With leverage markets still in limbo, firms are looking at Equity Buyouts (EBOs) in ever growing numbers. These all-equity deals have greatly increased in the small and lower mid-cap markets over the past year, and they’re starting to creep into the landscape of the big deals. Although it didn’t go through an example would be Bain Capital and Hellman & Friedman’s planned acquisition of Lehman Brothers’ much sought after subsidiary Neuberger Berman with an all equity offering of $1.85 billion. A sucessful case would be Advent International’s all cash deal last October for the card-processing business of Experian France (which Advent renamed Monext) for €203 million. A simplified explanation for the trend is that you don’t need to use leverage to buy companies when they’re trading at a 50% discount to their historic average multiples. The discount itself gives you a similiar effect to leverage. Plus without a debt market (junk bond prices, for instance, have gone from roughly 8% above 10-year Treasurys to about 19% above in the last six months), many firms don’t have any other choice.
There’s a lot of downside to all-equity deals though. They carry greater risk because firms have to contribute far more of their fund to a single deal than in a leveraged buyout. They also don’t provide the tax-shelter benefits of interest payments on the debt, which further increases the overall cost of capital. While these factors can be mitigated by paying a lower purchase price for the asset, in today’s climate it’s still a guess if valuations are as low as they should be. Meaning, after years of companies being overvalued in a bull market, firms now need to know that they’re buying at a discount to the true value of a company’s worth. Which is easier said than done.
The following graph is from a good article in the Wall Street Journal on the subject of EBOs: