Transcript M&A and Due Diligence - Financial Executives

FEI–Indianapolis CPE Day
M&A/Due Diligence/Corporate Finance
December 16, 2011
Tony Schneider, Senior Vice President
BKD Corporate Finance, LLC
Phone: 317.383.5458
email: [email protected]
Steve Martin, Director
BKD, LLP - Transaction Services Group
Phone: 317.383.4141
email: [email protected]
Introduction of Tony Schneider
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Indiana native; B.S., Ball State, 1980; MBA, Butler, 1989
27-year career in middle-market corporate finance advisory
Active in M&A & debt markets, having assisted in several
billion dollars of transactions
22-year career with Bank One & predecessor banks, serving
as managing principal of Indianapolis office of Banc One
Capital Markets
With partner, Patrick Huse, co-founded Schneider Huse &
Associates in 2002
Merged practice into BKD Corporate Finance, LLC in 2009
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Agenda
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Overview of the M&A market
Drivers of the M&A market
Due diligence
Current market conditions—M&A & Capital
Markets
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M&A IS ALL ABOUT
ME!!!!!
MONETIZING EXCELLENCE
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What are the fundamentals of the M&A market?
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Candidate buyers & candidate sellers…
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Influenced by MRIs…
 Motivations
 Resources
 Intentions
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Finding common ground…&
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Executing transactions
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Most Rewarding Deals have a Strong Strategic Foundation
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Strategy
Execution
Earnings
Value
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Creation
Buyers exchange currency (cash or securities) for
future earnings &/or enhanced prospects for future
earnings
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Overview of the M&A Market
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M&A has always been a component of
corporate growth strategies
 Turn of last century considered the first wave of
deals
 LBO transactions took hold in the late 70s
 Private equity has evolved significantly over the
past two decades & liquidity options for sellers
have been meaningfully broadened
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Long-term view…more deals, bigger deals,
global deals
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U.S. M&A Market—Number of Deals 1967 – Oct. 2011
Source: Mergerstat
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U.S. M&A Activity
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Private Equity Activity—2001–2010
Source: Pitchbook
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U.S. Middle-Market M&A Activity by Acquirer
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Transaction Activity by Market
Number of Middle Market Transactions
2007
Computers & Electronics
630
Healthcare
358
Professional Services
303
Real Estate/Property
240
Oil & Gas
213
Finance
229
Telecommunications
161
Utility & Energy
93
Mining
70
Other
858
TOTAL 3,155
2008
738
445
293
200
263
193
161
133
101
853
3,380
Source: Dealogic and Wm. Blair
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2009
829
539
243
145
220
166
148
116
85
654
3,145
2010
1,293
795
504
315
281
239
172
182
108
1,014
4,903
YTD
2011
883
443
335
344
263
168
102
118
115
765
3,536
Total
4,373
2,580
1,678
1,244
1,240
995
744
642
479
4,144
18,119
U.S. EV/EBITDA Valuation Multiples
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U.S. EV/EBITDA Middle-Market Valuation Multiples
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PEG Lower Middle-Market (<$250M) Deal Flow
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PEG Middle-Market ($250M–$1B) Deal Flow
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PEG Median Investment Multiple
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PEG EV/EBITDA Multiples by Deal Size
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Number of PE Firms with Deals
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Number of First-Time PE Investors
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Average Number of Deals per Year per PEG
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Average Number of Months Between Deals
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PEG Investing 2001–2010
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Deals by Deal Type
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The Geography of Private Equity Investment 2001 - 2010
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Private Equity Industry Investment 2001 - 2010
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Private Equity Company Inventory
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Drivers of M&A Market
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Balance between Buyers & Sellers—It moves wellbeyond the “willing” stage
 “Motivated” buyers
 “Inspired” sellers
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Macro-conditions
 Economic visibility—Certainty
 Access to capital—Capacity
 Commitment to growth—Catalysts
 Organic malaise—Challenge
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What “Motivates” Buyers?
