Enhancing Balance Sheet Efficiency
by Richard Bartlett, Head of Corporate Debt Capital Markets, RBS
The growth of private equity (PE) fundraising, which increased every year between 2002 and 2007, and exceeded $100 bn in 2007, has been phenomenal. PE investors led the vast majority of leveraged buy out transactions in the months leading up to the credit crunch when credit was readily available. With the markets now transformed and leveraged loans trading under par in the secondary market, banks are finding it difficult to underwrite large primary transactions on the one hand, while on the other, mezzanine finance is more constrained, resulting in increasing returns for these investors.
In this market, asset quality and the rationale behind a transaction become all important. So how are corporate treasurers responding to the new business environment in which they find themselves and how are financing structures changing?
With the decline of PE investment, the value of both traded assets and those held by industrial corporations has dropped, so companies hoping to dispose of non-core assets to PE investors will potentially find it more difficult to find buyers willing to pay an acceptable price. However, RBS has found ways in which corporates can improve the value of disposals given current market conditions, as the Home Depot example in fig 1 illustrates.
Changes in M&A strategy
Naturally the decline in asset value is leading to corporates rethinking their M&A strategy. There are two elements of this - firstly, disposals may be less attractive due to lower proceeds; secondly, companies in a strong financial position can take advantage of more attractive valuations of acquisition targets, which can be an important way of increasing return on equity and fuelling business growth. This latter point is substantiated by a recent Economic Intelligence Report, sponsored by RBS, which illustrates that 82% of executives feel or expect to feel the positive impact of more attractive acquisition targets (fig 2).
Consequently, while the current market conditions may pose a threat for some companies, others see the opportunity to gain competitive advantage and fuel growth and return on equity during a period of high costs and dispirited consumers. This is particularly the case as acquisition premia have come down due to the reduced involvement by PE investors. However, as acquisitions often have to be accompanied by disposals both from the point of view of financing and cohesion of business activities, PE players are often still desirable business partners, but as the Home Depot example (fig 1) illustrates, companies may have to play a greater role in financing. In addition, market conditions are not the same in all parts of the world, and investors from the Middle East and Asia have taken advantage of reduced competition for assets and have been instrumental in recapitalising financial institutions in recent months and can provide important access to liquidity and participation as an equity partner.