unleashing the wolf: opportunities in today’s tough … · 2015. 3. 14. · seller financing...

©2009 Reid and Riege, P.C.

UNLEASHING THE WOLF:  OPPORTUNITIES IN TODAY’S 

TOUGH TIMES

Reid and Riege, P.C.2009 Breakfast Briefing SeriesWednesday, May 20, 2009

©2009 Reid and Riege, P.C.

John V. GalietteReid and Riege, P.C.Stockholder, Employee Benefits Practice Group(860) 240‐1009jgaliette@reidandriege.com

Jon P. NewtonReid and Riege, P.C.Stockholder & Chair, Insolvency Practice Group(860) 240‐1090jnewton@reidandriege.com

Mark X. RyanReid and Riege, P.C.Stockholder & Chair, Mergers & Acquisitions Practice Group(860) 240‐1056mryan@reidandriege.com

©2009 Reid and Riege, P.C.

Gary MathiasCarter Morse & MathiasManaging Director(203) 254‐3333 x300gary@cartermorse.com

Caveat EmptorCaveat EmptorMay 20, 2009May 20, 2009

Agenda

� Time to Buy?

� Market Drivers

� Acquisition Financing

� Case Study

Page 1

� Conclusions & Recommendations

� Q&A

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

Page 2

� Minuses:

� Acquisition financing is severely limited

� Macro-economy creates uncertainty

� Most sellers are distressed

Rising Default Rates

Page 3

Source: S&P LCD

Declining Valuations

Page 4

Strategic Buyers Dominate

Page 5

Source: Capital IQ, “Monthly Market Observations”

Shift to Seller Financing

Page 6

� 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.

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

Page 7

� 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

Market DriversMarket DriversMarket DriversMarket Drivers

2007 2008

Cash Is King

Page 9

Dramatic Shift in M&A By Sector

Page 10

Source: Capital IQ

�

Declining M&A Debt Issuances

Page 11

Middle market defined as targets with EBITDA < $50 million

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

Page 12

� 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

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

Page 13

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

Secondary Market

Page 14

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.

Note: Prices as of December 10, 2008Sources: UBS, Markit

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

Page 15

� 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

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)

Page 16

� 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 2011-2012 )

Sources of Acquisition FinancingSources of Acquisition FinancingSources of Acquisition FinancingSources of Acquisition Financing

Overview

Instrument Source Structure Maturities Cost Other

Senior Debt Banks, Comm

Lenders, ABL

Term Loans, ABL

Loans, Revolving

Lines of Credit

3-5 yrs Libor + 600 bp +

upfront fees

(Large LBO)

Libor + 350 bp

Financial Covenants;

Senior Secured;

Personal Guarantees

Mezzanine Mezz Funds,

Private Equity

Subordinated Debt;

PIK Dividends

3-7 yrs 16-20% Financial Covenants

Seller Debt Seller Subordinated Debt 3-5 yrs 8-10% Protective Covenants

(Mild)

Page 18

(Mild)

Earnouts Seller NA 1-3 yrs NA Protective Covenants

(Weak)

Rollover

Equity

Seller Calls/Puts 3-5 yrs Equity returns Protective Covenants

(Weak)

