Letter number 125 of December 2019
- QUESTIONS & COMMENTS
We recently organised a round table on the environmental and social concerns that are changing corporate finance with Bertrand Badré, former Managing Director and CFO of the World Bank and founder of the Blue Like an Orange Sustainable Capital investment fund, and Cécile Cabanis, Danone's CFO. This is the transcript (footnotes inserted by editors).
Vernimmen.com When investing in external growth, does Danone factor the ESG performance of its targets into the price paid?
Cécile Cabanis: First of all, I'd like to remind you that Danone's founder, Antoine Riboud, stated a long time ago that corporate responsibility does not stop at the factory gate, and that to have a healthy business, you need a healthy society, and a just society, that you only have one planet and one life. This all sounds very normal now, but he was addressing a body for which this was quite a revolutionary idea at the time.
It's in our DNA. And that's important because we put it at the heart of the business. On the one hand, we don't have an economic policy, a trade policy, and then an ESG policy. Everything we do, every day, we try to do in a way that enables us to contribute to the goals we've set for 2030, with a view to achieving B Corp certification. For B Corp certification, extremely demanding societal and environmental criteria have to be met. So, it’s the way we put it into the business model. Because if you want to have an impact, you have to put it at the heart of the business. Companies will have an impact when this is really an integral part of their process and business.
Acquisitions we make must help us to achieve our goals and fulfil our mandates. So, when we announce a climate policy by saying that we will stick to 1.5 degrees, everything we do in business will have to lead us to that. And the same thing applies to our goals. When we look at Danone's portfolio, we see that we started out as a conglomerate specialising in groceries many years ago and the business has been consciously transformed, so that today almost 90% of our volumes sold are recommended for daily consumption.
We make sure that acquisitions fit our DNA and business model. Valuations for acquisitions are based on multi-criteria and depend on the transformation that has to be implemented, integration and many other things. To come up with a specific value based on a criterion (and when you look at ESG reporting today there are tons of criteria), we have entire teams doing nothing else and it's getting ridiculous. So we haven't yet decided what should be measured in terms of value. This is work that still needs to be done.
Vernimmen.com: That brings us neatly to you Bertrand, you're the founder of Blue like an Orange, an impact fund. How can investors find their way around the countless ESG criteria that exist today?
Bertrand Badré: The issue of indicators is both important and not that important. It's obviously important because in a world of measurement, comparisons and benchmarks, people want to hold on to something. So, we shouldn't pretend that they don't exist. They do exist and that's a good thing.
At the same time, they're not all that important. As Cécile said, there are a lot of indicators. What is very interesting is to see the capital movements that are taking place in this area. And in particular, what the major rating and proxy agencies that are marking their territory are deciding and which will probably come up with an answer to this question without us having any say in it. To put it bluntly, they'll just do what they did with IFRS again. We're probably quite far ahead in Europe in this area. And we're at risk if nothing is done, but there's also a risk of being overwhelmed by these issues and of seeing a system imposed that we won't necessarily have chosen, notwithstanding our head start, our sincerity and our commitment.
That being said, yes, they're important, but not all that important. What is important is the approach of both investors and companies. There seems to be a high level of awareness on these issues in advanced economies. However, in emerging countries, things are a little more complicated. First of all, because people don't necessarily know that there's a problem: there are a lot of ordinary people who are doing ESG without even knowing it. It's good to tell them that what they're doing is good and to value it. We must be careful that this doesn't appear to be a new Western approach by telling them that "this is good capitalism and this is bad capitalism", because we already went down that road in the past. This is an important issue. We have to be inclusive. The sustainable development goals, which are ultimately the backdrop to our discussion, are global goals, not the goals of Sweden, the United States or France, we must be very careful to adapt them.
Yes, there's a question of definitions, but it'll be resolved. There are several levels to the question of definitions. There are a number of international standards such as the Principles for Responsible Investment and others; these are moderately demanding, so we shouldn't delude ourselves, but they're going in the right direction.
