Our newsletter is designed to bring to your mailbox a wealth of experience and news on acquisitions, project finance, direct investments. In general, on anything to do with investments in private enterprises - both in our region and globally.

In every issue, you will find articles on the latest trends that impact the M&A market, analysis of technical issues and our corporate news.

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As Cyprus becomes the fifth EU State to request assistance from the European support mechanism while the nightmare of Spain and Italy needing a bailout is looming, I cannot resist the temptation to quote from our newsflash of August 2011:

"the USA [just] got downgraded by S&P and the EU tacitly admitted that there is no way it could bail out the faltering economies of Italy, Ireland, Spain, Portugal and Greece, all at once! [add Cyprus too, now].....the financial crisis of 2008 signalled the end of an era.... What we are living through now, is just the slow and painful death of that era, which was characterized by cheap and easy credit, indiscriminate consumption, expectations of continuous income growth and property value appreciation....The world's rich countries are getting poorer, no doubt about that...."

As always, it's not all bad news:

First, Cyprus is not in serious trouble. It's just that politicians prefer the IMF/EU to tell them what to do, it gives them an alibi for taking unpopular but much-needed measures which will inflict both the Civil Service sector and wealthy tax-evaders.  

On a macro level crises are (unfortunately) the only way to force structural changes and ultimately restart the Economy, hopefully on more solid foundations. There is no reason why the citizens of any country, anywhere in the world, cannot enjoy an acceptable standard of living, social justice and good quality of life. It's not a matter of natural resources, or luck, or strategic position - it's a people matter and, especially, a leadership matter. There are countless examples of countries which should have been "poor" but are "rich" - and vice versa. Just food for thought.

To get down to the micro level, an economic downturn and the accompanying asset deflation always offers opportunities for investments - as long as you are one of the privileged minority that has cash or access to funding.

For the majority, however, this is the time to get innovative, creative. This is the time for change. A few ideas - most of which require no funding - follow after our Featured Deals section below. 

US conglomerate seeking to acquire software companies in Europe: 
This US-based conglomerate has purchased 20 companies since 2006 and has since expanded internationally. It targets lower middle-market software companies with US$5 - 30M recurring revenues. Targets should have mature software products with a relatively high IP content, established customer base and recurring revenues. Otherwise, there are no growth or profitability criteria. Verticals include financial services, automotive, telecom, IT management, application development for SMEs, etc. It can purchase public or privately-held firms and in most cases existing Management is expected to stay on. All transactions are paid in cash.

UK Bank for sale:

Based in London, this is a closely held private Bank, licensed to operate in the UK. Equity (Book Value) is around GBP 20 Mil, not much else we can say in writing as the mandate is very confidential.

Balkans-based Bank for sale:

Based in a non-EU country in the Balkans this is a conservatively managed, closely-held private Bank but solid and profitable. Equity (Book Value) is €15Mil and Core Capital Ratio is in excess of 50% (how refreshing, for a change... !!). It is currently focusing on local retail banking, but is licensed for universal banking including corporate, merchant and investment banking. Would be ideal for a financial services firm, or investment bank, that would benefit from synergies with a deposit-taking institution in a country with excellent human resources but very low operating costs.

50 MW Renewable Energy project in Cyprus:

Not much we can say in writing, except that equity partners are invited to participate in the final stages of project development and that returns are very high - well in excess of 20% IRR. We also note that project owners/ developers are highly experienced and successful in the Renewable Energy sector internationally, with several hundred Megawatts in completed and successfully operating projects. We stress this because, nowadays, everybody seems to have become an expert in photovoltaics, wind parks, biomass, etc.

Small (local) businesses for sale:

Despite the economic slowdown, some businesses still manage to grow and increase their profitability. We feature two such businesses, both in the €500K - €1M range, which are offered for outright sale at multiples of around X4 to X5 times EBITDA.

Industrial Laundry: This business is conservatively managed with an emphasis on quality, reliable service and cost control. Therefore, it has no problems with collections or liquidity, has managed to increase prices while others are offering discounts and has retained a stable and loyal client base. We note that one of its main competitors recently went out of business as a result of over-aggressive growth and price reductions. But, one man's misfortune is another man's opportunity. For a short teaser follow this link.

