Healthy Companies Look To Those With Faint Pulse

While the leveraged buyout market remains as lively as a morgue, the M&A market has seen some action from healthier companies acquiring others that are on their deathbed.

Two examples of such transactions are Lions Gate Entertainment's $255 million acquisition of Macrovision's TV Guide Network, and Abbott Laboratories' $2.8 billion acquisition of Advanced Medical Optics. Macrovision, an entertainment technology provider, was burdened by a drop in consumer spending, while Advanced Medical Optics got a black eye when it recalled some of its contact lens cleaning solutions, which were linked to potentially blinding eye infections.

And market participants say this symbiotic trend will pick up steam as 2009 progresses. First, because it is a no brainer for healthier companies to acquire a competitor or some of a competitor's assets when they are sold at steep discounts, especially if they have the cash. And distressed companies are looking to get acquired, because it's either that or go under. Moreover, distressed companies with outstanding debt are being forced into acquisitions by their creditors so they can recover their assets. Advanced Medical Optics had $1.7 billion in debt outstanding that ranged from senior secured to subordinated debt. Macrovision had nearly $900 million outstanding.

"Healthier companies see this as a good time to buy distressed companies or assets at attractive valuations, thereby increasing their market position," said Andrew Bohutinsky, a managing director and global head of building and construction at Lincoln International, a global midmarket investment bank. "Companies are being forced to sell either to unlever themselves or because their banks are applying pressure due to broken covenants and desires to reduce their portfolio of loans outstanding. These sales are occuring outside of the bankruptcy arena."

Bohutinsky added that his firm has been quite busy working on such lender-driven assignments. One specific example he cited was a recent sale of a building products manufacturer. "The company's business was quite profitable a few years ago. We received a significant amount of interest from [the target's] larger, global competitors with healthier balance sheets."

Won't Hesitate To Liquidate

A similar transaction involved Coachman selling its recreational vehicle business to Forest River, a subsidiary of Berkshire Hathaway. Midmarket investment bank Robert W. Baird & Co. helped arrange the deal.

"For strategic buyers, they generally have access to capital already in place," said William Welnhofer, a managing director in Robert W. Baird's investment banking division. "Financing is still very tough to come by, and it will be very difficult for financial buyers to pay very much more than liquidation value."

For distressed companies it's not just a matter of get acquired or file for bankruptcy, it's get acquired or liquidate. That is because there is a lack of financing available even for debtor-in-possession loans, despite the fact that DIP lenders get paid back first. So rather than filing Chapter 11, a company that can't find a DIP is forced to file Chapter 7.

This was the case with electronics retailer Circuit City. Some market participants said the company could've looked for opportunities to merge with its competitor, Best Buy, to stay afloat. But others said there was no reason for Best Buy to do so because, why go through the trouble of buying out a competitor when you can just let the competition disappear?

"It makes sense for healthier companies to acquire distressed ones, especially in today's environment, as long as the acquirer can obtain the financing or has the cash to make the acquisition," said a source at an international investment bank. However, the only way a company can obtain financing for these types of deals is through an asset-backed loan, which guarantees some recovery to lenders, sources said. So the majority of these deals will be financed with a company's existing cash or funds available under its current credit facility.

"It will be tough for a financial buyer to arrange financing to complete the purchase of a distressed business much above the liquidation value," said Welnhofer. "I don't see the junk bond market opening to finance acquisitions for a long time, because there are billions of dollars of noninvestment grade notes and bonds available in the secondary market trading at huge discounts from par and thus offering very attractive yields to maturity. Why would an investor want to finance a new junk bond issue even at 15% if that investor could buy similar paper in the secondary market at yields of 20%? I don't see this type of acquisition financing coming back for many months."