Then, we go into more and more detail, and that's where we have to choose our indicators and, above all, I think, explain what we're doing and respect two important principles: integrity and transparency. That's what I'm doing, and it's not enough for Danone CEO Emmanuel Faber to preach from the pulpit – the whole company must be mobilised and move in this direction. For Danone, the messages have been more or less the same for 50 years, so it's easier. For some others, it involves a conversion. So don't promise a lightning revolution. Nobody will believe you. You're not going to become an exemplary company overnight. Define a path. Follow this path, and tell people transparently "I can do it", "I can't do it", "This is how I do it", etc.
I'm not afraid of this somewhat burgeoning aspect that reveals two weaknesses of the system. The first is that, because these ideas are burgeoning, it's easier to engage in greenwashing. Be careful, this is important. You have to be able to sniff out the liars. The second point is that, for the time being, all of this is still largely based on the good will of people. Nobody has a gun to Danone's head forcing them to do ESG, it's in their DNA, their culture, consumer expectations, etc. But basically, a company could just as easily not do ESG. I'm caricaturing a bit, but the system doesn't reward you for doing it. We could say yes it does, through consumers or investors. The truth is that it isn't integrated into our accounting standards and is barely integrated into compensation methods. So we have a system where, for the time being, we're relying on the goodwill, honesty and integrity of people.
What's great is that it's a pioneering system. It's burgeoning. I think the question now is how do we move from a system that is peripheral and ill-defined to a system that is central. In the meetings I attend, people ask me how many billions are invested in ESG. The answer is pick a number! You take an extremely strict definition, that of the GIIN, Global Impact Investor Network. There is roughly 400 to 500 billion across the world that qualifies for impact investments. At the other end, some will tell you that there is 30,500 billion. Between 500 billion and 30,500 billion, pick a number. So, that's why we can tell each other stories, that's why we can display very large numbers. I won't mention which major asset managers have explained that they have transformed their models, etc. We get into big numbers very quickly. I don't think we should delude ourselves We're at the very beginning of something. That's the good news, I think it's really starting. We must therefore remain calm and not allow ourselves to get too giddy.
Vernimmen.com: Cécile, basically, should we pay more for a company that is virtuous in terms of ESG?
Cécile Cabanis: If I could go back to the incentives. Six years ago, we included CO2 targets in bonuses, in all bonuses; and today many companies have done the same. The real divide I see is among investors.
You have a world of asset managers whose bonuses are linked to the purely financial IRR calculated by an algorithm. So it's not even up for discussion. These are passive management funds.
And on the other hand, you have teams that are absolutely amazing, governance and sustainability teams with active management policies that dialogue with you during shareholder meetings. But nothing has been reconciled or integrated. Once I was at the home of a major investor where I met their sustainability manager. When all the asset managers arrived, they asked who the person from Danone was. They didn't even recognise their own sustainability manager!
Until we have everyone on board, it won't work. I think that today, we talk a lot, there are a lot of things that are moving, but we're not yet actively getting together to define the business model that will enable everyone to move forward and have an impact. If we want to have impact, it won't happen with each of us sitting in our own corner, in a silo with our own small data, our own small measurements. Hence the coalitions that have been launched, which you've heard about such as Business For Inclusive Growth (B4IG) and the latest biodiversity coalition (One Planet Business for Biodiversity), where dozens of companies are getting together to come up with projects, initiatives and funds to ensure that we can move faster. And when you're part of a collective, where there are different initiatives, things go much faster.
How do you assume that it reduces risk, or increases value? Everyone will have a slightly different take on the matter. I don't think we're going to be able to define a standard on what value is, on what measurement to use. It's going to get extremely complicated.
On the other hand, I think that today, the real issue is not what the ESG criteria are. The real issue is in everything we do. When we make investments, a whole part of the approval process concerns the impact on the environment, electricity, water consumption, etc. which we monitor, but what really matters is what lies in the heart of the business. Nothing more nothing less.
Vernimmen.com: But if we use cash flow, it's bound to be reflected in valuation. Sooner or later, the problem will be the time horizon that investors are willing to take into account. If we use risk reduction, investors need to integrate the risk reduction of an ESG-sound business in order to reduce their required returns because there are fewer risks.
Cécile Cabanis: Yes, that's what I'm saying, although investors are not nearly there yet. Investors are still looking at quarterly sales. And so, you're having to permanently manage tension between short-term results and making sure that you're doing the right thing for the medium- to long-term future.
