Financial vs Industrial buyers
In 1985 the Sweden’s central bank (Riksbanken) decided (among other things) to de-regulate the credit market as a response to the slow growth rates in the Swedish economy.
Together with an increasing interest and application of financial theories from US on how to foster economic value in investments and portfolio management a number of private equity companies emerged as buyers on the market for mergers & acquisitions. Venture Capital has since then become known to anyone who reads a newspaper.
Have you ever wondered why private equity groups seem to win a lot of bidding processes against industrial buyers? Well, at Skarpa we have seen the patterns for quite some time. In 2006 I headed a transaction of a very successful medium-sized Swedish manufacturing company of products applied in the HVAC (Heating, Ventilation, and Air-Conditioning) industry. We ended up negotiating with a) “Alfa” – a Danish manufacturer of similar products with a huge set of industrial synergies to apply, b) “Beta” – a US manufacturer of similar products also with a huge set of synergies and c) “Charlie” a Swedish, small Stockholm based investment company with none or limited industrial synergies. Who do you think won the bidding?? Yes, “Charlie” did. Alfa had an internal solidity policy (equity/total assets) of 60% in all investments! No wonder, their bid amounted to half of “Charlie’s” bid given that the cost of equity is much higher than the cost of debt.
Recently Munters, a global leader in the HVAC industry, was marketed with two bidders in motion. Alfa Laval, the industrial buyer, and Nordic Capital, the financial buyer. Again, who do you think won the bidding?? Yes, Nordic Capital did. Again the industrial buyer did not manage to compete with the financial buyer despite immense industrial synergies. So what is wrong here?
Patricia Hedelius, a journalist at Dagens Nyheter, made a spot-on piece on the subject. See attached her article: DN November 1st (in Swedish unfortunately). An industrial company uses a variety of ratios to measure the performance of the business. An industrial leader is especially focussed on the return on assets (income/total assets) while a financial buyer in a transaction will solely focus on how much invested equity will return. The financial buyer will highlight the returns that are possible to pull out of the target company through dividends, payback of shareholder loans, re-finance or a future exit/sale. The quicker the better. The return on equity is maximised by NOT allowing to much equity in the financial structure. And the capital source for exchanging equity? Banks and corporate bonds of course. And yes, this discussion is still valid after the financial crisis although access to low interest capital is harder to source than before.
It is time for industrial buyers to modernize their view on investment capital and rethink how they structure and value the financing of a corporate transaction.