Institutional

Equity

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

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

Page 19

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

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 5 30 2006 250

GTCR Golder Rauner, LLC Midwest 30 250 2006 2750

Halyard Capital Northeast 15 40 2007 400

Key Principal Partners Corp. Midwest 10 40 2006 500

Maranon Capital, L.P. Midwest 2 10 2007 100

Page 20

Midwest Mezzanine Funds Midwest 5 15 2007 210

New Canaan Funding LLC Northeast 3 15 2006 370

Norwest Mezzanine Partners Midwest 10 50 2008 500

Praesidian Capital Northeast 5 15 2007 3700

Prudential Capital Group Midwest 10 75 2008 200

RoundTable Healthcare Mgmt Midwest 5 50 2006 200

Tower Square Capital Partners Northeast 4 10 2008 900

York Street Capital Partners Northeast 15 80 2006 700

Case StudyCase StudyCase StudyCase Study

Industrial Manufacturer

� Seller

� New England based manufacturer/supplier of parts for industry

� Family owned/managed since 1986

� Rapid recent growth in sales and earnings

� Skinny infrastructure

� Buyer

Page 22

� Buyer

� Selected strategic buyer backed by PE firm with significant

mezzanine position

� Acquisition is significant strategic add-on

� Financially accretive

Evolving Deal Structure

Pre and Post Debt Market Collapse

25%

Page 23

Concluding RemarksConcluding RemarksConcluding RemarksConcluding Remarks

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

Page 25

� 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

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

Page 26

� 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

Q&AQ&A

Gary Mathias

Managing Director

gary@cartermorse.com

Q&AQ&A

167 Old Post Road, Southport, CT 06890

Office: (203) 254-3333 � Fax: (203) 256-7753

www.cartermorse.com

©2009 Reid and Riege, P.C.

The “NORMAL” DealEBITDA: $2,000,000Multiple:  x6Price:   $12,000,000Debt:   $4,000,000Pre‐Tax:   $8,000,000Detailed Representations, Warranties, Indemnification

$1,000,000 of Price in Note subject to set‐off or in Escrow

Cash:   $7,000,000

©2009 Reid and Riege, P.C.

The View for Today’s Seller

EBITDA: $1,500,000Multiple:  x4.5Price:   $6,750,000Debt:   $4,000,000Pre‐Tax:   $2,750,000 $2,000,000 of Price in Subordinated NoteCash:   $750,000

©2009 Reid and Riege, P.C.

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:         $750,000

©2009 Reid and Riege, P.C.

Distressed Seller

EBITDA: $800,000Multiple:  x4.5Price:   $3,600,000Debt:   $4,000,000Pre‐Tax:   ($400,000) In default, so has to sell (or Bank is selling)

©2009 Reid and Riege, P.C.

Apparent Implications

For the Buyer:

Cheap deal

Hidden costs?

For the Seller:

No choice

Limit risk?

©2009 Reid and Riege, P.C.

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.

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.

Legal Due Diligence

Legacy Problems:EnvironmentalProducts LiabilityTaxesEmployee Benefits

Alternatives to Indemnification:InsuranceBankruptcy SaleSecured Party Sale

©2009 Reid and Riege, P.C.

People Due Diligence

Who is Key?Knowledge baseThreats if they leave

Compensation Structure

Expected Benefits

Maintaining / Rebuilding Interest and Loyalty

©2009 Reid and Riege, P.C.

Employee Benefit Issues Relating to Acquisitions 

from Distressed Companies

©2009 Reid and Riege, P.C.

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).

©2009 Reid and Riege, P.C.

Medical Benefit Plan

Buyer may choose to give credit under its medical plan for deductibles, co‐payments and out‐of‐pocket 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).

©2009 Reid and Riege, P.C.

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.

©2009 Reid and Riege, P.C.

Section 401(k) PlanBuyer 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.

©2009 Reid and Riege, P.C.

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.

©2009 Reid and Riege, P.C.

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.

©2009 Reid and Riege, P.C.

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.

©2009 Reid and Riege, P.C.

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 withdrawalfrom 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.

©2009 Reid and Riege, P.C.

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.

©2009 Reid and Riege, P.C.

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.

©2009 Reid and Riege, P.C.

Bankruptcy Issues Relating to Acquisitions 

from Distressed Companies

©2009 Reid and Riege, P.C.

Questions & Answers

©2009 Reid and Riege, P.C.

John V. GalietteReid and Riege, P.C.Stockholder, Employee Benefits Practice Group(860) 240‐1009jgaliette@reidandriege.com

Jon P. NewtonReid and Riege, P.C.Stockholder & Chair, Insolvency Practice Group(860) 240‐1090jnewton@reidandriege.com

Mark X. RyanReid and Riege, P.C.Stockholder & Chair, Mergers & Acquisitions Practice Group(860) 240‐1056mryan@reidandriege.com

Gary MathiasCarter Morse & MathiasManaging Director(203) 254‐3333 x300gary@cartermorse.com

©2009 Reid and Riege, P.C.

THANK YOU FOR ATTENDING

UNLEASHING THE WOLF:  OPPORTUNITIES IN TODAY’S TOUGH TIMES

Reid and Riege, P.C.2009 Breakfast Briefing SeriesWednesday, May 20, 2009