The recent GDP advance estimates for the first quarter of 2011 reinforce what I (and probably many others) have thought was the case for some time. Economic conditions have indeed improved over the past two years, but not enough to enable us to adopt the Candide philosophy that everything is fine in this best of all possible worlds. Our economy is gradually digging itself out of the gigantic hole we created, but there are many forces holding us back from crawling out more quickly. I have been told several times recently that Mergers and Acquisitions is one area that has greatly improved and is helping the country repair itself, but even there, we are not, in the words of the bard Prince – partying like it’s 1999.
It is true that companies are paying bankers to do deals and are not firing multitudes of employees when they purchase other firms. I am currently responsible for 6 companies within my firm’s portfolio. Many of these companies have improved their economic performance substantially in the past two years and are now in various stages of the M&A process. The M&A market is far better than it was in the very dark days of late 2008 to early 2009 when it was hard to get a meeting with a potential acquirer much less an offer. But no matter what companies may hear from M&A bankers today (a naturally optimistic lot compensated by doing deals which remain the perennial triumph of hope over experience), it’s still a buyer’s market. There are a multitude of reasons for this situation and it manifests itself in a number of ways.
For example, it remains the exception and not the rule that a target company can actually get two or more potential acquirers to engage in a formal process bidding against each other and drive up the acquisition price. There are very few companies like GroupOn that can spurn offers and seriously contemplate going public. The whiff of an auction causes such angina among corporate development officers at strategic buyers today that they rarely hang around for more than a second round of bidding if they will even go that far. Few targets are so strategic and irreplaceable that acquirers simply must have them. Therefore, potential acquirers often do not bid up prices much during a sales process. Moreover, in almost all market sectors, because there are far fewer public companies today than there were 10 years ago, there are typically only a handful of real, potential strategic buyers. And all of these buyers know one another and are often in fairly regular communication at conferences and other venues. Debt is expensive and accordingly financial buyers are at a significant disadvantage during such times. Even though there is talk that the IPO window has recently opened, very few companies offer a credible threat of an IPO and the data demonstrate a relative dearth of public offerings relative to the pre-bubble 1990s. Accordingly, buyers demonstrate bidding discipline and it is difficult to break down their resolve.
Once a target company has settled on a suitor and has signed a letter of intent to be acquired, the real fun begins. At this stage, the parties have negotiated relatively few provisions that end up in a Definitive Agreement or the very important schedules that accompany a Stock or Asset Purchase Agreements. Due to a relative paucity of alternatives, buyers hammer target companies on terms and conditions in final legal documents. For example, escrows are significantly larger percentages of deals than a few years ago and are lengthening. Representation schedules are enormous and growing and buyers’ initial positions on warranties are ludicrous. Providing a warranty for the GDPs of the G20 group of countries for the next 3 years would be easier than some requests I have seen.
So what can a company do to protect itself? I see two choices. Don’t play the M&A game until power shifts toward sellers. Few companies have this luxury. Unfortunately, I don’t see a power shift happening for a long time given the current regulatory and economic environment. The other choice is to arm oneself with the very best legal, accounting and consulting counsel necessary to combat the arguments that will inevitably come from buyers. In the end, targets must be prepared to say “No” if the terms and conditions are simply too onerous to bear. Walking away may be the only choice that will bring buyers to their senses and back to the table. Such a threat cannot be a bluff because it may indeed be called. This isn’t poker where one gets to play a different hand with a new set of cards with the next deal. A target willing to play the walk card must play the same hand it holds in the current economic game. And it has to be willing to play these cards after a buyer knows a lot more about the company.
In the meantime, let us hope our leaders will make the changes necessary to provide a more fertile environment for economic growth. And let us hope that buyers will feel more buoyant and demonstrate a greater willingness to spend to seek growth through M&A. The former will help drive the latter. I am ready to party again like it’s 1999. I hope I don’t have to wait a decade or more for another seller’s market party, however.
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