Managing M&A auctions in the current climate
January 2014 | TALKINGPOINT | MERGERS & ACQUISITIONS
financierworldwide.com
FW moderates a discussion on managing the M&A auction process between Rick Lacher, a managing director at Houlihan Lokey, Matthew Tedford, a partner at KPMG, and Nigel Boardman, a partner at Slaughter & May.
FW: Could you provide a brief overview of the M&A auction process? What are some of the advantages and drawbacks of using this approach?
Lacher: Clearly the biggest advantage is that an auction allows a seller to comprehensively survey the market to uncover every potential buyer. Even though the list of potential buyers may often seem obvious, sometimes the right candidate emerges from an auction process that was previously unnoticed or would not otherwise be considered. By going to a broad number of potential buyers, you will uncover lower probability buyers that you would not typically approach. While not a frequent occurrence, once every so often, one of those low probability buyers either ends up buying the company or helps create a more robust auction dynamic. The drawback is in some ways equally obvious: an auction process means more widespread dissemination of confidential information into the market, which is a necessary part of the process but creates risks that could potentially be harmful to the company. That is a curtain that cannot be drawn once it is raised. In addition, an auction is a process to which a company’s management must devote a significant amount of time and effort, dealing with multiple suitors and diligent requests – the more potential suitors, the more time that management must devote to the process and not to running the business. While the latter may be an issue in any process, you increase the odds of that happening when you cast a wider net.
Tedford: The M&A auction has become a common occurrence globally. It allows a seller to illicit offers from multiple buyers at the same time. The process gives the seller better control of information that can be produced more timely, and consistently, to potential buyers. Several advantages exist but one of the key benefits is speed of execution. With robust datarooms, well thought-out transaction documents, and organised processes for management time and site visits, auctions typically result in transactions closing earlier. Moreover, competitive tension compels purchasers to put their best bids forward. Some of the drawbacks associated with an auction include larger dissemination of confidential information, especially into competitor’s hands. Additionally, the process can be a distraction to operating the business, depending on the number of bidders management has to deal with.
Boardman: An auction may be used to sell a company or business and involves a number of bidders at the early stages. Typically the seller will prepare an information memorandum containing important information about the company or business being sold which will be sent to a number of potential bidders, and then each potential bidder will be invited to submit an indicative bid. The seller will invite those who submitted the most attractive bids to undertake due diligence, review the draft sale documentation and after this has taken place invite a further round of bidding. At this point, the seller will select a favoured bidder with whom negotiations will continue, which the parties hope will lead to a sale. A potential advantage for the seller is that the price may be driven up by a number of interested bidders. In addition, the seller may be able to use the auction process to secure better deal terms. The disadvantages for the seller include that it is harder to keep the process confidential when compared with a private treaty sale, and a failed auction is likely to result in negative publicity and reduce the chances of obtaining a good price for the company or business being sold in the near future. From the buyer’s perspective, there are not many advantages of participating in an auction as opposed to a private treaty sale. Negatives include that the bidder may have to agree to less advantageous terms in order to be selected as the preferred bidder.
FW: How do auction results compare to privately negotiated deals? When is a private negotiation a more desirable option?
Tedford: It really depends on the industry and the state of the economy. Auctions have become the norm; however, privately negotiated deals still exist. Extremely motivated buyers with secured capital and financing who understand the seller’s business intimately, will often try to pre-empt an auction process. There are benefits to the seller if they believe they can attain high price as they will avoid running a disruptive process which consumes management’s with multiple bidders. Buyers like negotiated deals as there is more certainty around closing and generally more control over negotiating contractual obligations including closing adjustments, warranties and so on.
Boardman: Auctions are chosen by sellers in the hope that the auction process drives up price and secures better deal terms for them. In some circumstances a private negotiation will be a more attractive option. Such scenarios include, first, when the fact that a sale is taking place is confidential. There is a greater chance of a third party becoming aware of a sale when a sale is made by way of auction, as more than one party is made aware of the proposed sale. This information may negatively impact on the company/business being sold until after the sale is completed. Private negotiations are also attractive when there are only a very limited number of potential purchasers, for example, due to the structure of the market. In this context the auction process may not create a competitive environment, and the additional complexity and costs associated with an auction process may be unjustifiable. Finally, private auctions are more attractive when potential purchasers will need to obtain regulatory approval. The pace at which an auction process moves may be inappropriate in this context due to the long period of time it may take to obtain regulatory approval.
