From the October 2009 issue of Treasury & Risk magazine

Cashing in Next Wedding Season

In the early part of this decade, Corning Inc. treasurer Mark Rogus spent a good portion of his time trawling through the balance sheets of acquisition targets in the technology sector to get a fix on their liquidity and cash flow. Today, not so much. Other than government-driven mergers and acquisitions in the automotive and banking industries, M&A transactions are few and far between. Most mirror Kraft's recent overture to unwilling prospect candymaker Cadbury. Yet Corning and other companies are whetting their appetites for the return of M&A, which the lessened volatility in the stock market seems to promise. Stability equals an ability to get a clearer sense of what companies are really worth, from the standpoint of both the buyer and the seller.

A few studies and Goldman Sachs' optimistic CFO David Viniar posit an uptick in transactions late this year and early in 2010. If and when it happens, the usual rush down the aisles is expected. Key to getting a good deal--in addition to not paying too much, finding the right fit, not buying something too broken, and having the money, stock or credit to make the transaction--is your friendly neighborhood treasurer. "Our primary role in life is maintaining access to capital markets to ensure when the company needs money and doesn't have it on the balance sheet, we can get it at competitive rates, terms and covenants," says Rogus.

When the M&A standstill eases, Rogus is prepared to wade back into targets' balance sheets. This could happen soon at Corning, a New York-based maker of specialty glass and ceramics that had $5.6 billon in 2008 revenue. Corning CFO James Flaws said during a recent call with analysts that the company's "substantial" free cash flow has to be spent somewhere. "We are looking at acquisitions with more urgency than we were before and are expanding our corporate development group, so definitely that would be a potential use of the cash," Flaws said, adding the disclaimer, "assuming that the economy doesn't do something strange."

Three years ago, when M&A activity was brisk, companies were awash in cash and spending it like shopaholics on Fifth Avenue. Then the worst recession since the Great Depression struck, decimating stock values and turning that form of currency into mush. Credit also dried up, killing another form of payment, particularly for private equity firms and hedge funds. That left cash as the dowry--and the adage "cash is king" carved in stone.

Unfortunately, having cash or identifying it in some other form, like accounts receivable, was becoming harder to determine. Sellers glumly tried to get a fix on their liquidity, and sprucing up balance sheets became a full-time activity for distressed companies preparing to be sold. In the meantime, M&A transactions stalled, then died.

How dead is M&A? The total number of deals in the U.S. in the first half of 2009--3,853 transactions--was off by 46.8% from the same period last year, according to Mergermarket. Total deal volume similarly swooned, down 43.4% to $708 billion. A survey by Thomson Reuters tells roughly the same story, tagging deal volume in the first half at $941 billion, down 40.2% from the same period last year and the lowest first-half volume since 2004.

Unable to figure out what a target company is really worth, and challenged in the ability to make a deal that will indeed be accretive, formerly acquisitive companies are idling. "We've been reluctant to pursue any M&A transactions because of apprehension over valuations and the general softness of the economy," says Roger Shannon, CFO and treasurer at Steel Technologies, a Louisville, Ky.-based steel processor with $1.5 billion in annual revenue.

Steel Technologies is far from alone in waiting in the wings for the curtain to reopen on M&A. On the bright side, data from IntraLinks indicates that M&A activity in the second quarter was 10% higher than it was in the dismal first quarter of this year. This glimmer of improvement is giving rise to hopes a turnaround will occur soon. "We nearly closed a deal in the fall but because of problems in the credit markets were unable to," says Dave Alberty, group vice president of finance and treasury at Scottsdale, Ariz.-based JDA Software Group, which makes supply chain planning solutions. "We're acquisitive--that's our growth strategy. We've done 10 acquisitions in 10 years. The recent failed one, we're thinking, was an aberration. The valuations [on the target] became an issue. But the markets seem to be stabilizing and that's giving us hope that things are returning to normal."

When normalcy does return, the people who make money off M&A transactions, such as consultants, banks and law firms, are urging dealmakers to give treasury a greater role in the process, given treasurers' unique skill sets and the current economic landscape. "We didn't see a lot of treasurers involved in transactions in the boom M&A period of late, but since liquidity is so important now I think they will become far more prevalent," asserts Greg Peterson, a partner in the transaction services group of PricewaterhouseCoopers.

Others share this view. "With reduced liquidity and the increased cost of borrowing, the role of the treasurer is far more important today in mapping and executing M&A transactions," says Melissa Cameron, a principal at Deloitte and head of its national treasury consulting practice. "Companies need to put more effort into working with bankers to come up with financing structures. The days of the CEO ringing up the bank and saying, 'I've got to fund $5 billion later this week' are gone. Not having the treasurer--the expert in the company around financing--at the M&A table is a mistake no CEO should make."

