Funding your acquisition. The options widen for hungry corporates

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1 Funding your acquisition The options widen for hungry corporates

2 Executive Summary Acquisition is back on the menu for corporates. One of the key ingredients for success is a financing solution that matches your appetite for growth. The return of corporate confidence has triggered a steady rise in the number of mergers and acquisitions. Many cash-rich companies are calculating that the time is right to secure strategic growth through takeover. Revolving credit facilities and, increasingly, US private placements remain the most popular financing routes for these transactions. However, other options are available which might offer a flexible, long-term fit, especially for larger corporates. The key lies in balancing the potential rewards of a new acquisition with the right level of debt and risk for your company. 2 of 8

3 Options for growth As the recovery strengthens, the appetite for carefully considered risk is growing. Boardroom discussions are focusing on investment of capital that has, in some cases, been judiciously hoarded for several years. Risk appetite % of CFOs who think this is a good time to take greater risk onto their balance sheets 80% 70% 60% 50% 40% 30% 20% 10% 0% Deloitte CFO Survey, QI The re-awakening of interest in strategic investments spans the sectors, according to Dave Davies, Director for Debt Finance at Barclays Some look to deepen their existing business with investments in plant and premises. Others are planning moves into new markets. And a growing number of firms are actively browsing the market for potential acquisitions Businesses linked to technology, which have tended to run reasonably cash-rich, are now being encouraged to use their cash for growth, he says. We re also seeing a lot of M&A activity in the industrial space, and a smaller but growing amount in retail. He says the decision to opt for acquisition generally reflects individual business circumstances: There can be benefits in coming together with another business to increase your critical mass or achieve diversification. If one part of your business offers a higher margin, a carefully selected acquisition could broaden your exposure to that part of the group. Alternatively, an acquisition could bring a new but complementary product or service into an existing business. A dynamic market Corporates can expect competition in this market, however. The number of M&A deals is rising steadily just over 14,000 last year, up from 13,621 the previous year and values are growing even faster. By the end of 2015, according to a global poll by American Appraisal, valuations are expected to reach a multiple of 11.3 times a company s net earnings. That s up by 23% from 9.2 times earnings at the end of With most transactions going to auction, the chances of picking up a bargain are slim. The financial flexibility now available to corporates is an advantage, but it also serves to push up vendors price expectations. Private equity competition is a factor too. PE is still a reasonably small share of all M&A activity by volume and value, but it makes a difference, says Davies. Their increased appetite for deals, and increase in the level of financing available to PE purchasers allows them to bid that little bit further. 3 of 8

4 EMEA announced M&A by value 700, , , , , , , YTD Dealogic database on 13 June Sponsor Non-sponsor % FS 30% 28% 26% 24% 22% 20% 18% 16% 14% 12% 10% Funding mix Once you have identified a target, listed markets and recent M&A transactions are readily available to help predict the likely price required. Balancing this against the required upfront investment, the costs of extracting synergies and the potential profitability will make it clear whether your purchase is viable. Work with your advisors to ensure all options are considered. The larger the business grows, the more varied the options in terms of investor appetite across different risk levels. Dave Davies, Director for Debt Finance, Barclays Move fast and engage Once the realistic benefit of the acquisition to your business has been calculated, early action to assess the right move and obtain stakeholder support is a key piece of advice, as Davies emphasises: The sales processes can move quite quickly, and you need to be in a position to place competitive bids at the right time, he says. Understand your acquisition firepower what you can fund via bank, capital or equity markets. Ensure you schedule early discussions with the board about the parameters you want to operate within: bringing a new acquisition to the board at a late stage could add unnecessary pressure to the process. Have discussions with your bank as soon as you can too. There is value in understanding the current banking markets, and your banks would welcome the opportunity to share their views. Talking through the possible scenarios lays the groundwork for future acquisitions, even if you don t follow through on your initial plans. To obtain bank support for an acquisition, once details become available, corporates need to be able to convey the strategic rationale for the deal. Banks need to understand the financial implications and see what the enlarged group will look like. Be equipped to outline the synergies that arise from the acquisition, the costs of achieving them and the timetable for the integration. Be aware that banks will also consider the capacity of your management team to absorb this extra workload. Assuming the answer is positive, consider the best mix of funding from the use of balance sheet cash through different types of debt, to the option of raising additional equity. Large corporates, in particular, usually look to use their own cash reserves in the first instance. These companies are comfortable with revolving bank debt and private placements, and the markets in these products are currently healthy and competitive. However, it s also worth considering the merits of less familiar structures. Larger corporates typically have a greater range of financing options, Davies says. The larger the business grows, the more varied the options in terms of investor appetite across different risk levels. 4 of 8