Lacher: It is impossible to know how an auction compares to a privately negotiated transaction in any given situation. If approached by the logical strategic buyer, then there may be no difference, even though most professionals talk about how competitive tension increases price and improves terms. If a seller is comfortable accepting a purchase price resulting from a privately negotiated transaction they must address a number of potential concerns. These concerns include confidentiality, the risk of rumors about the health and future of the company and dealing with customers or employees who hear about a process. Sometimes an owner’s biggest concern is not the financial terms but fit and culture – they are seeking to maintain a particular culture at their firm or they are seeking an acquirer with a similar culture or at least an acquirer who will not alter the one they have created. For family-owned companies that prioritise this, then an auction process may not be ideal for them.
FW: In what ways has the M&A auction process changed in recent years?
Boardman: Buyers have generally been far more cautious than in previous years. As a result, there are often fewer interested potential purchasers, meaning that it has been harder for sellers to maintain the competitive environment that make auctions successful. Furthermore, buyers are requiring in-depth and specific information before they are willing to submit a bid. This influences both the information that is contained in the information memorandum and the level of due diligence that buyers require. In addition, although the auction process has historically been controlled almost exclusively by the seller, buyers are increasingly able to exert more control over the process.
Tedford: The global private equity community has driven consistency and quality into the M&A auction process. Premiums are placed on high quality confidential information memorandums (CIMS) where information in the electronic dataroom is consistent with CIMS and other presentations that can be analysed quickly through properly indexed and organised spreadsheets. These are the things that facilitate more quality time with management. As a result, M&A auction processes are typically very productive and time saving, and can accommodate multiple local and global players with efficient flow of information, limiting unnecessary time and travel. Both sellers and buyers are as nimble as ever which is important to maintain pricing tension.
“Preparation well in advance of sale is critical. Sellers need to work with their advisors to ensure that the essential steps necessary to complete a transaction can be satisfied on a timely basis, which may include everything from landlord to customer approvals.”
FW: What steps should sellers take to attract prospective buyers to M&A auctions? In today’s market, how can they widen the net and bring in global players?
Tedford: Preparation well in advance of sale is critical. Sellers need to work with their advisors to ensure that the essential steps necessary to complete a transaction can be satisfied on a timely basis, which may include everything from landlord to customer approvals. Furthermore they need to fully understand the market of potential buyers to ensure the auction is robust from inception. This should include a competitor analysis by region as well as understanding financial buyers who have traded in the seller’s industry or who have publicly expressed an interest. Advisers are important because they generally have strong global networks which can help get buyers interested early in the process.
Boardman: Sellers should provide specific information at the early stages, which must be accurate and attractive to potential bidders. The information could be provided in the form of a management presentation instead of an information memorandum, which may be a more impressive way of providing potential bidders with information. Moreover, banks and financial advisers continue to play a very important role in identifying potential purchasers and bringing in global players to the auction. There is some debate over whether global players are attracted or deterred by the auction process; ultimately this depends on the sophistication of the global player and whether they have prior experience of participating in an auction. However, if there is a serious purchaser interested in the company or business being sold, the method of sale, be it private treaty or auction, is unlikely to deter them from trying to secure a deal.
FW: What advice can you give to sellers on extracting the maximum value for their company via an M&A auction?
Lacher: A lot of it has to do with how one positions and presents the company, including how it addresses and is prepared to respond to concerns that a buyer will likely raise. It is also helpful to access the right buyers at the right levels and get their focus – the higher up their priority list, the more the focus. Timing is also critical, both in terms of where the company is in its own cycle and its sector’s cycle. Of course the buyer needs to be in the right ‘place’ in its cycle as well, so to speak. Sometimes the timing isn’t right – perhaps the seller is presenting itself at the right time, but the ideal buyer is not ready due to internal issues with which it is dealing. We once sold a business that we believed to be the perfect strategic fit for a large, public company. That company was digesting an acquisition and could not focus on this opportunity. Two years later, the financial buyer who bought the company sold to that buyer at more than twice what they paid and made more than four times their investment. In that situation, the seller was a European public company that was liquidating its assets and did not want to wait until more optimal timing for ultimate buyer. In hindsight, that would have been the best option. We’ve also discovered that trust is an absolutely critical part of the success of any process and, related to that, being completely honest and forthcoming throughout the diligence portion of the auction. We always assume that we are dealing with sophisticated buyers and that they will discover all of the warts, if any – it is better to be prepared than hope they will miss something. If an issue arises at a later point in the process, it can be regarded as dishonest or deceptive – especially if you try to downplay the concern as unwarranted – and a positive dialogue with a good potential buyer can go sideways. It is very difficult to get two parties to agree on business or legal terms when they do not trust the other and believe the opposing party is try to pull the wool over their eyes.
