Bad news in the financial markets started the week off. Lehman Brothers Holdings Inc. is filing for bankruptcy protection after the Fed would not financially guarantee a buyout of the 158-year-old firm, and Merrill Lynch was sold to the Bank of America. AIG, the global insurance giant, is in big trouble. Stocks tumbled on Monday. The market was flat today until an announcement by the Fed that it would leave interest rates unchanged. That prompted, according to the Wall Street Journal, booing on the floor of the New York Stock Exchange.”
So what does the latest not-so-great news from Wall Street mean for deal-making and business lending? I spoke to industry veteran Jon Skelly of PCE Investment Bankers today to gain some perspective on current conditions. Skelly works with distribution companies and private equity firms on acquisitions, sales of businesses and ESOPs. Before PCE, Skelly worked on acquisitions for HD Supply and Hughes Supply Inc.
The Deal Market
Last year around this time, the credit crunch was just getting underway. The Home Depot was hitting snags trying to sell HD Supply to a trio of private equity investors, and other big deals had fallen through completely. At the time, those in the industry told MDM that while tight credit markets had affected sizable deals in progress and would dampen historically high valuations, firms still had a large chunk of cash that needs to be invested, even if deal terms aren’t as favorable to the sellers as they were the past two years. Strategic players became more competitive and in fact struck many significant mid- and small-market deals throughout the past year.
Fast forward roughly 12 months, and conditions haven’t changed much. In fact, credit conditions have tightened further, especially for acquisition deals on the higher end of the market, Skelly says. (Skelly was a panelist for MDM’s Distribution M&A 2008 Update: Value Redefined in a Tough Market –available on CD.) He thinks that this week’s events will fuel the credit crunch. “It shows how shocked the U.S. financial system is. When people are scared, they get conservative. Banks have taken a beating over the past year, and they’re going to be even more careful going forward,” Skelly says. “We’re seeing it on deals we’re working. It’s really grown a lot tighter over the past month or two.”
So far this year, more acquisition deals have been completed in the small and mid-size distribution markets, and we are seeing fewer HD Supply-like mega-deals. “For the really great company, there is a market,” Skelly says. “Valuations have decreased due to lending standards. Activity has decreased because people are willing to take less risk during times like this -doing an expensive acquisition can be viewed as a risk to certain people. But if financing is available there is appetite for really great companies. There are a lot of dollars on the sideline looking to be invested.”
Business Credit
When it comes to getting credit to grow your business organically, lending standards are likely to remain tight. Companies that already have credit may see terms become more stringent and may see more active oversight from their banks to ensure the business is performing, Skelly says. The bright spot for distributors? Distribution is an asset-rich business and because of a general market shift from cash flow lending to asset-based lending, they may be better positioned.
Distributors in today’s environment should pay attention to cash flow and make sure they are not overleveraged. “Make sure you are in the right financial position for what could be a prolonged economic downturn,” Skelly says.