But as long as we look at it as a cost or a risk, and not an opportunity for creating value, sustainability, it will be complicated. Investors must join us. Two years ago, we took an innovative step by renegotiating our syndicated loan: because we're on the way to being certified B Corp, 12 banks agreed to give us an interest rate discount if we stick to our plan, and on the other hand, we'll be in trouble if we don't stick to our plan. It's microscopic, but it means that at some point, there is an ability to recognise whether there is less beta or more alpha.
And it's when you do this sort of thing that you start to change things. But if we want to have an impact, we need to change in a more fundamental way.
Vernimmen.com: Bertrand, isn't there a contradiction with the principle of no trade-off by the investor that you're highlighting: not wanting to remunerate, or at least compensate, for the impact of ESG.
Bertrand Badré: This raises a lot of questions. We've reached an important stage in the history of our market economy. We realise that the model we've been using, which to summarise very crudely is based on the tenet of Milton Friedman, Jack Welch and a few others that the social purpose of business is to make profit or to create shareholder value, has come up against a few obstacles today. We can see that it's not very well suited to solving the issue of environmental challenges, the issue of social challenges, etc.
But this is still the model that structures our accounting standards, investors' expectations, the way (with some exceptions) people are mostly paid. And we shouldn't forget that we're emerging from a ten-year long financial crisis. I spent a lot of time with central bankers when I was at the World Bank and they all have split personalities. They say: "We understand that we must anticipate long term, that regulation must take the long term into account, but we're paid to ensure that there's not a crisis tomorrow." Obviously, the horizons in the Basel models, in the Solvency models, have a small intra-annual dimension, a kind of permanent elastic band, which means that despite all of our goodwill, you can't push too far. That's our system.
So the problem today is that there is no Master of the Universe saying yes, OK, the system is deficient, we need to switch to System B. When we set the terms of finance 40 years ago, we had Reagan, Thatcher, the World Bank and the IMF. The financial models were very clear and therefore what I learned, what we learned, became the obvious. There was a de facto Master of the Universe. Today, there is no longer any Master of the Universe at all.
And so that's why we sat down with Emmanuel Faber, Paul Polman and a few others. There is no Master of the Universe, so we'll work, sector by sector, looking at how we can create a critical mass of actors in a sector and start to change. And then, we're hoping that this critical mass will bring in others who'll start to feel bad about not doing what everyone else is doing and so they'll come over. And then when a lot of sectors have come over, little by little we'll feed these practices back into the central system and change things.
In the end, that's what we're doing. I don't know if it'll work, because I started out saying that the system had to be changed, and everyone told me "you're French, you like revolutions, etc." That didn't work so the idea was shelved. We're not going to change the system, even though I'd like to. And so, here's the debate. If we're not going to change the system, we really have to get to the bottom of questions like "What is the trade-off?" "How do we do it?" These are Danone's initiatives.
That's what I'm doing. If I want to raise funds to invest in sustainable development in emerging markets and I start having a conversation that is fair, in the mathematical sense of the word, undecidable, to know whether my returns will be impacted positively or negatively, because there are people who will prove that the opposite is true. Some people say that there's less risk, so it's better. And so, they're going to say, take a rate but we don't really know. In the end, it's going to impact on my cash flow. This isn't as good. You get people who are able to prove both sides with equal assurance. I'm saying that in 10 years, if the system changes, I'll change.
For the moment, I can't even start a conversation with an institutional investor by saying: look, our investments have an impact and therefore under these conditions, we have to accept lower returns. It's just not doable. So you're rewarded for the risk you take, you're in a market, the risk you take is worth so much, you assume it, you tell your investors, etc. That's OK. And then on top of that, surprise, surprise, free of charge, I'll give you an impact measurement. And that's how you have to do it, otherwise you can't do it. Otherwise, it's an endless debate that will faciliate the propagation of unscrupulous opportunists pedalling ideas that are just not true.
