With transaction volumes in the mergers and acquisitions area down by 40% as of mid-September, this year is likely to be remembered not only for the deals that were completed, but also for the reasons that more deals didn't get done. One of the main obstructions clogging up the pipeline since the beginning of the year is a scarcity of acquisition finance. But with a couple of landmark debt-financed deals already in the bag, the prospects for M&A in the near future look more promising.
"There is less liquidity in the market," said Marc Frenkenberg, co-head of Asia-Pacific acquisition and leveraged finance for Societe Generale. "The size of leveraged deals that could be done has been reduced dramatically: in the past there was enough liquidity to do transactions between $2 billion and $4 billion in size. After the Lehman crisis this was reduced significantly to about $500 million to $1 billion."
When the financing for acquisitions runs dry the dynamic, specifically for financial sponsor-driven control deals, completely disappears for two main reasons. Firstly, owners of companies stop looking for possible acquirers, because they become unsure that private equity buyers can raise the cash to complete the deal. Secondly, sponsors start to revaluate their business plans: instead of accumulating debt and chasing acquisitions, they instead start to focus on other kinds of investments, such as minority stakes.
Although corporate acquisitions are less affected by the poor credit environment - companies tend not to strike deals at the high levels of leverage that financial sponsors do - they are not completely unaffected. Every major corporate is closely associated with at least a couple of banks that, in the good times, are willing to step in to fund that big acquisition. But when the going gets tough considerations like maintaining a good client relationship, go out the window as the bank hunkers downs and stops lending.
More lenders, lending less
The main problem is that the network of banks offering finance has changed dramatically over the last year. Most of the international players are still in the market, and the US and European banks that withdrew did so because of problems in their home markets, not due to credit losses in Asia. This provided banks with stronger balance sheets an opportunity to step into the space: among the international banks looking to make inroads in the acquisition finance business is the Australia and New Zealand Banking Group (ANZ), which is said to be looking at many deals. But the main debutantes have to be Asia's domestic banks, which are taking advantage of small pockets of liquidity to support deals struck by local firms. This is mostly happening in China, Korea, Taiwan and Singapore.
"Regional and local banks are becoming more active in this field," said Sumit Dayal, global head of leveraged finance at Standard Chartered. "They might not be leading these transactions, but they are coming into the club deals."
A corollary of this trend is that the number of banks looking at deals is high with the bite size of each individual institution small. Banks evidently feel safety in numbers. One deal in particular helps illustrate these points. When private equity-firm Kohlberg Kravis Roberts and Company (KKR) bought Korean beer company, Oriental Breweries, from Anheuser- Busch Inbev this summer for $1.8 billion, it did so with an $865 million debt package. The debt consisted of a $800 million five-year term loan and a $65 million five-year revolver.
A plethora of banks, both domestic and international, took part: on the dollar portion of the loan, there were eight banks, including Japanese bank Nomura, Singapore-based DBS and French Calyon. There were another eight banks on the Korean won portion of the deal: there were local banks such as Korea Development Bank and Hana Bank, as well as international lenders such as Standard Chartered and HSBC.
InBev wanted a quick and hassle-free sale. It did not want to be renegotiating terms three months down the line when the buyer's financing package didn't work out. With so many banks backing the bid there was very little conditionality regarding the deal's financing. In fact, the strength of KKR's financing is considered to be a key factor in ensuring that KKR won the auction for Oriental Breweries instead of the other key bidder, another financial sponsor, MBK Partners.
Back to basics
"For lenders there is a renewed focus on the fundamentals of lending," said Clayton Carol, head of acquisition finance at Nomura. "Lenders ask about what the level of debt is and how covenants can protect them throughout the term of the loan." In the boom period companies would have covenants that were set so wide that it would almost be impossible for the lender to breach. Carol added that this year, covenants have become much tighter. "You don't want a covenant that is easy for the company to breach, but rather one that is set such that if the company is truly in trouble, it will breach."As lending becomes more traditional, so too does the way that loans are structured. Innovation is something of a dirty word now.
"Sometimes people try to innovate because the credit is not there - perhaps because there isn't enough cash flow," said Carol. Acquirers would therefore try to securitise to get a guarantee, but this option faded away along with the lull in securitisation markets. A change in structure that reassures investors however, is a welcome addition to a loan. Societe Generale's Frenkenberg gave the example of a deal that he recently worked on for a Korean company in the natural resources sector that was looking to buy assets overseas. The company attached an export credit agency (ECA) agreement that in effect created a guarantee from a quasi-governmental body, which made the potential lender a much more attractive proposition for the banks.
With the credit markets in recovery mode, heavy restrictions on lending might not last too long.
"We are now in a situation where corporates are in a better position in terms of organic and external growth," said Bruno Magnouat, Societe Generale's Asia- Pacific co-head of acquisition and leveraged finance. "From a banking perspective, the sentiment is that we are more open to underwriting, and we are more open to look at the larger deals."
This story first appeared in the October issue of FinanceAsia magazine.
