilution multiples. A Burger King may balk at paying a price above the multiple it is trading at – so 7x EV/EBITDA will not buy 9x EV/EBITDA even if there are synergies because the messaging to shareholders may be difficult.
For private equity firms, bankers can run LBO models to see what sort of reasonable price range they would get there at in order to meet their required IRRs.
Sometimes it also comes down to how badly the competitor firm wants it. When this is the case, they may stretch on financing or pay a higher premium than what would be normally justified. Sometimes this depends on commercial information only known to the competitor. So the investment bank has to say – pay this and you will win 80% of the time, pay this and you will win 100% of the time based on us backing out assumptions for the competing bidders.
The investment bank reconciles this with what the client’s value perspective is and then the ball is out of their court. The client has to decide whether or not they are comfortable with paying that much. Ideally, the price that the client can bid and win at is below what they are truly willing to pay for the asset. Dream scenario, however – rarely ever see it happen.
What you will find is that sometimes firms, some not even retaining an investment banker, will come over the top with a massive bid that no one can match. Just luck of the draw, and a lot of time spent without getting paid for the investment bank.