Food Industry: This business specializes in the mass production and distribution of cold snacks, mainly pre-packaged sandwiches, salads and sweets which are sold retail through convenience stores and cafeterias. Also caters to wholesale clients such as educational establishments, army and large companies. In addition it produces frozen, ready-to-eat dishes (mostly Mediterranean cuisine) both for export and for distribution to local supermarkets. Finally, it takes large orders for hot food, delivered daily to take-away businesses and cantinas. For a short teaser follow this link.

When it comes to M&A between private companies, the dominant type of transaction has always been the all-cash acquisition. However, the credit crunch and the understandable need of companies to preserve cash reserves have relegated all-cash transactions to "rare species" status. The most pressing challenges faced by companies today are to cut costs, increase productivity, retire idle assets, tap new markets, achieve economies of scale - definitely not to expand with cash-hungry acquisitions. So, we should hopefully see a new trend for mergers with no cash (or negligible cash) consideration, which for the purposes of the present we will call amalgamations. The word "amalgamation" implies a combination, a joining of forces, between roughly equal partners - in contrast to a classic merger in which one of the two sides obtains control. There are numerous scenaria under which an amalgamation-type merger makes sense for all sides (in an amalgamation there may be more than two sides, after all). We outline below some typical cases:

Direct Competitors:

During the stock-market bubble, these were very popular - for the wrong reasons. The idea was that, if you could slap together enough small businesses, then you could achieve an IPO and unload at a huge profit. Everyone would make a bundle, except those stuck with the shares, of course. Fortunately, very few of these deals ever materialized, mostly because there is a big difference between simple arithmetic (1+1 = 2) and M&A of substance (1+1 may be 0, or it may be 4, it depends on how well you put it together).

Nowadays in saturated markets, with too many businesses chasing too few deals, an amalgamation between local, direct competitors may be the only way to secure viability and solvency for both sides. As long as it's done right. It's complicated and egos often get in the way, but the prospect of imminent insolvency concentrates the mind beautifully!

An experienced intermediary is a must, not only to advise on deal structuring, but also to make sure traditional mistrust between competitors does not kill the deal.

Professional Services:

We single out professional services(architects, engineers, doctors, accountants, lawyers, etc) as a special case, because we see the serious problems they face daily - especially those professionals that depend on the construction industry. Regardless of the current situation, professionals always had a scale problem (a professional practice is usually an one-man-show or just a couple of partners) plus a succession problem (classic example, the children of an architect do not want - or cannot - become architects). All the value of a personal practice, created over many years of hard work, is lost when the professional retires. So, there was always a compelling case for professionals to team up and build a practice which has a brand and an indefinite economic life beyond the useful working-life of the founder.

Now that business is slow and clients bargain hard, there is even more of a need for professional practice mergers. To take an example from engineering consultants, several non-competing specialties (civil, mechanical, electrical, QS) could merge to save on overhead, diversify revenue sources and present a more compelling case to clients. But even seemingly competing professionals have an excellent incentive to merge, as can be demonstrated from highly successful partnerships of Lawyers or Accountants.

Vertical Integration:

Merging of companies with complementary activities on the same value-chain is a relatively simple proposition, as long as the benefits for both sides are immediately realizable. We stress the word "immediate" as, too often, vague and long-term strategic synergies are never realized. Plus, in the urgency which characterizes the current situation, it's only the prospect of immediate benefits that can motivate companies to amalgamate. Otherwise, mergers of this kind are probably the most common, e.g. between raw materials supplier and manufacturer, or importer/wholesaler and retailer. A good pre-existing commercial relationship, interdependence and mutual trust, are the perfect ingredients for an amalgamation.

International Expansion: Cross-border mergers between small companies in similar lines of business make a lot of sense, but are probably the most difficult to achieve. The motivation on both sides is strong: neither company can penetrate each other's domestic market or expand anywhere else abroad on its own, both are simply too small. A cross-border merger opens up the home markets of both companies and it may also help them expand to third countries, if the size of the combined entity allows it. If you add to the benefits a combination of knowhow, technology, management skills, geographical diversification and a bigger product line, you have all the ingredients for a happy marriage. Of course there may be problems with business culture, distance, miscommunication and control issues. Which is why, in most cross-border mergers, one of the two sides obtains majority control - even if it is a small majority.

