December 1, 2022
Financing is a major factor in all mergers and acquisition transactions, especially in buy outs, and is an important driver of valuations.
Companies looking to buy businesses through third party financing, or to have a minority or majority sponsor onboard, currently have to deal with higher financing costs and lower valuations. This is because of the persistent volatile macro-economic climate, which includes the issue of inflation, the Russian/ Ukraine conflict, with all of them causing rising interest rates. These all directly impact the M&A industry.
After reaching new highs in 2021, the M&A market globally has faced many challenges. One of the major issues is the doubling in the cost of debt, increasing from 2-2,5% to 5- 6% in a mere five months, something that the market has not been used too in the recent years.
According to Mathieu Lemesle, Partner at Translink Corporate Finance in France, M&As around the world are being dealt a double blow from the rising cost of finance and the subsequent leveraging issues and concerns about the service of the debt going forward for companies under leverage buyouts (LBOs).
These obstacles are preventing lenders from financing large deals, generally those above € 500m, and are preventing companies from engaging in LBOs. “This is what we call the double effect, and it is making it much more difficult to find financing in order to conclude a deal,” he adds. The lower end of the market, for deals below € 250m in enterprise value, to date remain rather protected, with some financing still available despite these very different market conditions.
Lemesle explains that factors influencing the cost of financing are three-fold. All three of these elements in a best-case scenario place the cost of debt at 4.5% but in reality, it is getting closer to 6%. Given that expenses are increasing while the cash flow of companies remains the same, arranging deals during this current economic climate is very challenging.
- The European Index, EURIBOR 3m, which for a long time stood at 0%, or even below, now stands at between 1.6 and 1.8%.
- Then, one needs to consider the cost of the bank, called the margins spread, which has remained constant at 1.7 – 2.2%.
- Fixed versus variable interest rates on loans now play a key role in the cost of finance. More than ever, variable rates are seen as too risky in the current unstable market, and the cost of swapping debt or part thereof to a fixed rate is extremely high.
Within certain sectors such as education, TMT or financial services that are very cash flow generative and often have highly recurring revenues, companies are still able to raise debt. In industries that are more capex intensive and can show far less visibility on the business going forward, it has become exceedingly difficult to obtain a good leverage given these rapid and adverse cost increases.
Lemesle says these challenges could signal a breaking point should they persist into next year, when inflation of valuations will need to adjust for the cost of debt, and scarcity of it. He adds that 2023 is still very uncertain and there is no clear view of what the situation is likely to be, including whether inflation will level out.
According to Lemesle, where valuations are concerned, deals currently close to conclusion through Translink in France have fortunately not been affected as they commenced much earlier this year. M&A projects which are starting now are, however, likely to be heavily impacted by these rising costs and the knock-on effect on valuations.
Fortunately, Translink Corporate Finance in France has managed to maintain good LBO exposure, making up approximately 30% of its transactions. Over the past years, Translink CF France has developed a great expertise in debt financing and has leveraged all options available on the market.
Apart from senior debt, which is mostly made available by commercial banks, the French market is served by private debt funds that offer new, non-dilutive, financial securities for small and midsize companies. Over the past 3 years, these newcomers have become key players on the market.
Translink CF France has had many opportunities to use their services to optimise deal structures (for example with the LBO III of Destia with Siparex, the MBO of Foliateam with SGCP or the acquisition of Jean Martin by Aquasourca).
Going forward, it is clear that structuring financing, be it for buy outs or acquisitions, will require a deep understanding of both the senior debt and private debt markets drivers and expectations. With its proven track record of successful buy outs transactions leveraging all options available, Translink CF France is perfectly positioned to make the best out of the situation in the interest of its clients.
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