5 Funding options Revolving credit Private placements Bridging to capital markets Revolving credit facilities are generally for five-year terms and come with a relatively established set of terms and conditions for the plc market. Where debt is expected to reduce fairly rapidly, the flexibility of this type of financing is attractive compared to bonds, for example, which can be relatively expensive to repay early. The use of revolving credit facilities offers the most flexibility for a purchase, and is likely to be the most cost-effective option for corporates which don t expect to run a meaningful level of core drawn debt over the medium term, says Kenny Hughes, Head of Debt Finance. Underwriting In certain situations, it can be beneficial or even necessary to have certain funding before announcing an acquisition. Should you wish to limit the number of parties you engage with, an underwritten financial package offers committed bank funding so that you can announce and present your acquisition process. The funds are committed from signing, with your bank or banks syndicating down their exposure into the bank market over the following few months. An underwritten facility provides certainty and allows the funds to be raised in a short timescale with one or a small number of banks. Accordingly, there are additional costs associated with the bank(s) taking on this additional underwriting risk. The use of US private placements (USPPs) by UK corporates has grown quickly over the past two years, reflecting a tendency of corporates to issue bonds alongside bank debt. USPPs offer a way of raising longer-term debt either in bullet and/or amortising form. Like bank facilities, they usually come with financial covenants. Their duration is rather longer, typically seven to 15 years, but also longer tenors, including out to 50 years, dependent on sector and issuer. Used in tandem with revolving credit facilities, USPPs allow corporates to stagger their debt maturities. Many corporates match their private placement debt level with their expected core borrowing requirements over the medium term, says Hughes. It is generally used in collaboration with a bank-revolving facility which exists as flexible financing headroom, rather than core debt. Alternative funding sources continue to complement bank liquidity Continuing to shift: the corporate capital stack across the UK 100% 80% 60% 40% 8% 74% 20% 17% 0% % 62% 29% % 39% 38% 2009 Loans DCM ECM 8% 74% 18% % 72% 25% % 49% 45% % 53% 37% 17% 54% 29% Bank financing can provide the certainty of funding which is vital in acquisition situations. However, corporates may consider that the correct capital structure for their business will include an element of bond financing to diversify investors and maturities. Corporates can raise shorter-term bank debt as a bridge to a capital markets issuance. A bank or banks will provide a 12- to 18-month bridge to capital market financing, such as a USPP, says Hughes. The business then works with the banks over that period to issue a new bond. This structure has the advantage of securing certainty of funding on day one whilst maintaining flexibility to lock in the best capital structure for the group. 1. H volumes up across debt capital markets H has seen an improvement in volumes across debt markets (aside from USPP) with loan volumes, in particular, up 37% on the year, but overall supply still outpaces demand. The latter is expected to change on the back of event-driven financing and demand for refinancings and amend and extends. 2. DCM continues to complement traditional loan financing Loans continue to be of significant importance to clients as they provide the most flexible funding source to suit borrowers needs, including bridge financing to a more diverse array of debt markets. Notwithstanding the latter, the trend towards a more US capital structure continues to be evident with DCM instruments playing an increasingly central role. 5 of 8

6 Convertible bonds Convertible bonds enable businesses to raise up to 10-15% of their market capitalisation of low-cost debt. Investors back the business to deliver growth, usually choosing to convert when the share price rises above a premium set at the outset. This route has been recently used to help fund M&A activity, and also to refinance existing debt or diversify funding sources. Because it entails issuing shares, it will not suit every corporate, but it has worked well for some larger, fast-growth businesses in sectors such as technology. A convertible bond is a non-amortising facility, typically over a term of five to seven years. It has an equity option embedded in it, which effectively subsidises the margin to the extent that the coupon on convertible bonds is often very low. Equity for M&A can be raised via a cashbox mechanism a legal construct which allows a company to issue up to 10% of its shares without triggering pre-emption rights. Dave Davies, Director for Debt Finance, Barclays It is materially cheaper on a month-by-month basis than any other product, says Hughes. It is also flexible, and provides the benefits of fewer operational and reporting requirements for the corporate. Typically the minimum amount for a convertible bond is m, so you need to be of sufficient size to get the liquidity you need. The market is currently very attractive, with clients securing a premium of around 30% on their day one share price. High yield bonds Some larger corporates have begun to use high yield bonds to diversify their funding source or finance acquisitions. These are bonds of mostly five to seven years in tenor (or potentially up to 10 years). They offer financial and operational flexibility and the ability to sustain a higher level of debt than bank facilities typically allow. The use of revolving credit facilities offers the most flexibility for a purchase, and is likely to be the most cost-effective option for corporates which don t expect to run a meaningful level of core drawn debt over the medium term. Kenny Hughes, Head of Debt Finance, Barclays The disadvantage is that while it is becoming less expensive, this option does involve a higher cost in return for the greater flexibility offered. Also, minimum issuance size of around 150m will mean that this is suitable for larger companies. As corporates reach the next level of growth, financing options widen further, and sub-investment grade public bonds are added to the menu. Attractive pricing and terms are available for regular issuers of public paper, but only the largest corporates will have access to this market. Equity options To facilitate large acquisitions, some corporates may choose to raise equity alongside debt. Davies explains: Equity for M&A can be raised via a cashbox mechanism a legal construct which allows a company to issue up to 10% of its shares without triggering preemption rights. The alternative to raise larger amounts would be a rights issue, which has been successfully employed by a number of larger corporates in acquisition scenarios. Case study: RPC Plastics producer RPC is always on the lookout for apt additions to its portfolio of companies. It found a good strategic fit in Ace Corporation, a Chinese manufacturer, which will add technology and know-how to the group s mix. In advance of the deal, Barclays Debt Finance team met the company s executives to talk through financing options. RPC eventually opted to fund the purchase through an equity placing and a new, 350m bank facility. The refinanced club arrangement allowed RPC to shuffle its banking mix to mirror its changing global footprint, while achieving certainty of funding for the acquisition. 6 of 8

7 Key takeouts When seeking to fund a potential new acquisition: Involve your stakeholders at the earliest stage engage your board, shareholders and banks in discussions about the most appropriate risk profile Explore the potential advantages of the full range of debt structures now on the market perhaps in combination with more familiar bank and private placement products Act swiftly to ensure you are prepared for new opportunities in a dynamic market where values are rising. To find out more about how we can help your business review current and future financing needs, visit barclays.com/corporatebanking, or contact your Relationship Director. 7 of 8

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