Nick O'Donnell explains why the digitalisation shift creates acquisition competition in the M&A market among luxury companies, PEs and SPACs.
There are a lot of good reasons to make acquisitions, and plenty of cash to fund them. Headline deals in this market environment include LVMH’s $15.8 billion acquisition of Tiffany and Moncler’s acquisition of Stone Island.
There was a time when private equity (PE) and investment money struggled to compete with strategic buyers in the sector, because of the inherent advantages strategics have in driving synergies. These can be huge. For example, Tapestry Inc.’s acquisition of Kate Spade projected synergies of $115 million. However, PE and investors not only sit on war-chests of cash but have changed their approach in the sector in a way that increasingly means founder-sellers see them as the more attractive option. Recent examples of PE deals include CVC Capital taking a controlling stake in Breitling and Carlyle Group’s acquisition of Acrotec.
Where this becomes particularly interesting is in mid-cap acquisitions from founder-sellers. For the sellers, it is often as much about their legacy and the future as the headline price.
Never give less than 100%?
Strategics typically prefer to acquire 100% of a target, whereas private equity will almost always provide some opportunity for founders to retain a portion of their investment in the target. That roll-over investment allows sellers to enjoy a “second bite of the apple”, when the fund exits its investment.
That is driving strategic buyers to become more creative on the management incentives they offer to key people on the seller’s team who are willing to stay with the business. In addition, earn-out arrangements may be structured to provide a clear and attractive option, as compared to the unquantifiable upsides on a future exit. The terms of those incentives and earn-outs can become complex, so it is important that they are presented in a clear and transparent way.
The market zeitgeist though, originally driven by millennials and the occasional older Generation Z’er, is that these financial calculations do not hit the emotional buttons needed to get founders and entrepreneurs excited about their businesses taking the next step. Whatever the generation of the sellers, we are increasingly seeing a preference to retain a meaningful, long-term and direct stake in the business. Strategics, and long-term funds, have the advantage here compared to the traditional private equity model as they do not need to bake in the need for an exit in, say, five years. We have seen this approach in Puig’s acquisition of Charlotte Tilbury, who retained a “significant minority” stake and Coty Inc.’s acquisition of a simple 51% majority of Kylie Cosmetics.
Private Equity in the industry is increasingly long-term in its thinking
In the classic private equity model the shorter the turn-around time, the better. It flatters returns and attracts heightened interest from their investors in the next fundraising. However, in the post-pandemic world, many PE and fund investors have concluded that the luxury market changes too quickly to rely just on balance sheet engineering to work its magic in three to five years. Increasingly, this private money is considering the sector a longer-term play to allow for their investments in digital transformations and sustainability to deliver the expected rewards.
Strategic buyers should recognise that PE and funds are often not only very smart about selling their ability to transform businesses, but increasingly can point to an enviable track-record of walking the walk. For example, the investments put into Missoni by the Italian investment fund that acquired a large stake in 2018.
Where a strategic buyer is open to leaving sellers with a material stake, or a direct financial interest (like an earn-out), they therefore need to be more on the front foot than ever about how they will leverage their group balance sheet, and deploy their industry know-how, to drive the future success of the business.
Other than price and future upside, what can separate the winner from the losers in an M&A auction process?
Culture: For a founder-owned business, selling into the “right hands” can make all the difference. Being able to demonstrate a track-record of nurturing other acquisitions, and introducing the individuals on those deals to tell their stories, is a common step. The value of ensuring that the culture, and ethos and approach of your operation is on display in every interaction cannot be underestimated.
Speed: To match the speed that private equity will bring to the process, strategics might consider getting advisers on board from day one.
Precision: Strategics often bring big teams to diligence so they can really kick the tyres and understand the potential synergies that will drive their bid pricing. The risk is that the number of follow-up questions this creates may overwhelm the sellers, particularly sellers without a lot of M&A experience. Having a senior point-person streamlining the questions can help make a better impression.
