Compiling a Buyers Universe
When investment bankers are looking at an asset or a corporate for sale, the natural question is who buys it.
This is part of the expertise that the investment banker provides in their services offering. At a large investment bank such as JP Morgan, there are large, dedicated industry coverage groups for everything from industrials to consumer & retail. While clients may have some sort of idea about what their competitors are doing and how the capital markets landscape is, they are generally focusing on their own business. This means:
- How are our sales doing year-over-year?
- What is our cost of debt right now if we issue?
- When are our debt maturities coming up?
- What division are we weak in and what do we need to do?
- Should we sell ourselves or consider strategic alternatives?
When JP Morgan comes in, they are expected to fill the gap and provide a picture of the competitive landscape. A lot of the time, this involves the following questions depending on the nature of the transaction.
- Looking to sell a non-core asset – create a buyers list for who would purchase the asset
- Looking to sell several non-core assets
- Looking to sell the entire corporate
- Looking to buy an asset – create a list of assets with operational or geographical synergy and subsequent buyers lists for each one
- Looking to buy a corporate – same as above, but one buyers list only if the client suggests a specific rival to the investment banker
Buy-Side Pitch Buyers List Example
As an example, we look at a hypothetical situation with a large toy company like Spin Master. Spin Master has generally been very conservative with their balance sheet and generates a very large amount of cash flow every year. Interest expense is low and they have ample debt capacity that they can tap into (banks and bond investors will likely be willing to let them raise debt at attractive interest rates).
It is looking to purchase either a large toy line with synergies or to roll-up a toy/entertainment company.
They ask their investment bank for some preliminary thoughts and valuation perspectives. This is where the investment bankers come in with a pitch book that can show some of the following idea generation:
Potential Acquisition Targets (or Target List)
Investment bankers will list a number of corporates and assets (toy brands and their associated factories and supply chains) that are attractive to Spin Master. There will be a list anywhere from 5-50 names depending on how wide the scope is and a description of the corporates or assets as well as their known cash flow and trading multiples (for corporates).
There will also be a list of precedent transactions informing what multiples these assets have historically sold at. Along with market knowledge from being on the pulse in the industry from constant coverage and professional judgment, investment bankers are able to provide commentary on what is a purchase that fits and what is not.
Potential targets will be tiered – assets that have the greatest operational synergies and are trading at an attractive EV/EBITDA multiple (perceived low growth, motivated seller or a company or major shareholder that is looking to exit for a variety of reasons) make the most sense.
The multiple is particularly important for public companies looking to buy a competitor because if you purchase at a higher multiple to what you are trading at that is dilutive to cash flow per share, which is a psychological wall that is set up immediately for shareholders and the company Board of Directors.
Potential Buyer Universe
This is where it gets annoying – for every asset or corporate, there are a natural list of buyers who would consider dipping in. These buyers can be both strategic – for example, Spin Master would compete against giants such as Hasbro, NamcoBandai and Mattel as well as regional players – or financial – private equity firms that encompass all fields from Carlyle Group to Advent International or mid-market private equity firms that see an attractive return.
This is where the investment bankers really have to dig deep – and tier the buyers. For each asset, how attractive is it to the rest of the buyer universe?
If one potential asset has their factories in close proximity to Hasbro, they may be willing to pay a premium owing to the synergies. If a new Chinese entrant has been overpaying on multiples and has easy access to cheap debt (which makes transactions accretive), they will need to be considered as potential interlopers.
Shareholder considerations also have to be considered – again, looking at the EV/EBITDA multiples Hasbro and Mattel are trading at versus the asset. If the asset or corporate is trading more richly than them, it is a hard sell unless there is a strong growth story that they can spin into a compelling narrative for all stakeholders involved.
Also, the investment banker’s knowledge of the landscape is key. If Mattel recently had a transformative acquisition, their balance sheet may be stretched and it may be difficult to tap the capital markets for cheap debt and equity – they could be divesting product lines instead of looking to acquire.
For some buyers, the asset may be attractive but simply too big and transformative of an acquisition. The relative size of the acquisition is a serious consideration. For a $200 million product, Hasbro may find it very easy to make a purchase. Smaller transactions that are less material do not require shareholder votes or major internal discussions. Also, the investment banker for the seller is not worried about financing – Hasbro could easily fund it using bank lines or operating cash flow.
Some buyers may like the asset but not find stakeholder appetite (their banks may not approve the transaction, or shareholders will vote it down).
For financial buyers, Ability to Pay analysis may be looked at by running a simple leveraged buy out model to see if the asset would meet their required returns. This differs from fund to fund – traditional PE shops such as Permira are going to want a certain return floor like 25-30%. Lower risk money, such as an infrastructure fund, may only require 12% returns.
Sell Side Process Buyer List
If Hasbro wants to sell off Parker Brothers or Milton Bradley, this becomes a far simpler exercise for the investment bankers.
They value the product line as a multiple of EBITDA, DCF or other method and then show a list of historical purchase prices (the precedents). Then they will show the buyer’s list.
As one would surmise from reading above, working on the sell-side (sell yourself or sell your assets) is more linear than working on a buy-side pitch (here are some acquisition targets, this is why they are worth this, this is who would buy them, this is their ability to pay).
Best Times for Mergers and Acquisitions
So when is the most opportunistic time to buy – especially for horizontal mergers? If there was recently a:
- Financial crisis
- Supply shock for a major supplier (you are an airline and the price of oil rockets)
- Demand shock (you are a gold producer and the price of gold plummets)
For companies that built up a fortress balance sheet before the pullback – so companies that smartly paid down debt and kept to their ideal leverage ratios (Debt/EBITDA) or raised equity beforehand – they are in a great position to act.
In this case:
- Many targets could be trading at distressed multiples and need to sell to avoid bankruptcy or other distraction
- Targets that are fine balance sheet wise (debt is manageable) but the share price has fallen so much with sufficient shareholder churn that you are able to offer a huge premium to the current share price opportunistically
– this works best if you evaluate the shareholder list and there are a lot of transient shareholders invested instead of a long term backer; then you will look at their weighted average cost of entry (what is their average share purchase price) – if the premium offered is above this, getting shareholders on board should be easy
- Competitors that would be natural bidders are unable to bid because they will not be able to finance the acquisition