Corporate Finance – Under the hammer

Last December, blue-chip auction house Christie’s started its biggest ever sale. The sale, which is still going on, is due to beat all records and set the tills ringing to the tune of #500m for a single item.

The item in question, however, is not Van Gogh’s Sunflowers or a work by Picasso. Instead, the price tag will be for the auction house itself.

How will Christie’s extract the highest price possible? Not by offering the business to the in-house management in a quickie deal struck in the local pub, that’s for sure. Christie’s advisers have taken a leaf out of their client’s book and begun to invite bidders for a winner-takes-all auction.

In the end, the winning bid might come from a financial buyer or trade buyer, a management buy-out (MBO) or management buy-in (MBI). Every situation is different, but in each purchase the management will be shunted to one side, at least at the beginning, to let the auction process draw out the most money.

If the management is marginalised then so are their traditional advisers, the accountants. Charles Sherwood, one of the leading partners at venture capital house Schroder Ventures, believes the inexorable rise of the auction as the chief vehicle for the disposal of assets has placed accountants at a disadvantage.

‘The whip hand has moved from the accounting firms representing management to investment banks representing the vendors,’ he says.

Traditionally, local management could send a message up to its board of directors with a proposal to buy out its part of the business. If the board decided the business would be better off outside the company than in, it would let the management sign up a firm of accountants to construct a deal.

The accountants would then introduce them to a venture capital house.

Accountants used to be at the heart of the process and, once the board had given clearance for a sale, they would almost certainly get paid a sizeable sum.

But the recession triggered a rethink at board level. Directors, particularly of plcs, came under pressure from shareholders to maximise the prices on offer. For most large organisations, the first port of call would be their brokers rather than accountants, even when the deal ends up at the bottom of the deal-making scale.

‘Vendors have taken back a grip on the process,’ comments Sherwood. ‘The auction prevents the management taking the process and running away with it after it has successfully scared off trade and financial buyers.’

Christie’s turned to investment bank SBC Warburg Dillon Read to orchestrate its own auction. Investment banks also handle most other deals over #100m.

On the larger deals, the accountants take a slice of the action as due diligence experts. They are also carving out lucrative consultancy roles as industry experts who can be used by all parties in a deal.

But the lead advisory role – the much coveted title conferred on the firm generating the highest profit margin for its advisory role – usually eludes them.

‘We used to do our own due diligence, but now we sub-contract that work, mostly to the accountants,’ says Norman Murray, head of Deutsche Morgan Grenfell Development Capital and the current president of the British Venture Capital Association.

Murray characterises the auctions of four or five years ago as Wild West shoot-outs that left too many wounded lying around. ‘Venture capital houses were confused when this process started and didn’t like the pain it caused.

It was often quite amateurish. Some people called for a boycott of auctions and some still won’t take part. But we must live with the process, and it is much more sophisticated these days.’

These developments divide the Big Six from the rest of the profession. With varying degrees of success, the six have tried to climb the greasy pole and grab the lead advisory role with the vendors.

They are looking at all merger and acquisition deals and not just MBO/MBIs, but are finding life difficult competing with the investment banks. They covet the lead advisory role because the margins are fatter.

But, according to Sherwood and Murray, vendors and bidders prefer to get experts in each field to act as advisers. Law firms will be brought in to work on the structure of the deal, while specialist consultants will act as advisers on the commercial prospects. Accountants can cover all this ground, but are finding it difficult to break out of the due diligence niche.

One of the main reasons cited by the Big Four merger candidates (Coopers & Lybrand/Price Waterhouse and KPMG/Ernst & Young) for their desperate dash to the altar was the need for greater resources to compete for major transnational merger & acquisition deals.

For each firm, fee income has increased dramatically. Last year saw a boom in merger and acquisitions activity in the UK and Europe. The downside was that much of the work replaced a dearth of stock market flotations.

It also resulted from an increase in the volume of commissions rather than the value.

Martin Thorp, head of corporate finance at Arthur Andersen, says the auction has effectively killed off the bid from local management. The recent buy-out by IPC management of the Reed-Elsevier consumer publishing division is an aberration, he says.

The IPC management was given access to venture capital house Cinven after the first expressions of interest were lodged. Unsurprisingly, Cinven had put forward the highest bid and, between them, they clinched the deal for#860m.

‘The IPC management was well known and entrenched. But in a controlled auction you can’t usually entertain an MBO. You offer it to strategic buyers or financial buyers,’ says Thorp. He says that deal structures decrease the influence of local management teams.

‘The lower the proportion of shares going to management, the higher the price the venture capital house can offer.’

Andersens has grabbed some of the biggest deals by any accountancy firm in the last year, one of the largest of which was the sale of rail-leasing company Eversholt for nearly #900m. KPMG, on the other hand, takes the top spot for the number of deals lead by an accountancy firm, although the value of most of them has stayed below #50m.

Medium-sized firms have probably suffered the most. They had come to rely on local managers approaching them to construct a buy-out deal. They were the natural companions of the buy-out team, especially when they found they couldn’t afford Big Six fees.

Robson Rhodes spent hundreds of thousands of pounds setting up a pan-European corporate finance network. Unfortunately, drumming up business from a standing start proved difficult and partners took a large hit against their profits last year. The dominance of the vendor means due diligence work makes up the majority of corporate finance business.

Dermot Mathias, head of corporate finance at BDO Stoy Hayward, has strong links with the entrepreneurial community and will pick up work when it wants to sell up. He says that local management is still allowed to get corporate finance advice, but they represent just one bidder among many.

‘We have sought to represent vendors rather than buy-out teams because you have more control over the whole process and the competition is not so fraught,’ he says.

Much of the firm’s work involves putting together buy-in teams and talking to the community of entrepreneurs on its books about a possible sale of the business. In these situations, Mathias can take control of the process with the minimum of competition.

Thorp agrees that competition drains resources and says he avoids competing with the investment banks for advisory work. But he has gone head to head with rival firms to get the nod from the vendor.’

It is always better to work on selling a business, as well, because there is little risk – you will ultimately sell the business nine out of 10 times. On the buy side, you are competing with lots of rival bids.’

The trade buyers and financial buyers, though, are forced to compete when the auction process starts. Unlike bidders for a Van Gogh or Picasso, the highest offer at the first time of asking might not secure the deal.

The auction process can go to a second or even a third stage as the lead adviser extracts the highest price possible.

And, as long as the buyers continue to bid, the competition to become auctioneer is likely to intensify.

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