UNLEASHING THE WOLF: OPPORTUNITIES IN TODAY S TOUGH TIMES

Transcription

1 UNLEASHING THE WOLF: OPPORTUNITIES IN TODAY S TOUGH TIMES Reid and Riege, P.C Breakfast Briefing Series Wednesday, May 20, Reid and Riege, P.C.

2 John V. Galiette Reid and Riege, P.C. Stockholder, Employee Benefits Practice Group (860) Jon P. Newton Reid and Riege, P.C. Stockholder & Chair, Insolvency Practice Group (860) Mark X. Ryan Reid and Riege, P.C. Stockholder & Chair, Mergers & Acquisitions Practice Group (860) Reid and Riege, P.C.

3 Gary Mathias Carter Morse & Mathias Managing Director (203) x Reid and Riege, P.C.

4 Caveat Emptor May 20, 2009

5 Agenda Time to Buy? Market Drivers Acquisition Financing Case Study Conclusions & Recommendations Q&A Page 1

6 Is Now A Good Time to Buy? Pluses: Competitors in financial stress may need to sell Less competition from financial buyers Valuations are down and improved deal terms Seller financing available Minuses: Acquisition financing is severely limited Macro-economy creates uncertainty Most sellers are distressed Page 2

7 Rising Default Rates Source: S&P LCD Page 3

8 Declining Valuations Page 4

9 Strategic Buyers Dominate Source: Capital IQ, Monthly Market Observations Page 5

10 Shift to Seller Financing EBITDA multiples have dropped from 7.2x in 2007 to 5.0x in Q4-08 Senior secured is now at 2.0x EBITDA and there is less stretch or mezzanine debt available. Page 6

11 Favorable Deal Terms for Buyers Asset purchases Versus purchasing equity and assuming liabilities Acquisition financing Seller paper and earn-outs Increase in breakup fees in favor of buyers disincentive to sellers walking More onerous due diligence conditions justified by poor economic conditions Buyer financing contingencies justified by capital market instability Page 7

12 Market Drivers

13 Cash Is King Page 9

14 Dramatic Shift in M&A By Sector Source: Capital IQ Page 10

15 Declining M&A Debt Issuances Middle market defined as targets with EBITDA < $50 million Page 11

16 Financial Landscape Changed Forever Classic Wall Street investment banking firms are gone Commercial banking business is the surviving model Non-bank lenders using CLO market are disappearing Government involvement Tight oversight of banks and credit agencies Massive deleveraging to meet capital requirements Investors risk profile for generation(s) Re-assessment of risk Renewed focus on fundamentals Page 12

17 CLO Market Down By 90% Major finance companies, unable to raise capital in the CLO market, have been forced to draw down warehouse lines, using capital that otherwise would have been available for direct lending by banks New CLO issuances were down by more than 90% in 2008 CLOs made it possible for smaller finance companies like NewStar, Gladstone, and Patriot to come into the market with just $100M in equity, lend $500M, and then sell the whole portfolio to the market and start again. * CLO = Collateralized Loan Obligations Page 13

18 Secondary Market The glut of corporate debt trading in the secondary market makes it possible to buy existing secured debt in large cap companies with strong earnings at high yields. At 63 cents on the dollar, this Goodyear loan yields 14.6% as of 12/10/08. Sources: UBS, Markit Note: Prices as of December 10, 2008 Page 14

19 Return to Conservative Lending Market Debt markets are underwriting very conservatively Lower lending multiples for smaller companies Stretch senior debt and mezzanine financing have virtually disappeared from the middle market Equity contribution at 50% of purchase price Much higher pricing on leveraged deals Shorter maturities (364 day loans) Seller financing, earn-outs and rollover equity filling the gap Page 15