Tedford: Sellers should always go through the process by putting themselves in the shoes of a buyer. What are the critical areas to understand, how should these areas be explained through the dataroom, and how should certain sensitive data be incrementally added to the process, are all questions sellers need to be able to address. If the transaction has to be financed through the public markets sellers should also know what reports buyers would need to produce. 'Quality of earnings' reports are likely required; therefore sellers should use their advisers to help prepare the detailed analysis required for these types of reports. This will typically save management’s time by limiting having to answer similar questions throughout the process.
Boardman: At the outset, inviting the correct parties to bid in the auction is key and can make or break the auction process. Timing is also crucial and ideally the auction would take place at a time when there is strong demand for the type of company or business being sold, although it is not always possible from the seller’s perspective to wait for such a time. Exclusivity shouldn’t be agreed too early on, as otherwise the process can quickly become controlled by the exclusive bidder, meaning that many of the potential benefits of the auction process are not obtained. The timetable may also impact on the success of the auction process. The pace of the auction should cultivate a competitive environment, but the timetable should not be too ambitious as otherwise potential buyers may be deterred from taking part in the process, especially in a market where buyers are generally requiring a greater time period for due diligence.
“When preparing a bid, bidders need to put themselves in the shoes of the seller and ask what is important to the seller, and form their bids accordingly.”
FW: What strategies can buyers use to increase their odds of being the successful bidder at auction?
Tedford: The buyers that are most successful in today’s auctions have done significant analysis in advance. For financial buyers this can include anticipating industries where sales may arise and getting a leg up on their commercial analysis. Buyers who understand the industry and the related issues can assess risk much more rapidly on issues unique to the seller which allows them to assess valuation more judiciously. Prepared buyers are also better equipped to play the auction game; they will understand the process rapidly and be able to ask for incremental data requests earlier which helps them get ahead of other buyers. To put it bluntly prepared buyers can pay the most.
Boardman: When preparing a bid, bidders need to put themselves in the shoes of the seller and ask what is important to the seller, and form their bids accordingly. The price is often the determining factor, but certainty of available funds to finance the transaction and having a cooperative bidder that is committed to the transaction is likely to be equally as important. Bidders should, if possible, complete full due diligence and submit a comprehensive mark-up of the sale documentation, which will demonstrate commitment to the process. It is crucial for bidders to prioritise which points they wish to argue in relation to the deal documentation, otherwise they may deter the seller from selecting them as a preferred bidder. In addition, another factor to be considered is whether the seller wishes to have any ongoing involvement with the company being sold.
Lacher: The key is understanding who the decision makers are and, more importantly, what is motivating them. Is it price? Is it culture? What are the hot buttons – is it something specific, like keeping operations in a particular city of which the company has become an integral part? Price and certainty tend to be the two biggest concerns, but there is also cultural fit, specific requests, and other factors behind sellers’ motivations to enter into an agreement. There is also the trust issue mentioned above – it’s always easier to get something done when you do not doubt the other side. A buyer creating a track record of always doing what they say they will do and not worrying about immaterial details – including on the legal side – will have an advantage. A buyer creating certainty by completing diligence and taking all material legal issues off the table will be viewed very favourably. Whether that can overcome a differential in price and terms will be based on the situation, but price tends to trump all – assuming the transaction can be closed.
FW: A number of M&A auction methods are available. Could you outline these and provide an insight into which type seems to be most popular in today’s market?
Boardman: An auction can be structured in many ways, ranging from auctions targeted at only a few bidders to auctions with many bidders. The stages of an auction process can also vary, for instance, the number of rounds of bidding and information release. However, the key characteristic of the auction process is that there are a number of bidders at the early stages and that bids are submitted in a competitive context. The main consideration is always whether the structure of the market makes an auction process suitable – beyond this the method adopted depends on what is likely to maximise value and secure the best deal terms for the seller in the market in question.
Lacher: Broadly, the three types of auctions are the ‘rifle shot’ approach, in which a company and its adviser selects less than five or so potential suitors to engage; the targeted approach, which is similarly focused but on a larger universe of buyers – up to 20 or so; and the ‘shotgun’ approach, which as its name implies is a very broad look at the market. The method one chooses is largely driven by the goals of the seller – culture, fit, and so on. However the type of seller is often a factor; for example, a private equity shop may take a broader approach – especially given it has an obligation to its investor base to prudently maximize value – while a family business may want to go narrower and focus on a shorter list of potential buyers given non-financial considerations.
