- October 30, 2008, By George M. Spilka, George Spilka and Assoc.
As this article was being written during the fourth week of September, and updated on October 7, the US was in the midst of its greatest financial crisis since the Great Depression. Congress approved a $700 billion bailout package for the financial industry on October 3. This infusion of capital is the most massive governmental intervention in the financial markets in this country's history.
After the initial rescue package was denied, the second version passed relatively quickly, as the consequences of not doing so were too dire. Had Congress not approved the package, there would have been a complete freezing of the credit markets.
Congress's delay in passing a rescue package caused an intensification of the anxiety and fear gripping the financial markets. This significantly contributed to the overwhelming crisis of confidence that now impacts the US financial markets and has spread to all global financial markets.
Subsequent aggressive and prudent measures instituted by the Federal Reserve and US Treasury, i.e., the direct lending by the Federal Reserve to industrial companies, and the reduction of the Fed funds and discount rates, among others, did not immediately stem the panic devastating the financial markets.
However, the former eventually will loosen up the commercial paper and general credit markets for numerous reasons, and the latter will have a positive impact on overall economic activity. More dramatic actions are likely to occur over the next few weeks.
I believe the world central banks and most national governments now seem to be making the right moves, while operating in a tremendously complex, unique, and opaque environment. These moves eventually will bring stability to the world financial markets.
In my opinion, we are definitely not facing a financial Armageddon. The market should hit bottom in the very near term. At that point, the return to normalcy will begin. Normalcy should arrive much before most people expect. Despite what you have witnessed, there is no reason to panic.
What brought the country to the brink?
Very simply, the reckless, verging on idiotic, residential mortgage lending that took place starting in 2004, combined with the use of modern technology to design exotic financial derivatives, the consequences of which almost nobody fully understood. The massive use and distribution of these derivative products was funded almost completely by debt.
Why did it happen?
The crisis was fostered by a culture of greed that has permeated this country since the "dot-com" explosion of the 1990s. This culture reached its apex on Wall Street, where the "Wall Street Whizzes" felt that no amount of money was enough. It was nurtured and brought to maturity by the easy money policy of the Federal Reserve under former chairman, Alan Greenspan. This resulted in the most excessive and imprudent lending and use of leverage seen in US history.
The consequences should have been realized by all at least three or four years ago. I assure you the eventual consequences of their actions were evident to the Wall Street Whizzes. However, why should they have worried? They already would have made a vast fortune from it. Their personal wealth would be secured before the problem became evident. Others could deal with the carnage. The others turned out to be the United States and the taxpayers.
What hasn't happened in the financial crisis?
The impact has been limited to the financial industry, which has been devastated by the losses sustained in the residential mortgage lending market and the losses related to credit default swaps and other derivative products. At the peak of the financial crisis on Wednesday, September 17, as financial institutions became concerned about extending credit to anybody; thereby almost causing a meltdown of the US financial structure, the Federal Reserve and Treasury stepped in and proposed the bailout package. This brought renewed life to the credit markets.
However, while this scenario evolved, US industrial companies (both manufacturers and distributors) had their strongest balance sheets since the 1970s. There has been no massive borrowing by America's industrial companies during this period, nor has there been any meaningful disruption in the manufacturing and distribution segments of our economy. The immediate impact has been limited to the financial markets, and this is where the impact will be contained.
As I survey the landscape, although the economic figures indicate the country is in a recession or an economic downturn (define it as you like), the profits of US industrial companies remain strong. The results for public companies indicate that although profitability is moderating, it remains at historically high levels. My clients are realizing moderate to strong profit growth this year. In my opinion, the intermediate and long-term impact of the financial crisis on the economy is going to be negligible, if any.
I believe that by the second half of 2009, the country will be coming out of the economic downturn. My major concern regarding future economic performance is the amount of guarantees that have been made by the Federal Reserve and Treasury. These could possibly lead to a significant worsening of the Federal deficit. If they do, it will exacerbate our dependence on foreign countries and provide further opportunities for foreign sovereign wealth groups.
In this scenario, without foreign governments increasing their already large purchases of US debt instruments, we will likely have a significant increase in the inflation rate and a further weakening of an already-weak dollar. Obviously, this foreign ownership of America is not only a political concern, but it also has potential long-term business consequences. However, despite the aforementioned concerns, I believe the financial crisis will have limited impact on the intermediate and long-term economy.
Owners and executives of middle-market companies, defined as companies with a transaction price between $5 million and $250 million, now will continue to get their ceaseless level of calls from brokers, intermediaries, and low-grade investment bankers. Now, however, their storyline will be-—either upfront or as a deal progresses—-something similar to: "You better sell at a discount price before the carnage gets worse," or "You should be thankful to receive this price due to current financial conditions." There is no justification for those types of statements.
Most acquirers will tell you the devastation in the financial markets means you will have to accept a substantially discounted price. You will be told that pricing will be "dirt cheap" into the foreseeable future and might even deteriorate further. Don't pay any attention; this is hogwash.
The impact of the financial crisis on the sale of middle-market companies will be as follows:
1. Short-term impact (up to one year)—-There will be a period of three (possibly even six) months where there is some turmoil in the acquisition market. Conceivably, there could be a degree of transaction pricing weakness through the end of the second quarter of 2009, but I doubt it.
2. Intermediate-term impact (one to three years)-—There should not be any impact on transaction pricing, unless the effect on the Federal deficit of the guarantees made by the Federal Reserve and the Treasury have a greater impact than I believe they will. At this point, I don't anticipate that happening. Therefore, I expect deal pricing to be similar to the first half of 2008, which was reasonably solid.
3. Long-term impact (three plus years)-—None. Many things will affect pricing, none of which will be the current financial crisis.
Based on my economic outlook, I don't feel the financial crisis should have any significant impact on potential sellers of middle market companies.
The Recommended Course of Action
Don't change the overall strategy regarding the sale of your company. If selling satisfies your personal and business objectives, you should proceed with the process. You might delay contacting potential acquirers until after the first quarter of 2009, but that will not be necessary in most cases. Furthermore, don't modify your expected transaction price at this time. I am not reducing the pricing for any current clients.
Companies not yet in the market, or ones at the very start of the sale process, whose fundamentals and business foundation are somewhat deficient, might want to delay the sale while they strengthen and reposition the company. However, where there is no need to strengthen the company's fundamentals or foundation, I see no reason why approaching acquirers should be delayed past the start of 2009.
My overriding advice is don't be intimidated by acquirer's "doomsday scenarios." The financial crisis has not changed anything in the industrial sector of the US economy. Most companies remain very profitable and the intermediate and long-term business outlook remains good. Therefore, there should be no transaction price concessions. If patience is necessary, it will provide you a bountiful reward.
These are times when you truly need a strong-willed, determined, knowledgeable investment banker that understands the causation of the financial crisis and how it is likely to play out. They will provide you the proper guidance in how to proceed in these exciting, but turbulent, times. If you have this strength and expertise on your team, you will get a premium price. Don't let acquirers intimidate you! Don't accept less than you deserve!
George M. Spilka is president of George Spilka & Assoc., Allison Park, PA, an acquisition consulting firm near Pittsburgh that specializes in middle-market, closely head corporations. He has advised clients on the sales of their firms for 25+ years. His client base includes converters, manufacturers, and distributors. Contact Spilka at 412-486-8189; firstname.lastname@example.org; www.georgespilka.com.