20 Upshot: 2009 Outlook for LBOs is Bleak Continued tightening as economy recovery remains uncertain Small cash flow deals difficult without strong capitalization ratios Certain sectors particularly hard hit (autos, retail, consumer discretionary, real estate, marine) Leverage ratios and fixed charge ratios becoming more restrictive Commitment maturities dropping from 3-5 years to 1-2 years Refinancing risk (huge overhang of debt maturing in ) Page 16

21 Sources of Acquisition Financing

22 Overview Instrument Source Structure Maturities Cost Other Senior Debt Mezzanine Banks, Comm Lenders, ABL Mezz Funds, Private Equity Term Loans, ABL Loans, Revolving Lines of Credit Subordinated Debt; PIK Dividends 3-5 yrs Libor bp + upfront fees (Large LBO) Libor bp Financial Covenants; Senior Secured; Personal Guarantees 3-7 yrs 16-20% Financial Covenants Seller Debt Seller Subordinated Debt 3-5 yrs 8-10% Protective Covenants (Mild) Earnouts Seller NA 1-3 yrs NA Protective Covenants (Weak) Rollover Equity Institutional Equity Seller Calls/Puts 3-5 yrs Equity returns Protective Covenants (Weak) Private Equity, Angels, Friends/Family Preferred Stock; PIK Dividends 5-7 yrs 25-35% Protective Covenants (Strong); Board Seat Cash (Buyer) Buyer NA NA NA Total Control Page 18

23 Senior Debt Lenders Category Examples Current Position Appetite National Lenders Bank of America; JP Morgan Chase; Wells Fargo; Citibank; GE Capital, CIT, Harris Bank, Comerica Bank, PNC, CapitalSource Highly Constrained $5-25 mm Regional Lenders TD Bank, Webster Bank, People s, M&T Bank; Key Bank Constrained $3-15 mm Local Banks Farmington Savings, Rockville Savings, Fairfield County Bank Corp., Union Savings Active $1-5 mm Page 19

24 Mezzanine Lenders With Recent Funds Company Name Location Min Invest ($mm) Max Invest ($mm) Most Recent Fund Year Most Recent Fund ($mm) Churchill Capital, Inc. Midwest GTCR Golder Rauner, LLC Midwest Halyard Capital Northeast Key Principal Partners Corp. Midwest Maranon Capital, L.P. Midwest Midwest Mezzanine Funds Midwest New Canaan Funding LLC Northeast Norwest Mezzanine Partners Midwest Praesidian Capital Northeast Prudential Capital Group Midwest RoundTable Healthcare Mgmt Midwest Tower Square Capital Partners Northeast York Street Capital Partners Northeast Page 20

25 Case Study

26 Industrial Manufacturer Seller New England based manufacturer/supplier of parts for industry Family owned/managed since 1986 Buyer Rapid recent growth in sales and earnings Skinny infrastructure Selected strategic buyer backed by PE firm with significant mezzanine position Acquisition is significant strategic add-on Financially accretive Page 22

27 Evolving Deal Structure Pre and Post Debt Market Collapse 25% Page 23

28 Concluding Remarks

29 Buyer Perspective Acquisitions must add value on day one Focus on clean companies Forget about trailing 12 months (TTM) Access to capital is a significant value driver Buyer equity + seller financing = 60% of value Difficult in out-of-favor industries Bridge valuation gap with earn-outs Don t be a first time buyer Page 25

30 Recommendations for RR Clients Financial Cultivate your existing lenders your new best friend Use advisors to identify opportunities to improve performance M&A Identify companies for acquisition - proactive players in best position Think merger Build a stronger company without cash Confirm that your lender is able and willing to fund acquisitions Buyer beware Get visibility on future performance Page 26

31 Gary Mathias Managing Director Q&A 167 Old Post Road, Southport, CT Office: (203) Fax: (203)

32 The NORMAL Deal EBITDA: $2,000,000 Multiple: x6 Price: $12,000,000 Debt: $4,000,000 Pre Tax: $8,000,000 Detailed Representations, Warranties, Indemnification $1,000,000 of Price in Note subject to set off or in Escrow Cash: $7,000, Reid and Riege, P.C.

