The David and Goliath of M&A

by Ian Smith

 

 

Asian "Davids" taking on American Goliaths in the M&A battlefield


It must have been quite an experience for young David, to face off against the purportedly 9 foot tall Goliath. David had but a sling shot and a few stones, while Goliath was decked out in the most advanced protective gear of the day. Fortunately for David though, he was more nimble and could strike from afar, without fear of being stabbed by Goliath's huge sword.

Sometimes working with Asian clients considering acquisitions of American businesses can make you feel like the lonely David, looking across the expanse at your massive competitor in the US. Most companies shrink from the thought of acquiring a strategic American business, let alone competing in the process with well-funded American buyers. That may be the case, but there are a few Davids out there proving the challenge to be worth contemplating!

The unknown contender
Fortunately Asian acquirers of American businesses can avoid detection until the last minute. This anonymity can be a powerful tool as you research opportunities and meet potential sellers and their advisors.

We've found multi billion dollar enterprises from Asia virtually ignored in traditional auction processes, as American vendors (and their advisors) tend to focus on better known domestic contenders. This anonymity can play to Asian acquirers' advantage, as they assess what others are willing to bid and then make an informed decision themselves. Keeping with a battle theme, Sun-Tzu once remarked, "if you know the enemy and know yourself, you need not fear the result of a hundred battles".

In this context, if you know what others are willing to bid for a business and you know what it is worth to you, your success should be assured. If you don't know what your competitors (the 'enemy') are willing to pay, you will only be successful half the time - if that. Unfortunately, many Asian acquirers fail to adequately assess the full strategic value of an acquisition or, conversely, fail to recognise their own limitations in taking on overseas acquisitions. Both errors can be fatal in the post-acquisition turmoil when clear objectives and strong leadership are required.

American companies no longer know their competition
Until recently American business owners (or managers) could look around their industry and quickly identify the competition. They could estimate market share fairly accurately and could act, and react, based on what the competition was doing - or expected to be doing. Recently, however, American businesses have been struggling against seemingly 'invisible' competitors. It may be that their customers (particularly large retailers) are seeking alternative sources of product, or that the more nimble and responsive Asian suppliers can better meet the rapidly changing demands of US consumers.

This disintermediation of the supply chain is one of the greatest threats facing US industry and also one of the greatest opportunities for well-run Asian companies looking for growth in the world's largest marketplace. According to Bloomberg1, the total transaction value of US acquisitions by companies in the Greater China region jumped significantly to US$2.57 billion in 2005, from US$879 million in 2004. That said, the opportunity is NOT just to acquire and manage US business as they have traditionally been run, but to modify their operations to fit today's competitive landscape. This may mean moving production, software development, logistics support, or other service lines to Asia, while leaving the core brand/product development and marketing to the American company. It may also mean focusing US production on higher margin, capital intensive production, while moving lower margin/labour intensive production overseas.

Back to David...
The reality though is that even 'small' US companies have sales in excess of US$100m and many potential targets will be much larger still. As shown in the table below, enterprise values (EV) on transaction in the consumer products/services industries in the US achieved an average of 8.4 times EBITDA in 20052. At these multiples the opportunity must be particularly compelling for Asian acquirers to complete a transaction.

One could argue that David had a bit of Divine intervention on his side, which certainly helps, but that may not pay the bills! We believe that the next best thing may be to partner with a US financial investor that knows how to manage a US-style restructuring.

This potential partnership between an Asian strategic and American financial investor helps in many ways, as it:

1. allows Asian acquirers to purchase much larger businesses, while maintaining management control and, importantly, allows consolidation of results on their financial statements;
2. reduces risk (operating and political), by having an experienced local (American) partner who can deal with painful restructuring issues;
3. provides the opportunity to raise less expensive US debt, thereby reducing the upfront cash required to complete the transaction; and
4. creates a follow-on investment opportunity when the financial partner wants to exit, leaving the option to the Asian buyer to gain further control of the business, or take it public on an international stock exchange.

In addition to the traditional acquisition risks, touched upon in previous editions of Insight, there are further complications with larger US acquisitions that need to be pointed out. First and foremost these days is the political risk involved in any plan involving the retrenchment of US workers by Asian acquirers.

Secondly, the risk of a mis-alignment of interests between the corporate/strategic investor and their US financial partner can create tension. It is therefore critical to understand the investment horizons and investment return expectations of your financial partner BEFORE concluding a transaction. This will allow you to avoid conflict when they wish to sell their stake in the business. It is just as important to understand your financial partners' investment parameters, as it is to understand the terms and conditions involved in the transaction itself.

Lastly, consider the quality of the financial partner you choose. As with strategic investors, the quality of management and expertise of financial partners can vary dramatically from firm to firm. Some financial partners aren't afraid to 'roll their sleeves up' and become directly involved in the day-to-day operations of an acquired business, while others choose only to show up to Board of Directors meetings. Choose your financial partner based on the needs of the business, rather than on their ability to finance the transaction.

Grant Thornton Corporate Finance Limited in Hong Kong and our counterpart in the US have considerable experience working with private equity investors and corporate owners, both in the acquisition of businesses and in assisting to sell businesses they own. Over the past few months, a number of leading private equity firms in the US have expressed to us their interest in partnering with Asian corporate investors when making investments in traditional consumer product and services businesses in the US. We expect to see this trend continue throughout 2006.

1 Bloomberg L.P.
2 Grant Thornton Corporate Finance LLC, Dealmaker Winter 2006, Vol 2, No.3		  

ian.smith@gthk.com.hk    

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