Acquisition Finance: Oiling the Wheels of Business Deals
By Tsholanang Kgosimore, Transactor, Debt Financing Group, Rand Merchant Bank
Mergers and acquisitions offer a handy insight into the health of a business environment. Acquisitions are usually done by large corporates to meet strategic objectives, including growth and diversification. However, M&A activity in South Africa is currently experiencing headwinds owing to political and macroeconomic factors. An analysis by DealMakers South Africa shows that total deal value by exchange listed companies for the calendar year to end-June 2019 was R100.7bn (including seven failed transactions) from 212 deals. Excluding failed and foreign deals (offshore companies with secondary listings in SA) the deal value drops to R80bn (184 deals) compared with H1 2018 of R135bn (208 deals) – a 41% drop in value and 12% in number.
Generally the relatively lower valuations, compared to previous multiples, present a good buying opportunity and analysts anticipate an uptick in M&A activity in South Africa over the next three years. However, potential acquirers are discerning in their approach and are taking their time before making investment decisions.
One of the most important decisions in making an acquisition is the manner in which a transaction is to be funded:
- Certainty of funding is key for the sellers, particularly if the target is a listed entity;
- Timing is also important and therefore it is critical to partner with an experienced and reputable funder that can secure funding on time;
- Cost of funding for an acquisition should be managed carefully as it affects the overall returns of the transaction; and
- Funding for a large acquisition will affect the company’s capital structure and must be considered in the context of the company’s long-term capital management.
Broadly speaking and for the purpose of evaluating available funding alternatives, acquisitions can be split into two; bolt-on acquisitions and transformational acquisitions.
Bolt-on acquisitions are usually of smaller companies in the same line of business. These acquisitions allow companies to enhance their product offering, technological capabilities, market reach and customer services through a much lower level of investment. Large corporates typically have ample gearing capacity and liquidity available to them in cash holdings and committed facilities such as a Revolving Credit Facility (RCF) from their relationship banks, or they can typically secure an RCF from relationship banks relatively easily on normal terms. Funding an acquisition through debt often provides an optimal cost of capital outcome relative to cash. Bolt-on acquisitions are best funded by a facility such as an RCF, preferably from a single bank. This approach best preserves the confidentiality of the transaction and allows for efficient execution. For a large corporate, this size of funding is not expected to materially change the capital structure of the company. However, if it does, an RCF allows the company sufficient time, post the transaction, to consider ways of optimally re-balancing their capital structure.
Transformational acquisitions require larger investments and funding them requires careful consideration. For these transactions, speed of execution and confidentiality are most important as they typically involve publicly-listed entities with specific reporting requirements. Certainty of funding is equally as important - it is a requirement of the Johannesburg Stock Exchange (JSE) where the target is listed. There is significant value in a single bank providing a holistic offering, from advisory to funding. A recommended funding approach for a large acquisition is through a bridge facility, preferably from one bank. Bridge funding is typically for 3 – 12 months and will provide a company with suitable time to assess some of the key considerations in relation to the company’s long-term capital structure:
Considering the equity base of the business and credit profile in relation to the level of financial flexibility required to execute strategic objectives
Post the acquisition, large corporates typically prefer to maintain their credit profile (and their public ratings where applicable) and the financial flexibility that comes with it such as lower cost of debt funding and borrower-friendly funding terms. It is also advisable for a company to consider how their targeted gearing compares with their peers and how the markets will react if the company becomes an outlier. Where an equity take-out is required to achieve the targeted credit profile, bridge lenders will require some level of certainty that such an equity raise will be successful. The larger the equity raise relative to the company’s market capitalisation, the more certainty bridge lenders will require. The Companies Act requirements for large equity raises such as board and shareholder resolutions can be onerous and time-consuming and therefore lenders would require assurance that those requirements can be met.
Where required, determining the appropriate approach to raising equity
An equity raise can be done in the form of a Rights Offer (RO) to all existing shareholders on a pro rata and pre-emptive basis, or an Accelerated Bookbuild Offering (ABO) whereby shares are offered to the institutional market on a non-pre-emptive basis. An ABO can be executed fairly quickly, which provides the company with the flexibility to time a launch when market conditions are favourable. The amount that can be raised through an ABO is, however, generally limited by the size of the company’s existing shareholder authorities and market capacity. A RO on the other hand allows a company to raise a larger amount of equity capital, however the execution process is longer, which introduces market risk. Given the large quantity often required, ROs are typically underwritten by a bank or a strategic/major shareholder to provide certainty of proceeds and pricing for the company.
Assessing the right mix of funding instruments for the repayment of the bridge facility
The spectrum of funding instruments includes traditional funding such as bank loans and debt capital markets. Other forms of funding are preference shares and hybrid instruments such as convertible bonds. Diversification of funding becomes more important with the size of funding required. A company would have to consider the pros and cons of each instrument and determine an appropriate balance. The benefit of a bridge is that it affords a company time to bed down the acquisition and incorporate that knowledge in determining the appropriate funding instruments. Another important consideration is the approach to the market, i.e. private or public bond issuance; bi-lateral, club or syndicated loans; best effort or underwritten syndications. The major benefit with underwritten funding packages is that they provide companies with certainty on funding and terms and are quicker to implement. A well-structured bridge should afford the company the flexibility to approach the market for funding when the market conditions are optimal to do so.