33 The View for Today s Seller EBITDA: $1,500,000 Multiple: x4.5 Price: $6,750,000 Debt: $4,000,000 Pre Tax: $2,750,000 $2,000,000 of Price in Subordinated Note Cash: $750, Reid and Riege, P.C.

34 The Upshot: Seller with a Choice Won t Sell EBITDA: $2,000,000 Multiple: x6 Price: $12,000,000 Debt: $4,000,000 Pre Tax: $8,000,000 $1,000,000 of Price in Note subject to set off or in Escrow Cash: $7,000,000 EBITDA: $1,500,000 Multiple: x4.5 Price: $6,750,000 Debt: $4,000,000 Pre Tax: $2,750,000 $2,000,000 of Price in Subordinated Note Cash: $750, Reid and Riege, P.C.

35 Distressed Seller EBITDA: $800,000 Multiple: x4.5 Price: $3,600,000 Debt: $4,000,000 Pre Tax: ($400,000) In default, so has to sell (or Bank is selling) 2009 Reid and Riege, P.C.

36 Apparent Implications For the Buyer: For the Seller: Cheap deal No choice Hidden costs? Limit risk? 2009 Reid and Riege, P.C.

37 Real Implications More of an As Is, Where Is deal Seller will not stand behind, or cannot stand behind The true cost of the deal may not be apparent Due Diligence is the key 2009 Reid and Riege, P.C.

38 Financial / Business Diligence What s wrong with the business? Is it salvageable? How does it fit? Key customers? Key vendors? Key assets? 2009 Reid and Riege, P.C.

39 Legal Due Diligence Legacy Problems: Environmental Products Liability Taxes Employee Benefits Alternatives to Indemnification: Insurance Bankruptcy Sale Secured Party Sale 2009 Reid and Riege, P.C.

40 People Due Diligence Who is Key? Knowledge base Threats if they leave Compensation Structure Expected Benefits Maintaining / Rebuilding Interest and Loyalty 2009 Reid and Riege, P.C.

41 Employee Benefit Issues Relating to Acquisitions from Distressed Companies 2009 Reid and Riege, P.C.

42 Welfare Benefit Plans Buyer may choose to count service with Seller for purposes of determining eligibility to participate and/or the amount of benefits available under Buyer s welfare benefit plans (i.e., medical, dental, vision, prescription drug, life insurance, short term disability and long term disability) and paid time off plans (i.e., vacation pay, sick leave and holiday pay) Reid and Riege, P.C.

43 Medical Benefit Plan Buyer may choose to give credit under its medical plan for deductibles, co payments and out ofpocket amounts credited under Seller s medical plan for the year through the date of the purchase. Buyer will be responsible for COBRA coverage for Seller s employees and former employees if Buyer is a successor employer (i.e., Seller s controlled group ceases to maintain any medical plan and Buyer continues the business operations of the Seller without interruption or substantial change) Reid and Riege, P.C.

44 Medical Benefit Plan (cont.) If Seller has a medical flexible spending account plan and Buyer is a successor employer of Seller, Buyer must offer COBRA coverage to employees who have unused contributions to the medical flexible spending account plan. In that case, it may be better for Buyer to assume the plan. Buyer must address whether any of Seller s employees who are eligible for COBRA coverage are also eligible for the 65% COBRA subsidy, and how that will be obtained from the IRS Reid and Riege, P.C.

45 Section 401(k) Plan Buyer generally will not want to assume the Seller s 401(k) plan or merge it into the Buyer s 401(k) plan. As a result, Seller will have to terminate its 401(k) plan and distribute the assets to participants. Buyer must determine if it will count service with Seller for purposes of determining eligibility to participate, vesting and allocation of contributions under Buyer s 401(k) plan Reid and Riege, P.C.