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Serial Acquirers
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 Strategy focused
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Stagnation
Leadership change
Fear
“Buy” their way out of
challenges
 Reactive
 Return on investment
• Transformational
• Optimization
• Globalization
 Prior success
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Sporadic Acquirers
Start small
Do a lot of small deals
Active in all market conditions
Enhance diligence & integration
capabilities
 Confidence
 Pro-active
 Cash
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What “Inspires” Sellers?
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Life circumstances
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 Age
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Professional, honorable
buyers with:
 Management succession
 Compelling Vision
 Risk appetite
 Exciting fit
 Transition to retirement
 Bright future
Rewarding deal “window”
is open; frothy market and
earnings momentum
Knock on the door
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Execution capability
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Cash!
Overview of Private Equity Investors
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Asset class made up of equity securities in operating companies that are
not publicly traded
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P/E investing is primarily conducted by:
 Private equity firms/groups (PEG’s)
 Venture capital firms
 Angel investors
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PEG’s – Buyout/Growth Capital
 In U.S., nearly 2,500 PEG’s managing about 4,200 funds
 Globally, approximately 3,600 PEG’s managing 5,900 funds
 Have invested nearly $1.5 trillion over the last 5 years
 Historically, have accounted for about 10%-20% of all middle market buy-side
deal flow
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Why Private Equity Has Been Successful
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Only segment to yield double-digit return over
10 year period
US Private Equity Index and Venture Capital Returns for the Periods ending March 31, 2011
US Private Equity
US Venture Capital
DJIA
Russell 2000 Composite
S&P 500
NASDAQ Composite
Source: Cambridge Associates
2011
Q1
5.4%
5.0%
7.1%
7.9%
5.9%
4.8%
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3
5
10
15
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YEAR YEARS YEARS YEARS YEARS YEARS
21.5%
5.2%
9.8%
10.8%
12.4%
13.3%
18.5%
2.0%
5.9%
-0.1%
34.3%
26.5%
16.5%
3.1%
4.9%
4.7%
7.8%
10.0%
25.8%
8.6%
3.3%
7.9%
7.8%
9.8%
15.6%
2.4%
2.6%
3.3%
6.8%
8.7%
16.0%
6.9%
3.5%
4.2%
6.4%
9.2%
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Why P/E Has Enjoyed This Long-term Success
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“Scoreboard” & “Clock”
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Talented, driven teams chasing the rewards of success
 Develop investment thesis
 Source deals
 Assess opportunities
 Compete or walk
 Evaluate achievability
 Close transactions
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 Plan growth
 Coach/support/evaluate
 Build
 Monitor exit opportunities
 Exit
Private equity investing is no longer EASY!
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What Deals Are Attractive to P/E?
Those with the highest prospects of future
value creation
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Return/risk ratio is high
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Industry prospects/growth
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Management team
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Competitive position
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Exit prospects
Growth
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Free Cash Flow
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RETHINKING THE DILIGENCE PROCESS
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Introduction of Steve Martin
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Director in BKD’s Transaction Services Practice
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20 years of due diligence/transaction advisory, enterprise
change initiative, and turnaround management
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Specializing in middle market manufacturing and distribution
companies with revenues and enterprise values between $10
million and $250 million
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Successfully managed numerous enterprise-wide strategic
change initiatives, most including implementation of enterprise
information technology
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CPA Indiana, Kelley School of Business , Indiana University
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Current State—Understanding Risk in the New Economy
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Acquisition targets with stories
Changes in long term market demand
Residual damage from 2008 course corrections
– Hollowing out capacity & capabilities
– Reducing bandwidth
– Impacting scalability to support growth plans
– Unsustainable cost structures, all leading to “False
Positive Results”
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Value Creation Period
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Deal Cost Curve
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Definition of Terms
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Basic due diligence
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Enhanced due diligence
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Integration/enhancement
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Phased Approach to Due Diligence
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Deal Cost Curve & The Phase Approach
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Basic Due Diligence
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Quality of earning
Balance sheet exposure
Net working capital analysis
