KUHN CAPITAL Monday, March 19, 2018
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Debt is the New Equity


While tech M&A has stood up better than most sectors in the current deal drought, that’s cold comfort to most businesses that want to sell but can’t find buyers.

What sorts of companies are attracting suitors today? In general, it’s that select subset who are seeing growing or at least flat sales and who are generating positive EBITDA.

Among those not in this club, a lucky few can still connect with buyers based on clear-cut operating synergies: overlapping or adjoining markets, distribution channels, product lines, etc. Some of these strong fits may work even in the case where sales and profitability are weak. If you’ve got both strong financials and well-fitted synergies, you’re going to fetch a satisfactory price.

But notice that the buyers of these firms, and of many firms in general these days, are so-called “strategics” – that is, operating companies. They’re not private equity groups. It’s strategics that reap operating synergies, not financial engineers. The occasional exception is where a PE group can realize synergies by acquiring a target that it adds on to a current portfolio company at a cheap price.

Since this is pretty rare, most PE groups have effectively dropped out of the M&A game. Not only are they bereft of synergies, they’ve been crippled by the harsh desert that has become commercial lending. Without leveraged loans, PE firms can’t generate the returns on equity they seek: somewhere between 25% - 50%. They have no financials to engineer. And without leverage, it’s the hard-up seller who is willing to sell cheap enough to allow the PE firm its rich return.

What about cases where the seller’s equity is worth nothing? Is that cheap enough? Not necessarily. Often just taking over their debt can price these targets out of PE range. Oh, one day in the rosier future we may see an enlightened dialog between PE groups and banks about these situations. In it, the PE guys buy the distressed debt of operating companies from banks in deals where the banks admit they have to take a haircut. But right now, the banks don’t want to admit to anything for fear the government will TARP ‘em or force them to raise new equity capital.

So what’s a company owner to do when you want to sell? If you’re convinced you’ve cleared the market for prospective buyers and come up short, you next need to assure your company’s long-term survival. Obviously, you’re managing your operating cash flow as tightly as possible. You also want to confirm that your debt is under control. We can’t help you much on managing your business, but we can tell you your options on managing your debt. We’re old M&A guys… but debt is the new equity.

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