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Posted: December 01, 2009

Let’s make a deal—but not right now

Colorado's M&A activity is beginning to rebound but will end the year more than $50 billion off its 2007 peak

David Lewis

A year to 18 months ago, mergers and acquisitions nationally and in Colorado, too, were in what could be called M&A hell.

Today, M&A has climbed all the way up to purgatory. Deal heaven, which you will recall occurred right around 2005 to 2007, is not a possibility and for all we know might never be again. But the chance of returning to something like normalcy, today defined as "the year 2004," seems within the market's grasp.

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The rules for the last couple of years have been: the larger the deal, the more credit required to make it work to be completed, the lower the chance it could get done; the lesser the deal, the more cash involved, the more likely it was to be completed.

This was because credit had entered the deep freeze and, worse yet, the marketplace was in the state of mind that comes right after panic and might be even worse: sheer dumbfounding, mind-numbing, bone-chilling, white-knuckling, gut-paralyzing fear.

A year back most M&A activity was "focused on the rescue situation, acquisitions of distressed assets and opportunistic acquisitions where strategic buyers feel they can buy assets that are undervalued by the market," Frank Aquila, partner at the New York-based law firm of Sullivan & Cromwell, told this reporter in summer 2008. (Dealogic rated Sullivan & Cromwell the No. 1 U.S. M&A law firm, by the way.)

In other words, the vultures were circling, and sometimes swooping.

"The market really soured in 2007, and 2008 was a terrible year," says Mark Coleman, partner with Englewood-based Laurus Transaction Advisors.

This year hasn't been much of a relief. Indeed, 2009 has displayed not all that much M&A activity in Colorado.

According to FactSet Mergerstat LLC, state deal volume peaked in 2007, when it tallied 386 transactions valued at about $60.1 billion. The 2008 volume dropped off the precipice, with 311 M&As worth almost $3.3 billion. This year the picture looks both better and worse, with a mere 187 agreements through the end of October valued at about $3.9 billion.

Or not. Using a different set of criteria, Colorado M&A statistics from Denver-based Green Manning & Bunch Ltd. note a couple of deals that, all by themselves, would substantially swell those numbers. Top of the charts: Liberty Entertainment Inc.'s $12.7 billion merger with DirecTV Group Inc.

(Liberty's busy John Malone has kept Colorado in the M&A game all by himself, with eight transactions in 2009 through October.)

However the numbers are toted, the problems remain the same.

Now, the mergers and acquisitions market is fighting its way through the hangover. Terrible obstacles remain, but some have diminished, and pent-up demand of various sorts is beginning to assert itself.

"We've actually seen a significant pickup in activity since June 1," says Warren R. Henson, president and senior managing director of Green Manning & Bunch. "We have an internal board which met yesterday, and we noted that we have signed up seven new engagements in that time frame, which is really good. ... I would characterize the market as certainly getting better. There are pockets or niches where companies are still performing very well financially."

Yet skeptics remain, with good reason. Nationally, October merger and acquisition activity fell 42 percent, making it the slowest month this year. Regardless, a high proportion of observers expect evidence of a revival by year's end.

"In our world, from an M&A deal professional's perspective, activity is good regardless of the causes for that activity. We were in an environment where there was just no activity for several quarters," says Nate Ford, partner in the corporate group of the law firm Faegre & Benson and head of its Colorado M&A group. "There is an uptick in activity. I don't think it is the return of the Golden Age.
I don't think that it is a sign of a big, fast recovery. But any activity is good activity."

Then again, many experts expected a recovery by fourth quarter 2008.

In the good ol' days of 2005 to early 2008, "senior debt was, and remains, a cheap financing source," Coleman notes. "The difference then compared to now was, first of all, lenders were willing to take a much larger position, and a much more leveraged position, in the businesses they were financing. Cash-flow loans were very common. They were also doing covenant-light loans, so the typical covenants that companies have to abide by were very much loosened in 2005, 2006, 2007.

"There were also a lot of back-end loaded payment structures, where principal repayment was not required on day one, but rather they were able to get a period of two to three years of interest-only before principal repayment kicked in."

Back then the market even countenanced "bullet maturities, where after a period of time the whole loan became due, but the company would have the ability to refinance at that point. That is totally gone," Coleman adds.

Today, it appears the No. 1 problem remains the troubled state of credit markets.

