M&A strategy in a downturn

• Organic growth is hard to come by and profit margins are constantly under pressure.
• A carefully designed M&A transaction can accelerate growth by providing access to new markets, customer segments, technologies, human resources, and economies of scale.
• Indian M&A volumes have dropped from USD 42 bn in 2007 to USD 33bn in 2008 and just USD 3.7 bn in Q1 2009. Global volumes are down to USD 427 bn in Q1 2009 from USD 2498 bn in 2008 and USD 4058 bn in 2007.
• Reasons range from a shift in focus from growth to survival, higher risk aversion, poor or no availability of capital, reduced PE appetite etc.
• However, valuations are modest and an increasing no. of companies are looking to consolidate by divesting non-core/non-performing assets.
• Further, market uncertainty has resulted in a widening of the bid/ask spread, where bridging the gap between buyer and seller expectations has made deal closures difficult.
• With lower leveraging opportunities, promotoer contribution has become important. This will significantly reduce highly leveraged buyouts. Max debt levels are likely to be between 2.5-3 x EBITDA (post acquisition) vis a vis levels of 4-5 x EBITDA, structured through multiple levels of senior, subordinate, quasi, and unsecured debt instruments.
• Some solutions that can be considered include cashless transactions via the share swap and asset swap route, delayed payment schemes, "earn out" strategies, upside sharing, and minority sales.
• Also, SWFs who continue to be more optimistic can be considered a source.
• Global research has shown that downturn mergers generate about 15% more value (total shareholder return) as compared to bottomline transactions.