46 Section 401(k) Plan (cont.) Buyer must determine if its 401(k) plan allows (or will be amended to allow) rollovers from the Seller s 401(k) plan. If participants in the Seller s 401(k) plan have outstanding plan loans, they will have a taxable distribution equal to their unpaid loan balance, unless they repay the loan prior to their distribution. As an alternative, the Seller and the Buyer can permit a participant in Seller s 401(k) plan to make a direct rollover of the loan note to Buyer s 401(k) plan Reid and Riege, P.C.

47 Defined Benefit Pension Plan If the Seller maintains a fully funded defined benefit pension plan, the Buyer generally will not assume the plan and the Seller will terminate the plan in a standard termination. However, there are many complex issues if the Seller maintains an underfunded single employer defined benefit pension plan or participates in a multiemployer defined benefit pension plan Reid and Riege, P.C.

48 Defined Benefit Pension Plan (cont.) If a single employer defined benefit pension plan is underfunded, it can be terminated only in a distress termination with the approval of the PBGC. Liability for the underfunding will be assessed not only on Seller, but also on members of Seller s controlled group. PBGC can attempt to assert liability for the underfunding on the Buyer if it can establish that the Buyer purchased the Seller s assets at less than fair market value. If Seller is in bankruptcy, PBGC will be a creditor in the proceeding, and will attempt to obtain additional Seller contributions to the plan or to require Buyer to assume the plan as a condition to the approval of the sale of the Seller s assets in bankruptcy Reid and Riege, P.C.

49 Defined Benefit Pension Plan (cont.) If the Seller participates in a multiemployer defined benefit pension plan, the sale of the Seller s assets may result in a complete or partial withdrawal from the plan that causes withdrawal liability to be assessed by the plan. A complete withdrawal will occur if the Seller permanently ceases to have an obligation to contribute to the plan or permanently ceases all covered operations under the plan. A partial withdrawal will occur if there is a 70% contribution decline or there is a partial cessation of the Seller s contribution obligation under the plan Reid and Riege, P.C.

50 Defined Benefit Pension Plan (cont.) Under the sale of assets exception, the sale of the Seller s assets will not constitute a complete or partial withdrawal if the Buyer continues to participate in the multiemployer defined benefit pension plan at substantially the same number of contribution base units, the Buyer provides a bond or escrow to the plan for the five plan years beginning after the sale, and the sale agreement provides that the Seller will be secondarily liable for withdrawal liability if the Buyer withdraws during those plan years. In this case, the Buyer would be primarily liable for withdrawal liability if it later withdraws from the plan Reid and Riege, P.C.

51 Defined Benefit Pension Plan (cont.) Buyer may not become obligated to participate in the multiemployer plan (for example, if it does not hire any of the Seller s union employees, or if it negotiates with the union employees not to participate in the multiemployer plan). In that case, the multiemployer plan could still attempt to assert withdrawal liability on the Buyer by establishing that the Buyer purchased the assets for less than fair market value. In addition, if the Seller is in bankruptcy, the multiemployer plan will be a creditor in the proceeding and may attempt to require Buyer to participate in the plan as a condition to its approval of the sale of the Seller s assets to the Buyer Reid and Riege, P.C.

52 Bankruptcy Issues Relating to Acquisitions from Distressed Companies 2009 Reid and Riege, P.C.

53 Questions & Answers 2009 Reid and Riege, P.C.

54 John V. Galiette Reid and Riege, P.C. Stockholder, Employee Benefits Practice Group (860) Jon P. Newton Reid and Riege, P.C. Stockholder & Chair, Insolvency Practice Group (860) Mark X. Ryan Reid and Riege, P.C. Stockholder & Chair, Mergers & Acquisitions Practice Group (860) Gary Mathias Carter Morse & Mathias Managing Director (203) x Reid and Riege, P.C.

55 THANK YOU FOR ATTENDING UNLEASHING THE WOLF: OPPORTUNITIES IN TODAY S TOUGH TIMES Reid and Riege, P.C Breakfast Briefing Series Wednesday, May 20, Reid and Riege, P.C.