Candour: In today’s market, “pre-emptive” offers (a take-it or leave-it offer) should be anticipated from private equity. Having candid conversations with the sellers about what a competing bidder can do to reduce the chances of a pre-emptive offer from another party being accepted, before it is too late, can help avoid wasted efforts.
Certainty: Minimising closing conditions can make a huge difference to the attractiveness of an offer. There are typically two aspects to this. Firstly, if there is an anti-trust angle then doing that analysis early is crucial to convince sellers that an offer is deliverable. Secondly, requests for a “material adverse change” closing condition. This can become an emotive issue for buyers and sellers, and lead to discussions around highly hypothetical, or even slightly absurd, scenarios. Taking a step back about what level of risk is worth arguing about is usually time well-spent.
Locked-Box v. Completion Accounts: A private equity buyer will typically get comfortable with a proper locked-box approach if that is the sellers’ preference. A strategic buyer who is willing to do the same may help convince the sellers that they are a buyer they can do business with.
Risk Reduction: Taking the risk of warranty and indemnity claims largely off the table by obtaining W&I insurance makes a huge difference on how a bid is perceived. Although not right for every deal, it should at least be considered early. If the sellers are retaining a direct or indirect interest, then it should be the default position to reduce the risk of damaging the relationship by bringing post-closing claims against the sellers.
What is the real competitive threat in the M&A market from Special Purchase Acquisition Companies (SPACs)?
In the first half of 2021, 430 SPACs were launched, raising $104 billion. We are also just starting to see the anticipated wave of European SPACs coming to market. There are a lot of SPACs, with a lot of cash, out there hunting for targets – including in the luxury sector. Sector interest in selling to SPACs (“de-SPAC transactions”) was further heighted in July this year following the announcement that Ermenegildo Zegna would list in New York via a $3.2 billion deal with a SPAC. This was driven by factors such as having greater visibility in the important US luxury market and a desire for funds for expansion in newer territories.
For regulatory and practical reasons, de-SPAC transactions (or, the acquisitions of targets) are not small deals. Last year, the average size of a de-SPAC transaction was $1.1 billion and, in practice, SPACs would not typically target businesses with a value below around $250 million. They will therefore only occasionally be a realistic route for founders. Where a strategic buyer does find itself competing with a SPAC, then it should be ready to offer what a de-SPAC cannot. If the founders would prefer a clean exit, then a de-SPAC should not be their first choice, as they would be expected to roll-over some exit and have a post-transaction holding period. Equally though, if they want to retain a real seat at the table then it would be worth testing if the requirements of public company life will really allow them to do that and how ready they are to start operating in the glare of life with public shareholders. Finally, an informed view of the real deliverability and pricing of a de-SPAC transaction should be sought. These are typically expensive transactions, with sponsors ending up with up to 20% of equity as a fee, and so the headline price may not be exactly what the sellers receive. If the target company is otherwise considering an IPO, then a de-SPAC will often be the smarter move. However, for founders who want a partial exit, a strategic buyer should often be able to provide a more compelling alternative by offering what a de-SPAC cannot.
A final thought for private equity and strategics alike: Don’t be afraid of take-private deals
Twenty years ago, private equity in Europe hardly looked at public takeovers. In the post-financial crisis world, that changed as they saw that public companies were often available without having to compete in an auction process, and at lower multiples than often expected by private sellers. Today private equity is the driving force in the public takeover market, already taking 14 companies private in London in 2021 alone. However, the PE players with takeover track-records haven’t shown quite the same appetite for luxury companies. Admittedly, there is a limited universe of targets but there are a number of interesting luxury businesses trading at relatively modest multiples on European growth markets (like AIM or Nasdaq First North in Stockholm). We may see some of these become targets for private equity in the next couple of years - unless strategics take a leaf out of private equity’s book and get there first.
Nick O’Donnell is a partner in international law firm Bird & Bird’s London corporate team. He can be reached at email@example.com