Even with the Triumph of Hope Over Experience, it's still a Buyer's Market

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.

Much Ado About Nobility -- In Advance of a Royal Wedding

On the eve of a “royal wedding” between Prince William and Kate Middleton and movements toward democracy in the middle east, I began to ruminate on the efficacy of monarchies and aristocracies in modern societies.  I have seen data pointing to the existence of about 50 royal families in the world – far more than I would have guessed.  If countries wish to have them and pay for their security and upkeep, it is certainly their business to do so and I do not begrudge them their decision.  Nevertheless, I wonder whether it really makes sense to adhere either to this form of government and the hereditary aristocracy it creates or to this form of class privilege in a modern society. 

Although there are many arguments (and solid examples) in favor of benign dictatorships, there are just as many cogent arguments (and many more examples) demonstrating that absolute power corrupts absolutely.  A monarchy (and accompanying nobility or aristocracy) does not necessarily imply such absolute power.  For example, a constitutional monarchy as in Spain serves as Head of State but is not politically active.  Nevertheless, a monarchy promotes privilege and it certainly perpetuates an inherited and almost certainly unearned (after a generation or two) class system.   Moreover, if a society has a monarchy, but does not bestow on such a monarch some real executive powers, then it has many of the cons but none of the real benefits of an Executive Head of State who can make a decision without having to go to committee.

Since it is the Easter season, I feel it is appropriate to paraphrase scripture.  The poor will always be with us.  Class systems are bound to arise in societies whether or not they are based on ancestry, history and tradition or wealth, brains, skill, athleticism, good looks or luck.  To a certain extent, nature and nurture will help perpetuate a class system.  Successful people marrying successful people will tend to have more successful children over time.  Parents naturally give their offspring every advantage they can.  What sense does it possibly make to offer state sponsored hereditary privilege for even greater advantage?

It is very difficult to estimate the costs of maintaining a monarchy and a landed gentry in a modern society.  In the United Kingdom, the BBC estimates the security costs alone for the royal wedding will run somewhere between 5 and 20 million pounds and perhaps over $300 million per year.  It is equally difficult to estimate the benefits such as increased tourism as well.  Would the UK really lose out much in tourism if the royal family were no longer “royal?”  The UK’s deep, royal history would not disappear.  The castles and country homes of the royals and the nobles are not going anywhere.

Indeed, what is this “history” that is being celebrated?  Isn’t the genesis of royalty, the biggest, baddest chieftain (e.g. William the Conqueror, née Bastard) who decided that he would band together with some big thug, noble buddies and beat up on other lesser thugs who had land he wanted and declare himself the chief thug of the land.  He would then parcel out the land to those thugs who were on the side of victory and tax it at a level where they would not complain too much but would instead throw their support behind “their” king.  The king would then cement “alliances” by marrying members of his family to members of other important, noble families to keep them loyal by blood and take the sons of other noble families to the royal court for “education and training” so the king could keep these additional noble families in line.  It is all wonderfully Machiavellian.  So that’s the “history” tourists celebrate?

The poor will always be with us.  Class will always be with us. Let’s not have the State pay for and perpetuate an outdated class system.  Isn’t it time for royalty and nobility to exit quietly and gracefully?

The Middle East, North Africa and the Ferengi Rules of Acquisition #s 34 and 35

War is good for business.  Peace is good for business.  At least according to two of the Two Hundred Eighty-Five Rules of Acquisition that compose the sacred code on which all of Ferengi society is based.  You just have to love the writers of Star Trek sometimes! 

Last evening, I listened to President Obama tell the nation why America is participating in enforcing a no-fly zone over Libya.  Skeptics on the left and the right will assuredly be pissed off by this recent decision of the executive branch.  The left will abhor any military engagement and the right will hate any Obama Administration action.  I think the President probably waited too long to do what we are doing now (we should have stepped in to assist a couple of weeks ago and not let Qaddafi’s forces gain any upper hand), but ultimately the Administration decided to back the same forces of change in both Tunisia and Egypt that have sandwiched Libya.  Very few in the broader Arab world can complain about preventing a potential slaughter of civilians in Benghazi and fewer still will shed many tears at Colonel Qaddafi’s departure. 

It would be nicer and more convenient if the United States held a coherent, regional strategy.  But consistency is the hobgoblin of small minds.  America is now interested and involved and is doing the right thing alongside the political cover of the UN.  We are the chicken and not the pig in bacon and eggs in this situation.  The Obama Administration appears inherently conservative (I am shocked I am using “conservative” in the same sentence as Obama Administration, but yes, it appears to be so in this case) on many foreign policy issues so this slight delay and ultimate handover of control to NATO should not come as a surprise to Washington watchers.

Ultimately, if a war does not drag on for years on end and if there is a peace that follows and Libya does not evolve into Iraq, this situation is good for business.  I do not think Libya is Iraq.  The Libyan people back the intervention and the insurrection is part of a broader trend.  There is an arc in northern Africa extending from Tunisia to Egypt of well over 100 million people who will ultimately have the opportunity to have some sort of self-government.  Although a peaceful transition to a democratic society where millions of people will finally have the opportunity to enjoy the fruits of their labors and enter the middle class is by no means assured, I believe the chances are far better today than they were one week ago. 

In the meantime, someone will benefit from rebuilding after the bombing raids.  Someone will make money from the explosion and flowering of new commercial efforts that will burst force and erupt once the shackles of the Qaddafi regime are thrown off.  As the Ferengi have noted, “War is good for business.”  Perhaps they should have said “Peace is even better.”