Gear up for battle(3)

KPMG shows how FTSE 350 companies could comfortably take more debt on their balance sheets and see off competition from buyout firms

New research from KPMG Corporate Finance shows the UK’s FTSE350 companies have the necessary financial advantage to out manoeuvre private equity companies in acquisitions.

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.

Mick McDonagh, private equity partner at KPMG Corporate Finance, said: “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.”

The survey found 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 weighted average cost of capital of 9-10 percent and private equity houses have an equivalent cost 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.

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 weighted average cost of capital.

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

McDonagh said: “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.”