Tedford: There are a number of auction methods available including a ‘stalking horse bid’ auction; a ‘true auction’ where the process is highly competitive; a ‘beauty contest’, where each bidder is assessed based on presentations for price, fit, and ability to close; and a ‘single negotiation’ that is open to other bidders until exclusivity is reached. The true auction, where bids are solicited on a conventional basis with timelines and processes to follow is the most commonly held auction. It would be misleading to assume however that true auctions are broad 'shotgun based' procedures that cast a wide net. The most effective are directed at the most logical buyers. A stalking horse concept is used in some bankruptcy situations and inherently in 'plans of arrangement' or other take-over bids where the top bid is known to the public and can be 'topped' – after typically paying a 'break fee' to the initial bidder – right up until the deal is approved by the shareholders or the court, as the case may be. Stalking horse bids can be very effective, because the floor is set and the price has nowhere to go but up.
“The biggest mistake we see is failing to understand the extent to which emotions play a big part in a decision makers’ process; it is not always about the numbers.”
FW: What common mistakes do parties – on both the buy and sell side – tend to make during the auction process? What is your advice on avoiding these missteps and managing the risks involved?
Boardman: This ties in to many of the points discussed above. Bidders often fail to demonstrate commitment to the transaction, by taking short cuts and trying to keep costs low. Bidders should avoid arguing points too aggressively when they are not crucial to the deal. What it often comes down to is that the bidder is not offering enough money. On the sell side, common pitfalls include that the seller fails to invite the correct parties to participate in the auction; exclusivity is agreed too early in the auction process which removes the competitive pressures that an auction is designed to cultivate; and sellers fail to give enough information, both in terms of material in the information memorandum and at the due diligence phase. Often it is that the seller is expecting an unrealistic price and deal terms. A common mistake on both the buy and sell side is a failure to prepare adequately – both the seller and buyer should not underestimate the planning and resources that are required to run and participate in a successful auction process. They should appoint appropriate advisers and ensure that the internal team are also available so all deadlines can be met.
Lacher: The biggest mistake we see is failing to understand the extent to which emotions play a big part in a decision makers’ process; it is not always about the numbers. Often one side misreads the other and trust begins to break down. If that happens, it’s hard to recover, even if there is a good fit. It really goes back to managing potential missteps – not making them in the first place, and of course, fixing them quickly and properly as well. This also happens with clients-there are times when a client may not understand why you are suggesting a particular course of action or may perceive that you have become too friendly with the other side. In one transaction, our client believed that we were not being abrasive enough and insisted that we tell the other side to do a very unkind act. We were in a difficult position – we knew the other side well, but had a responsibility to our client-even though we could not convince him to drop the demand. At the end, we were able to navigate the issue, maintain trust with both our client and the other side and complete the transaction.
Tedford: One of the common mistakes sellers make is they underestimate how much time the process can take when they are unprepared. Excessive time frustrates deals for any number of reasons including changing credit and market conditions, buyer fatigue and a lack of quality management time with the buyer, to settle differences and to fully understand complicated issues. Purchasers typically lose auctions because they cannot pay the most. But paying the most doesn’t mean it costs you the most. Understanding what synergies are available, market growth potential, and the impact of consolidating a potential competitor, need to be part of every assessment before bids are launched. The most common observed downfall of purchasers, particularly financial purchasers, is when they overstate the risks inherent in the business by simply not understanding it well enough.
Rick Lacher is a managing director in the Dallas office of Houlihan Lokey, where he co-heads the firm’s corporate finance efforts in the Southwest region of the US. He is also a co-director of Houlihan Lokey’s national Fairness Opinion Committee. Mr Lacher has over three decades of experience advising public and private clients on mergers, acquisitions, dispositions, leveraged buyouts, capital-raising activities and assessing strategic alternatives in a variety of industries. He can be contacted on +1 212 220 8490 or by email: rlacher@hl.com.
Matthew Tedford is the Canadian Managing Partner, Transactions and Restructuring, at KPMG. In this role he is responsible for coordinating and managing KPMG’s various Transaction and Restructuring solutions. Mr Tedford has transaction experience over a wide array of industries and focuses on private equity and natural resource clients. In his 20 years with KPMG, he has managed over 200 due diligence projects for various large public and private equity clients. Mr Tedford can be contacted on +1 416 777 3328 or by email: mtedford@kpmg.ca.
Nigel Boardman is a partner at Slaughter & May. His broad practice includes domestic and international corporate finance, mergers and acquisitions, joint ventures, IPOs, demergers, private acquisitions and disposals, private equity, public takeovers, issues of compliance and corporate governance, investigations and insolvency, restructurings, investigations and sports law. Mr Boardman has received a number of accolades and is the highest ranked UK lawyer in Who's Who Legal Corporate Governance 2013, and one of Chambers' Top 100 for 2013. Mr Boardman can be contacted on +44 20 7090 3418 or by email: nigel.boardman@slaughterandmay.com.
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