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MBOs forecast to increase in 2004 as funding remains plentiful Back  
Activity levels in the Irish management buy-out (MBO) market looks likely to remain strong into 2004 writes Gervaise McAteer (pictured right) driven by the strong availability of funding.whilst traditional M&A activity may have slowed, market conditions are ideal for management buy-outs (MBOs). This is clearly evident from the level of activity in the market with seven public to private transactions with a combined capital value of EUR 5.4 billion completed in the twelve-month period to August 2003, pushing Ireland to the forefront of European buy-out surveys.
Over the course of 2003 Irish M&A activity has slowed with many companies taking a more cautious approach to business expansion. However whilst traditional M&A activity may have slowed, market conditions are ideal for management buy-outs (MBOs). This is clearly evident from the level of activity in the market with seven public to private transactions with a combined capital value of EUR 5.4 billion completed in the twelve-month period to August 2003, pushing Ireland to the forefront of European buy-out surveys. The volume of the reported private company buy-outs in 2003 has also been strong with a doubling of the levels reported on 2002. So what has driven this leveel of activity? And perhaps of more relevance, will it continue? To assess this it is useful to look at some of the principal market drivers.

Weak stock markets
Over the past number of years weak economic conditions and global political concerns have depressed equity markets and have led to high number of management teams looking to take undervalued businesses private. With the recent recovery in equity markets and the majority of the more obvious public to private buy-outs having now completed we are likely to see some slowing on the level of public to private buy-outs. However the general view is that there remains a number of small-cap listed companies who must be questioning their futures as public companies.

Falling valuations
Vendor price expectations are one of the key factors, which will either support or kill an MBO approach. Historically high valuation multiples created a situation whereby the only potential market for the vendor was a trade buyer with a strong balance sheet. In the current climate many trade buyers are taking a more cautious look at transactions and opting for organic as opposed to acquisition-led growth. Despite this, the number of vendors seeking an exit has not diminished. This has resulted in a fall in valuations, which has opened the possibility for management teams, with the support of a strong availability of debt and equity, to leverage a company’s balance sheet to acquire the business.

Business consolidation
Companies disposing of non-core subsidiaries in order to focus on their core businesses have also led to buy-out opportunities. This is evident in transactions such as the buy-out of Calyx from Alphyra plc (prior to its subsequent public to private buy-out), or the buy-out of Grassland Fertilisers from Greencore Group plc.

Receiverships / distress sales
Trading difficulties can also create opportunities for either an incumbent management team to attempt a buy-out in order to preserve their jobs or for an external management team to purchase either the complete business or one of the more profitable subsidiaries of an ailing business. Similarly, companies facing difficult trading may be compelled to dispose of subsidiaries in order to raise funds to deleverage and in situations where the time frame is tight, management may be the only realistic candidate to buy.

Low capital gains tax
Low Irish capital gains tax rates have acted as a catalyst for vendors (perhaps nearing retirement) to sell their business. Assuming no significant tax changes in the coming budget this is likely to continue to be a motivating factor for buy-out activity.

Available funding
Perhaps the most significant factor in driving buy-outs is the strong availability of funding. Most buy-outs will be funded through a combination of senior debt, subordinated debt instruments and some equity. The availability of this type of funding has increased both from banks and private equity investors.

From the banking perspective some of the more innovative banks, such as IIB, have established specialist-lending departments to focus on MBOs and are now showing an increased willingness not only to provide senior debt but also to provide subordinated debt and equity products. Such banks are also showing a greater willingness to lend against trading cash flows (as opposed to requiring strong asset backing), which has facilitated the completion of a wider range of transactions in a broader range of industry sectors.

From the private equity perspective, the current low interest rate and volatile equity markets have encouraged investors to look at MBOs as an alternative investment option. Typically this type of investment would be more suited towards the smaller mid corporate / SME transactions where the level of required investment may be too small for venture capital firms. However, some of the recent larger Irish public to private transactions have seen high net worth private investors supporting / replacing traditional venture capital money.

Whilst market conditions supporting buy-outs may be favorable the decision by any management team to embark on an MBO is a significant one and should be well considered before beginning the process as the underlying fundamentals behind every business may not necessarily support the leverage in a buy-out. The key fundamental is that the cashflow characteristics of the business must be sufficiently robust in order to support the level of debt which the business is committing itself to as part of the buy-out.

As a broad guideline businesses with the following characteristics should normally represent good MBO candidates:
• A consistent trading record of profit growth and cash generation.
• Cashflows resilient to a downturn in trading.
• Good growth prospects.
• Strong competitive position within either a growing or a stable business sector.
• Good spread of customers and suppliers.

The above obviously represents an ideal scenario and it is rare in practice that they will all come together in any one transaction. In this regard strength in one area may compensate for any weaknesses in another.

One of the key principals in structuring the transaction is that management not only need to consider the ability to service the debt in good times but also under sensitised scenarios. This is particularly true in the current environment with many businesses facing slowing turnover growth and increasing pressure on trading margins and profitability.

Looking ahead to 2004 it would appear that the factors that have led to the strong MBO activity over the past 12-18 months remain valid today. The expectation therefore remains that, save for any unforeseen circumstances, activity levels, particularly within the private SME / mid-corporate market, will continue with a greater level of deal flow from the less traditional type sectors such as media, facilities management, and consulting businesses.

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