Yet that's just what many CEOs did during the last heyday of M&A. "There was a time during easy credit when no one really cared--they were tempted into doing a whole bunch of acquisitions and all sorts of repurchases feeling like credit would be there forever," says Linda Harty, executive vice president and treasurer at Cardinal Health, a Dublin, Ohio-based distributor of medical supplies with $99.5 billion in 2009 revenue. "Obviously, that has changed. Now cash is king and the treasurer is usually the only person really looking at it with a unique perspective. In partnership with the CFO, they can say, 'Here are the earnings, here is the operating cash flow, here we have to pay dividends and some level of capital spending, and here is what's left over in the cigar box for acquisitions and organic investments.'"

Alberty, who is involved in JDA Software's M&A strategy, concurs with this assessment. "The treasurer has the best visibility as to where the cash is, how much is available and when it is available, and can weigh in on the best use of this cash," he says. "Without this insight, companies are treading on thin ice."

When that happens, we all know the result--failed mergers and acquisitions like AOL Time Warner, DaimlerChrysler, Quaker Oats-Snapple, Mattel-Learning Company, Universal Studios-Vivendi, Chrysler-Cerberus, and (add your own favorite).

"Balance sheets are a minefield in this day and age," says Joe Johnson, a partner and head of the M&A practice at Boston-based law firm Goodwin Procter. "Just because something is analogous to cash doesn't mean it is. Few people other than a treasurer have the knowledge and expertise to dig through a balance sheet to understand precisely what is actually cash, how much there is of it and the liabilities that will reduce it. People laugh at little things like accounts receivables until they realize it can blow up the deal."

This nearly happened to a client of law firm Baker Hostetler in Cleveland. "We had a client, an eager buyer, that did a deal with a seller, an eager seller, in which the receivables weren't given their adequate due because of everyone's eagerness to get the deal done," says Rob Weible, a partner and chair of the firm's securities and corporate governance practice team. "What we were hearing from the seller was that the receivables were collectible subject only to the reserves on its books. What the seller heard itself say was that the receivables represented products sold to its customer base and what the buyer couldn't collect was their problem."

When the transaction closed and the buyer collected substantially less in AR that it thought it was promised, the parties ended up in litigation, with the seller ultimately making a settlement. The lesson? "Don't filter information through your hopes for a transaction," Weible says. "Get the treasurer to realistically and objectively make a statement on the target's balance sheet before going any further."

Such balance-sheet gazing by treasurers must focus inward, too. "Where I think treasurers will add value when M&A transactions revive is creatively looking at their own companies' balance sheets insofar as how best to exploit them," says Brian Hoffmann, partner and co-head of the M&A practice for the Americas at law firm Clifford Chance in New York.

PricewaterhouseCoopers' Peterson agrees. "A treasurer is adept at taking all the stuff a company is doing and then converting that into cash flow," he says. "Companies put these M&A spreadsheets together to predict future returns, until it gets to year three and the assumptions make astrology look like a science." A treasurer, Peterson adds, "can bring the aspect of cash into play. A balance sheet may look like this, and an income statement may look like that, but how this can turn into cash is a treasurer skill."

Paul Reilly, CFO of Arrow Electronics, a $16.7 billion distributor of electronic components, has a similar take. "Treasurers have the skill to understand the efficiencies that can be had from managing the target's cash flow differently or better," he says. "There may be an opportunity for the target to adopt the buyer's policies and procedures to free up cash tied up on its balance sheet."

Figuring out how to unleash cash within an acquisition target that does business in restrictive economies around the world is another job best left to the treasurer. Deloitte's Cameron says few in an organization other than a CFO or treasurer (with help from the tax department) can muster the due diligence required. "We've seen examples where treasury and tax working together can supplement the actual funding of an M&A transaction by releasing trapped cash within the target acquisition," she adds.

Treasury also brings singular FX expertise to the table. Cameron cites examples of treasuries that put together foreign currency hedging strategies to protect the operating margins of the target company post-acquisition. "Treasury should be the key leader in working with the CEO and CFO in terms of the combinations of debt and equity to fund an acquisition, and whether it makes more sense to fund it in U.S. markets or foreign markets," she says.

Treasurers are prepping to become more involved if and when M&A activity rebounds. Cardinal Health, for instance, recently spun off a subsidiary, giving it the opportunity to make investments in both organic and strategic growth in the coming year. Reilly at Arrow Electronics says he is involved in targeting acquisitions that will assist product and geographic expansion, in addition to sourcing a new customer base.

At Corning, Rogus says he doesn't expect another fusillade of technology deals like the one that occurred during the telecom bubble earlier this decade (Corning is a major player in the fiber optics space). Nevertheless, he will be applying lessons from the past as the company mulls future transactions. "We learned that the deals where the payment mechanism was shares-for-shares were the ones that became permanent and a long-term portion of our corporate capital structure," he says. "The very few deals where we bulked up on leverage ran into problems. We will no longer buy a piece of technology using debt. The uncertainty of the cash flows associated with the business doesn't lend itself to paying principal payments on debt."

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