Berisford Grey, Guest Writer
As Caribbean companies grow, more are turning to acquisitions.
The US$156-million acquisition of Courts (Jamaica) Limited by El Salvador-based Cobalt Holdings Company was touted as the first leveraged buyout of this kind in Jamaica.
Faced with the need to enhance market power and penetrate new markets, global and regional companies are finding that acquisition is one of the quickest ways to fast track development, gain access to market, develop economies of scale and create value through the elimination of inefficiencies.
Consequently, as the world economies become more integrated the levels of local, regional and international acquisitions have increased significantly.
According to Thompson Financial, in 2006, global acquisitions were estimated at over US$1 trillion, a growth of over 250 per cent compared to US$400 billion in 2000.
Jamaica and the wider Caribbean have also experienced a very active acquisition environment in recent times.
GraceKennedy, for example, has participated at all levels - acquiring FirstGlobal Bank locally, Trident Insurance in Barbados and the WT Foods in Britain.
Other regional companies such as Sagicor, Neal & Massy, Scotiabank, FirstCaribbean, the Musson and Facey Groups have all been active in growing their businesses through acquisition.
In the last three months the most notable announcements of this type of activity are the pending acquisition of RBTT by Royal Bank of Canada (RBC) and of Lascelles Group by Angostura.
Given the importance of acquisition to the growth of regional businesses, the question is how do companies typically finance acquisitions?
FUNDING ACQUISITION
Whatever the acquisition, the acquirer will typically require financing solutions that are specific to the acquirer's (and sometimes the target company's) situation.
The options include: cash, debt, equity or a hybrid of these.
Companies may opt to use excess cash resources to finance acquisitions, especially when they wish to prevent the dilution of equity or avoid leveraging their balance sheet.
However, this method will typically inflict constraints on cash flows, and is therefore hardly used alone.
Debt involves some form of borrowing with the main instruments being bonds, senior secured loans, asset-based financing, and mezzanine financing.
Debt financing is a very popular technique, not only because it is relatively easy to access the bank or capital markets, but also because debt is the cheapest form of capital; it provides tax benefits and it also diversifies some of the risk associated with the new business to lenders.
Equity financing gives companies the opportunity to acquire targets without the burden of interest payments.
It typically involves the use of common and/or preferred stocks, share swaps, convertible and warrants, etc. Equity financing usually involves a trade-off between the dilution of ownership and interest costs.
Other approaches to acquisition financing involve leverage buyouts (LBO), asset-based financing and mezzanine finance.
LBOs are debts financed by funds generated by the acquired company's operations, often by the sale of its assets.
Prior to 2005 when the new Companies Act was passed, leveraged buyouts were not permissible in Jamaica, as targets were strictly prohibited from assisting in the purchase of their own shares.
However, the new Companies Act makes these transactions lawful.
LEVERAGED BUYOUT
The US$156-million acquisition of Courts (Jamaica) Limited by El Salvador-based Cobalt Holdings Company was financed via a loan guaranteed by a debenture over Courts' entire fixed and floating assets and a mortgage over all its real property.
This was touted as the first leveraged buyout of this kind in Jamaica.
Leveraged buyouts reduce the need for a purchaser to fund the acquisition with its own equity or security, and are therefore popular.
Often, it is the only route through which huge, or very expensive companies can be acquired.
The global market for leveraged financing is estimated to have moved from over US$300 billion in 2000 to more than US$670 billion in 2005, and is expected to continue this swift growth according to Thompson Financial, 2007.
Unlike LBOs, asset-based financing involves the use of the value of an acquirer's assets - primarily receivables and inventory due to their liquidity - as collateral for funding.
Whilst this method is under-utilised in Jamaica, global deal volume, according to Thompson Financial, is estimated at US$950 billion in 2005 from US$650 billion in 2000.
Mezzanine financing is described as the middle layer of financing in leveraged buyouts.
A Mezzanine debt combines the features of both debt and equity and is popular in acquisitions involving venture capital firms.
Though more expensive than a plain vanilla debt, Mezzanine Financing is attractive because it often provides for a lot of flexibility and exposes the financier to equity-like risk in the business. In the Caribbean mezzanine financing is rarely, if ever, used in acquisition financing, partly due to the absence of an active private equity market, but is very popular in the European and North American marketplace.
As expansion activities intensify within the region, banks and other financial institutions are vigorously competing for the mandates to offer advisory, structuring and underwriting services in relation to the financing of these acquisitions.
Acquisitions, like most financial decisions, demand decisiveness, speed and strong execution support and capabilities.
A company making an acquisition, will, therefore, demand certainty of funds, flexibility and compelling financing terms and conditions, and proven execution expertise from their bankers.
In some circumstances, an acquirer will need to have access to committed short-term financing/bridge financing in order to secure a deal or strengthen its position in a bidding process.
A bank leading or supporting an acquisition must, therefore, have the balance sheet capability or a strong enough capital markets team to support immediate requirements such as a bridge facility.
In addition, a lead financier should have experience in structuring and executing longer-term, take-out instruments to refinance the short-term bridge with some degree of certainty.
As acquisitions can be so complex, investors must ensure that their chosen financial partner is credible, has strong and stable credit ratings, a solid reputation, and an experienced team of experts, preferably in the capital markets.
IS ACQUISITION FOR YOU?
The benefits notwithstanding, acquisition only makes economic sense if the value of the combined firm is greater than the value of each firm added.
While acquiring another company may be the quickest way to expand and balance a business' portfolio, it must be thoroughly analysed and properly structured to gain the optimal benefits.
Companies must evaluate financing options, their cash flows and credit histories, their management expertise and the quality and condition of the company to be acquired.
This should result in a tailor-made solution, geared toward the specific need of the buyer, as well as to suit the character of the target.
As such, it is advisable that special care must be taken in selecting a financial partner to facilitate the acquisition.
Berisford Grey is director capital markets, FirstCarib-bean International Bank.
