I have previously touched on the differences in Valuation
and Capital
Structure between PE and CSB. The differences go beyond these two factors
and distort M&A averages. They reflect the differing incentives and
objectives of the two groups of acquirers.
CSB have permanent capital and take a longer term strategic
acquisition viewpoint. PE is transactional orientated with an intermediate
investment horizon of 5-7 years. This reflects the temporary nature of their
capital - 10 years per fund with a 5 year investment period. This distinction
is critical. As Warren Buffett likes to say there are no called strikes in CSB
M&A - you can wait for your pitch. In PE, the clock is ticking - there are
called strikes. This difference raises the risk of forced errors for PE. I am
not suggesting CSA does not error. Rather, I am suggesting PE errors have a
different basis from CSB.
Some of style differences are as follows:
1)
Valuation:
a)
CSB use a WACC based DCF and perpetuity based
terminal value.
b)
PE uses a cost of equity bases RETURNS TO EQUITY
model with a 5 year exit multiple usually tied to the purchase price multiple.
2)
Debt Capacity
a)
CSB employ a permanent capital structure with an
investment grade focus that is company determined. Additionally, they use simple
funding instruments - straight debt and common equity.
b)
PE uses temporary capital structure focused on
maximizing debt capacity. This means their capital structures are non
investment and market not company determined. Also, they use complex structures
with multiple debt layers.
3)
Value Added
a)
CSB value added is synergy related.
b)
PE value comes from financial engineering and
exit multiple expansion.
4)
Affordability Constraint
a)
CSB EPS dilution from any required equity
issuance serves as the main constraint. Typically prefer a dilution earn back
of 2-4 years.
b)
PE maximum debt capacity and the IRR on the
required equity (usually 35% of the price) serve as the main constraints.
5)
Holding Period
a)
CSB infinite
b)
PE 5 - 7 years with an outside limit equal to
the fund’s life-usually 10years.
6)
Integration Risk Concerns
a)
CSB high as the acquisition is usually merged
into the acquirer’s existing operations.
b)
PE low the target is usually treated on a
standalone basis.
7)
Search Process
a)
CSB strategic focus
b)
PE opportunistic
8)
Incentives/Performance Evaluation
a)
CSB corporate level
b)
PE at the transaction and find level
Understanding the differences between PE and CSB allows a
better understanding of their styles and allows improved recommendations.
J
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