"There are shining stars out there. That's the good part. But day-in, day-out, everything I hear, sense and feel is that it is still a very, very tight credit market for acquisitions and pretty much everything else," says Ned Minor, president of Denver-based Minor & Brown in Denver and an attorney who specializes in M&A transactions.

To put that another way, "The bottom line for what really needs to happen in M&A right now is that the financing options really need to come back to the table. The debt markets and traditional capital structure need to be on the table. Going back to make some of the transactions work, to justify them, financial sponsors and strategic sponsors really need to have access to the debt markets in a meaningful way," Coleman says.

Some troubles are newer. One is apprehension about the course of the Obama Administration.

While to date there have been no significant material changes in M&A law under the current D.C. regime, Ford says, "There's a lot of concern about this administration changing laws or approaching enforcement in ways that may impact M&A activity in the future both from an antitrust perspective and the Securities and Exchange Commission perspective. We were in an era of a laissez-faire regulatory environment that promoted what we saw and that drove M&A. We had hedge funds and others buying all these mortgage-backed securities that were funding a lot of this M&A activity. Now we're seeing a movement toward regulation of private equity finds, toward hedge funds, and other market participants in the M&A marketplace."

But the prospect of a hike in capital gains tax rates overshadows all other M&A-related worries.

"The concern of sellers, particularly family-owned businesses, about the increase in capital gains rates is a real concern," Ford says. "We are having conversations with sellers today that I've never had before, and that is, ‘I would rather take a lower multiple today than pay a much higher tax rate in two years.' To the extent that you have a good company, to the extent that you're thinking of selling in the future even though it may not be the ideal time from a market perspective, it may be a better time today because of the impact of tax law changes in the future."

Coleman adds: "From a regulatory standpoint, today's problems boil down to tax policy more than anything. That's the real wild card. What may happen with the current administration is that the capital gains rates revert to a Clinton-era-esque cap gain rate, which is going to threaten many business owners' wealth, business owners who have a meaningful amount of money tied up in their businesses.

"To the extent that that is on the forefront in the next couple of years, and you still have this baby-boomer retirement thing that is just now starting, that could be a meaningful event for M&A. You will see a transition of ownership, but you're also going to see it impacted in many cases by what people feel about tax policy."

Another woe facing M&A is unchanged from the depth of the economic crisis. Then, deals couldn't be made because the markets were so confused and depressed that buyers had no way of knowing their acquisition target's market value.

Something like that pertains today. "Debt financing is an issue, but not the biggest issue. The biggest issue in the work we do and the companies we're working with is their own ability to have insight into their future financial performance," Henson says.

"If you start a sale process today, you don't want to do that as an owner unless you have some visibility into your future earnings," Henson adds. "After we've marketed the company, after we've had management presentations and had offers, you don't want to get to the end of the rainbow and your profitability is two-thirds of what it was when you started. That, I believe, is the biggest issue."

One more issue might be termed repressed sell-side demand. That's a way of saying that a lot of entrepreneurs are fed up - and entrepreneurial sellers and buyers both are an important factor in Colorado's largely mid-market M&As.

"So many of these guys woulda, coulda and shoulda sold their businesses back in 2000 when multiples were at an all-time high. They didn't. They didn't sell in 2007, 2008, when multiples were very robust," Minor says. "They are now 10 years older than they were in 2000, and they're starting to come out of the worst recession since the Great Depression, and they're saying, ‘As soon as this economy turns, as soon as my business turns in the right direction, I'm going to sell this business. I'm not going to go through this again. I'm tired, I'm beat up, I've had enough. Let's get the deal done.' "

So optimism prevails among deal-makers.

"It's hard to believe, but the legitimately well-performing, financially profitable businesses are the companies that are coming to market," Henson says. "As we look out to 2010, we're positioned to have a good year. There are more uncertainties about getting deals done, but the key is the company's underlying financial performance because there are buyers out there, and there is capital out there."

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David Lewis is a freelance writer based in Denver.

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Readers Respond

Great article! I agree with your assessment of the M & A market in general. There is going to be rabid buy out growth in the venture sector in 2010. Expect many lenders to exit portfolios to the extent that they are willing to convert to either an exit or equity at a discount or loss. In our space (broadcast media) this trend is teeing up quickly. By Chuck Lontine on 2009 12 02

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