In our October Newsletter we identified the increasing appeal of Sale/Leaseback agreements. To quote one key paragraph from this Newsletter:

 "What makes Sale/Leaseback particularly attractive nowadays is the difficulty in raising capital - both equity and debt. The credit crunch, coupled with the general economic slowdown, have left many businesses literally starved for cash; and in many cases, unable to service their debt. This is not a problem just for small, private businesses. Even listed companies are unable to raise fresh capital from the stock-markets while at the same time they are under intense pressure from their lenders."

On June 5th Louis plc, a listed company (CSE ticker symbol LUI), announced a sale/leaseback deal with Bank of Cyprus. This transaction is worth commenting on, for several reasons.

• Since the buyer/lessor is also a Bank lender (i.e. not an arm's length third-party investor) this is obviously not a conventional Sale-Leaseback transaction. Indeed, as announced by Louis plc the transaction is specifically intended to reduce company debt with BOC.
• Theoretically, Louis plc (or any hotel owner at that) could have achieved the same result by closing a Sale/Leaseback with any other investor and using the sale proceeds to settle bank debt. Not so in this case. This is financial engineering, more than anything else.
• Considering the ridiculous valuations of most hotel assets in Cyprus, the selling price of Althea seems reasonable: €16 Million for a well-managed, Class A beach complex with 150 apartments. In this special case, reasonable pricing makes sense not just for the buyer/lessor, but as we will see below, also for the lessee.  
• BOC now has on its books a seemingly reasonably-priced, income-generating asset. The flip-side, is that Louis plc has an exclusive option to buy back Althea from BOC, at the same price within two years - plus a first right of refusal for another three years.
• The only detail that has not been announced is the amount of lease payments and how they compare with debt service on €16M? Because, nowadays, it's not about the Balance Sheet, it's not about the P&L, it's about Cash Flow.  

Short-term, it's a win-win, seems to me more of a "win" for Louis plc than for BOC, so congratulations to our friends at Louis plc for negotiating this deal. Let's see if more hotel owners (and their Bankers) follow their example.

Long-term, however, I doubt if BOC wants to turn into a property holding company, so the asset will be sold.

What makes sense for Louis plc (and many other hotel owners) is to find a "real" real estate investor (excuse the wordplay...), e.g. a Real Estate Fund, to buy assets and commit to a long-term lease-back. In any case, with asset deflation it's unlikely that any hotel owner will see any capital gains in the mid-term. So, the money is in managing hospitality assets not in holding the assets. Time for a strategic re-think on the part of hotel owners.

QUICK LINKS

Time for a Property Fund?

The BOC/Louis transaction (see last article in this Newsletter) is indicative of how useful a Property Fund would be, both to the Banking sector and to indebted property owners. A Property Fund would become the owner/ lessor instead of the Bank, assume the loan, maybe also inject some cash into the sale/leaseback deal to "grease the wheels" (or "sweeten the pill" depending on how you look at it). We have worked on the establishment of several closed-end, Private Equity-type Funds and from a first analysis of alternate investment strategies such a Fund could be viable and profitable in the long-term. As always, the key is in finding investors, but if the Government makes good use of forthcoming EU funding and plays well the "financial engineering" card (very popular with Brussels) it could secure a prime anchor investor - such as the EIB. Of course the Fund will only be able to invest in income-generating properties, Banks would have to take a once-off write-down (better than slow death...) and corporate property owners will have to forget valuations of years past. But, yes it could work. Collateral benefits, are that it will also kick-start the income-property market again and that investors (including the State) will actually make a profit at the end, instead of just throwing tax-payers money away to "promote development".

Or even a Mezzanine Fund?

While on the subject of Funds, a "Cyprus Mezzanine Fund" would go down very well with the EIB/EIF and what better way to promote development than to offer finance and equity investment to those enterprises that actually deserve it? For this to happen, a Mezzanine Fund (just as the Property Fund above) has to be professionally managed by experienced practitioners on a for-profit basis. Crucially, State incentives are needed to entice private investors. EU Member States have launched numerous schemes to promote fund establishment. Some of these are designed to supplement State Policy in relation to development, others are just designed to help the Venture Capital/Private Equity industry grow, because it's good for SME's and the economy. There is no need to re-invent the wheel, it has been done and is being done globally; all we need is a the policy framework.