Tax diligence—federal, state & local (SALT)
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Enhanced Due Diligence
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Phase approach—at front end of cost curve
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Risk based approach “looking for the red Xs”
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Tell me something I don’t know “challenging
the investment thesis”
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Evaluating the risk elements
 Business drivers
 Economic drivers
 Operational drivers
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Enhanced Due Diligence
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Business Drivers
 Strategic enablers—“secret sauce”
 Market drivers
 Human capital
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Economic Drivers
 Segmental profitability by value stream
 Profit density (does not all mean concentration)
 Vendor/commodity exposure
 Deconstruction of prospective financials
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Enhanced Due Diligence
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Operational Drivers
 Capacity
 Core competencies
 Scalability
 Information technology—fit to strategy
What works best in the lower middle market
“unbifurcated” approach to process
not dividing: market/operational/financial
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Sell Side Diligence Reversing the Process
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Sell Side Approach
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Type 1—Reversed due diligence
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Type 2—Enterprise assessment
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Type 3—Enterprise value project
 Sellers taking control
 Sellers market: “Too many buyers—too few
deals”
 Seller risk mitigation: enhance, package, validate
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Type 3—Create or Enhancing Value—Buyer/Seller
Prospective
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Creating the Plan
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Market focus
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Size the box (physical change)
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Tame complexity (process change)
 Theory of constraints—ability to manage complexity
 Group theory & PLPV (product lines, property,
values)
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Manage processes, not people (people change)
 Create a culture of change
 Process defines organization not function
 Create standard work
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Successful application of IT
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Current Market Conditions
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Fundamentals
 Fortune 1,000 companies hold more than $2 trillion in cash
 Access to credit (& low cost credit) has steadily improved
 Valuations are stabilizing
 Mounting pressure for growth in a low organic growth environment
• Recent E&Y survey indicated 36% of U.S. companies will pursue acquisition in next year
 Many making corporate and/or business unit judgments:
• Can they grow?
• Resources/capability/energy to grow?
• Cost of growth?
• Rewards of growth?
 Focus on divestitures
 Generational/succession planning
 Global platforms
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U.S. Middle-Market M&A Activity
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GF Data—PEG Data
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GF Data—Total Enterprise Value (TEV)/EBITDA—
All Industries by Deal Size
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GF Data—TEV/EBITDA—Quarterly Splits
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GF Data—Total Enterprise Value (TEV)/EBITDA—
All Industries by EBITDA Size
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GF Data—TEV/EBITDA by Industry
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GF Data—Pricing & Incidence of Buyouts
with Above-Average Financials
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GF Data—Senior Debt/EBITDA-Splits by Period
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GF Data—Total Debt/EBITDA-Splits by Period
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GF Data—Equity & Debt Contributions
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Current Debt Markets—Middle Market
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Sr. Bank Market
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 ABL
Subordinated Debt
Market
 5-7 yr. bullet facilities
• 200–300 bps Libor
spreads
 Upfront Fee: 2% +/-
• 50–100 bps upfront
 Coupon: 11%–13%
 Traditional Bank Market
 PIK: 0%–5%
• 175–275 bps Libor
spreads
 All-in Return: 14%–22%
• 25–75 bps upfront
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Outlook
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Fundamentals support favorable deal environment
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Data & direct dialogue with transactors reflect optimism that 2012 will have a
sizeable uptick in deal volume
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There is a meaningful segmentation emerging between the “high performers,” the
“me-too’s” & the “under-achievers”
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The long-term winners are those that are focused & driven. The winners will:
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Fully understand the prospects of their industry & recognize the product & service demands of
customers
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Thoughtfully & realistically assess their strengths & the momentum, or lack there of, it or its
competitors enjoy
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Develop a compelling strategy
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Communicate a vision and action plan
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Transact with discipline & execute with precision
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