New research from KPMG Corporate Finance shows that, contrary to the consensus view, the FTSE350 has the necessary financial advantage to out manoeuvre private equity companies in acquisition situations. The report suggests that if FTSE 350 companies ‘shape up’ they could significantly reverse the recent trend.
KPMG believes that if FTSE 350 companies choose not to employ some the techniques used by private equity houses, they will lose out on future growth or risk becoming private equity targets themselves.
KPMG has analysed the Weighted Average Cost of Capital (WACC) of each of the FTSE 350 using public data, producing a weighted representative WACC . The firm has also calculated each company's net debt to EBITDA ratio to prove the broad relationship between higher leverage equating to lower WACC (on the basis of an investment grade credit rating). In addition, KPMG has analysed 30 UK private equity transactions with a deal value of over £500m between January 2004 and October 2006, using assumed cost of equity of 20 percent and 25 percent to derive weighted private equity WACCs.
Key Findings
The FTSE 350 has a slight advantage over private equity houses when it comes to cost of capital. Research reveals that FTSE 350s have an average WACC of 9-10 percent and private equity houses have a WACC of 11-13 percent for deals greater than £500 million
Private equity players are often held up to have an edge in the competition for deals due to their high leveraging levels, but when you look at WACC it emerges that there is in fact a fairly level playing field
This therefore begs the question as to why corporates are failing to take advantage of the assets available to them in the marketplace, given a lower investment hurdle rate
Corporates are risking ceding future earnings growth and therefore superior shareholder returns by allowing PE players to behave more acquisitively
Changing Approach to Debt could further widen Corporate’s Financial Advantage
Further analysis by KPMG Corporate Finance shows that the FTSE 350’s current net debt to earnings before interest, tax, depreciation and amortization (EBITDA) ratio is 1.2 x, versus £500m plus private equity-backed businesses’ total debt to EBITDA of 7.7 x. This is positive news for embattled plcs - even if they doubled their amount of debt they would still be conservatively leveraged, and achieve even finer WACC
By slightly increasing leverage, corporates will be able to further increase the cost of capital advantage they have over private equity houses
Corporates need to realise the need to change their attitudes towards debt and some are waking to the potential of using the same techniques as private equity players, but not all boards are operating at this level yet
Many corporates are using outdated forms of growth versus earnings-based valuation techniques – they are concerned that by adding debt, they will increase their interest expense line, which in turn would ‘dampen’ their expected net profit growth rates
Mick McDonagh private equity partner at KPMG Corporate Finance, comments:
“There are other methods that create true shareholder value, such as economic profit or cashflow-based analysis. And an efficient balance sheet is definitely a way of enhancing shareholder value. It is possible then that an outmoded way of looking at corporate valuations is influencing boards to not leverage up.
“Organic growth alone is not good enough for the FTSE 350 - they need to acquire new earnings streams in order to outpace the general market - and they need to do this to produce superior returns for their shareholders. However, private equity houses are increasingly beating them to the growth targets. Plcs, and their shareholders, need to take action or they will lose out in competition with the PE community.
“Corporates need to sharpen their processes; they have plenty of financial cards in their hands, which they must play effectively, but need also to tighten up on the non-financial side – their speed of thought, speed of action – and adopt more aggressive internal processes. To win assets corporates need to price some of their synergies in and not keep them in the back pocket, hoping to take all the upside from synergy realisation on completion. It’s impossible to buy an asset on the cheap in this competitive climate.”
-ENDS-
Further information:
If you have any queries or would like to arrange an interview please contact:
Kate Ryder, PR Manager, KPMG - Corporate Finance
Tel: 020 7311 8807
Mobile: 07867 536567
Email: kate.ryder@kpmg.co.uk
Notes to editors:
KPMG’s Corporate Finance practice provides a range of independent, investment banking services internationally and comprises more than 1,600 investment banking advisory professionals operating in 51 countries. KPMG’s Corporate Finance practice provides strategic advisory and deal management services covering: acquisitions and disposals; mergers and takeovers; valuations and fairness opinions; structured and leveraged financing; private equity strategies; initial and secondary public offerings; joint ventures and transaction alliances. KPMG Corporate Finance is a division of KPMG LLP. The registered office is 8, Salisbury Square, London, EC4Y 8BB.
