How much ketchup is enough, or is it blood in the bottle?

By now we all know that 2023 was a very poor M&A year. The rumor has it that a general partner of a market leading global PE house described the performance of his/her fund in 2023 like this to his/her biggest limited partner–one, we did not buy anything as the sellers held on to old, too high valuations, unrealistic in the current interest rate environment and two, we did not sell anything as the buyers were not willing to pay a fair price.

Cash hungry investors have been unhappy and somewhat reluctant to make commitments to new funds when the old ones are not returning money and investment activity is on the low side. PE houses have created interesting liquidity options, including the use of follow-on vehicles and borrowing on a fund level against perceived equity of the portfolio.

Are things looking better for 2024? I visited a global Private Equity conference in London some weeks ago to find out what the state of play is. Interestingly there seemed to be a near euphoric belief that there is so much ketchup in the M&A bottle that the cork will surely fly across the room during H1 2024.

I do understand that the global PE model cannot sustain this low level of activity much longer but is that alone sufficient to get the ketchup out of the bottle as any deal tango takes more than two (sellers and hopefully multiple interested buyers to reach a competitive price and acquisition financing). For deals to take place, the parties need to agree on price and the deals need to be bankable at leverage multiples that leave enough bread for the equity as well. The downturn has now arguably lasted long enough for the parties to come to terms with lower valuations, and a more stable interest rate environment helps calculations on both sides of the table.

Whilst we eagerly wait for the next global deal bonanza to materialize, we also need to take a sober look at the Finnish market. Some of the liquid in the proverbial bottle may be blood that will be spilled from over paid deals and underperforming assets. Firstly, Helsinki will most likely once again not be the first to recover, so look at the deal numbers in US, UK, and Sweden first. Secondly, there are some poor performing listed companies prone to be taken private. But will the boards see the light or rather continue to wait for general recovery in the Helsinki Stock Exchange to wash away the problems?

The composition of the bidding consortium in take-privates, including which existing shareholders can be included and on what terms, has evolved a lot lately. Bidders and target boards may become weary about FSA or Takeover Board stepping in with stricter guidelines and are advised to acquaint themselves with recent Delaware case law including In re Mindbody to get a flavor of latest fiduciary duty thinking.

As the market recovers some things might also look a bit different than before. Direct lending has given a record breaking 86% of US LBO leverage in 2023. Although the banks account a lion’s share of acquisition financing in the Finnish market, the direct lenders have come to stay, so we can expect their share to continue to increase also here.

The Ministry of Justice has appointed a working group with the instruction to finally introduce debt-to-equity conversion into the Finnish Restructuring Act. So, in the future we foresee the equity to take a substantial dilution hit in formal restructuring processes and this also affecting negotiation positions in out of court voluntary workouts.

If you have a poorly preforming asset, you might consider when to act. The size of the Helsinki based PE funds limit their capability to execute +100-million-euro deals. Maybe this is finally the cycle when Finnish PE houses accept the ways of their international counterparts and start doing club deals i.e. syndicating deals with each other to come up with the equity ticket needed for bigger deals. The described liquidity PE models popular in the UK and US have not really landed in Helsinki, so we can enjoy the view as some of these deals will go south and their investors will a have an opportunity to repent at their leisure.

Insolvency numbers are approaching historical levels in Finland. The bankruptcy wave started before summer break 2023 with small companies and moved to midsize companies in the fall. Bearing in mind the basic message of insolvency studies that the bigger the elephant the longer it takes to fall on its side, we should reasonably expect a fair amount of distressed financing and equity opportunities to materialize in 2024.

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