Monday, March 20, 2006

Score—Financial Buyers, Five; Strategic Buyers, Nothing

Michaels Stores Inc., the nation's largest arts-and-crafts retailer, is expected to announce that it is exploring "strategic alternatives," a decision that could lead to the sale of the company, which has a $4.61 billion market capitalization, according to people familiar with the matter.

—Wall Street Journal

A small, closely held company with which I am familiar decided to put itself up for sale last year.

The company is a perfectly decent little manufacturer of glass fiber yarn—a sort of poor-man’s Corning. It's had a rocky history, having been in and out of bankruptcy, but management did a good job of turning things around and decided, in today’s vernacular, to “explore strategic alternatives.”

Being small and closely held, however, the company was on nobody’s radar screen—and the Wall Street Journal didn’t even report on the fact that it had put itself up for sale.

Nevertheless, according to the information statement mailed out to shareholders, a total of 105 potential buyers signed confidentiality agreements to look at the financial package.

And of those 105 potential buyers, 15 were “strategic or industry buyers” while 90 were “financial buyers and capital providers.”

(This kind of information is contained in the “Background to Merger” discussion which is always the most interesting part of a merger or takeover information statement. I recommend reading as many as you can get your hands on.)

Back to those 105 “potential buyers” for our little glass fiber company: 21 of them expressed interest in pursuing further negotiations, and out of those 21, 11 actually went into a second round of negotiations, out of which “five potential buyers submitted second-round bids.”

Now, you might expect a small glass fiber yarn manufacturer to prove most valuable to other industry players—the original group of 15 “strategic or industry buyers” out of the first 105 willing to sign confidentiality agreements. After all, an industry buyer would be best able to assess the value of the assets and derive the greatest benefit both in adding sales and being able to reduce costs.

You might expect that, and you would be wrong: all five of the second round bids “were from financial buyers.”

Last week at the Bank of America consumer conference, one of the most crowded presentations was not current investor fave Coldwater Creek or bull/bear tug-of-war Toll Brothers: it was a panel discussion among representatives from several large private equity firms.

The private equity cycle, which today looks to engulf Michael’s Stores, is nowhere near finished.

If our experience with a tiny glass fiber yarn company is any indication, this feeding frenzy is going to make the Drexel/Milken years look positively tame.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.


Tim said...

Not sure I understand the comment here. Your headline implies that the financial buyers are "winning", while the post implies (I think) that they are potentially overpaying. Which is it? Certainly feels to me that the strategic buyers are in a much better position to figure out what it's worth than financial buyers....

Aaron Koral said...

Hi Jeff - the issue which intrigues me about your post is that the financial buyers must have a lot of cash on hand to buy-out privately-held firms exploring strategic alternatives. I wonder whether Buffett really is onto something - he too is buying more privately-held businesses than publicly-traded equities lately. All the recent buyout deals make me wonder, what's the reward for firms like Cerberus Capital buying out privately-held businesses? Happy trading...

Captain Obvious said...

With the amount of uncommitted capital sloshing around the private equity market these days, this is hardly surprising.

I would also think that it would be hardly surprising if the valuation that this company eventually sells at is richer than you might think.

xocoatl said...

According to S&P's Leveraged Buyout Review, the private equity industry's overall (median I imagine) price-to-EBITDA multiple on deals was 8.1 X in 2005, up from 6.9 X in 2004. It has been higher: 8.3 X in 1998 (highest level since 1994/1995). I don't know what happend to private equity market returns on investment after that, but given that 8.3 X in 1998 went to 6.3 X in 2001 (the low since 1994/1995), I imagine returns were relatively bad.

Rick said...

Your post was the basis for a post on my blog Value Discipline. In short, there is a confluence of factors playing into the market that I think should not be ignored. The potential flood of private equity capital looking for LBO kinds of deals should not be ignored. Companies that are sloppy with their capital efficiency have to be aware of these potential buyers as well as the growing number of activists that are lurking. Strategic buyers ordinarily pay too high a price for their acquisitions; however, financial buyers are accepting lower internal returns than they had demanded previously,largely because of the competition for deals and the ample supply of funding.

A fabulous and thought provoking blog!

Martin said...

Hi xocoatl, could I ask where did you get that document? I mean the S&P's Leveraged Buyout Review. I was looking for it on the internet, but couldn't find it anywhere. Would you be able to advise? That would be very much appreciated. Thanks Martin