So you have to play with the system. We can't transform the system by waving a magic wand. So we play with the system and move forward on its foundations, and we wait for pioneers like Danone and a few others who are changing things. I hope to be one of those pioneers and that the system will gradually be reformed. But we shouldn't delude ourselves. In today's world with the United States, which is what it is, and China, which is what it is, we're not going to get together around a table. I've participated in meetings of the G7 or G20 Financial Stability Board. It's not reconstruction that's on the agenda, it's damage control. So we're going to try to prevent the system from collapsing before we think about rebuilding it. Let us seek to be part of the system as the righteous ones who are holding the flame, ensuring that we create something else afterwards. That's what's fundamental, really. We have to be realistic.
Vernimmen.com: We're trying to contribute to this in the Vernimmen by infusing ESG voluntarily so that the next generation take it as a basic given, and not as an addition to a basic finance.
Bertrand Badré: My conviction is that at some point, there will no longer even be any need for this debate. When you're a company, if you don't behave well, it'll come back to haunt you. It may take five years, ten years, it will all depend on the sectors, etc. I work with JAB Holdings, one of the largest consumer goods holding companies in the world. JAB buys 10% of the world's coffee, they have restaurant chains: Prêt à Manger, Eat and a few others. They serve 2 billion meals a year. They asked me to work with them on ESG and sustainability issues. Together with Danone, they are part of the Business inclusive for Growth coalition because this is in line with the deep conviction of their managers. But when you're a company that serves 2 billion meals a year in today's world, you can't not put the issue of food waste on the table, you can't not put the issue of packaging on the table. Similarly, when you buy 10% of the world's coffee, you have to ask yourself questions about the terms and conditions on which you buy it. So, at some point, it's not even so much the issue of the income statement anymore. It is a strategic issue. And so, the question is exactly what Cécile was saying, how do we transform the business model so that the issue no longer arises? Let a normal investor understand that a company that chooses ESG doesn't do so because it's good, it's nice, etc. It's because it has become indispensable. We're not there yet, but I think there are a number of things that are going happen.
There are many things that worry me about the way the world's moving today, the hypocrisy of a certain number of actors, etc. But fundamentally, what reassures me is the new generation of young people. There's no need to draw a picture for them, they understood. The system will evolve under their pressure, as consumers, as citizens, as investors, etc. We won't be able to tell any more fairy tales. And as for those who were cynical about Business inclusive for Growth, just as they were cynical about the 200 American groups that signed the Business Roundtable position. Who are they kidding?
No, they're wrong. This isn't the right way to look at it. When you put your name to a paper today, and you sign at the bottom, well, there are people who'll look and say: "You said you were going to do that, and in fact, you didn't". And that's when you start putting yourself at risk.
So that's it, that's how it works. It's not perfect. Once again, we'd prefer a magic wand; but that's what's being put in place. And I have the feeling that something is starting to happen, it's getting serious, even if the battle hasn't been won yet.
Cécile Cabanis: I think that investors just aren't there yet. We can all do a lot but at some point you have to get them on board and I think it actually starts with bonuses. The head of a large investment fund sends us a letter every year in which he says that he cares about the long term. And then you find yourself in front of the fund's asset managers who ask you why quarterly sales are down by €10 million? And they don't ask you a single question about the long term. So, the biggest problem is how to introduce long-term issues with investors seeking short-term returns and how to make the right transformation at the right pace, always factoring in the short, medium and long term, in order to make the right decisions. Because in the end, the financial markets, the quarter in question can cause decisions to be made that turn out to be very bad decisions in the long term.
Bertrand Badré: I couldn't agree more. This is clearly matter of assessing financial work, valuation and culture. And that's why what you do on the Vernimmen is essential. I think we're going to have to change what we learn at business schools.
Just as IRR is the instrument that summarises the risk/return approach and ultimately conditions a whole series of things. I think we need to integrate a third dimension: risk/return/sustainability, which shows that we are in a finite universe, that we work with real people on a real planet, in real temperature conditions, and not on something that works because it works on a spreadsheet. IRR is the result of many things, it's a figure that summarises, but behind it there are dozens of long-term assumptions. We shouldn't delude ourselves, you know as well as I do that IRR isn't scientific, I'm sorry. We need to find an impact-sustainability IRR, which integrates this dimension into a formula that will simplify everyone's life and ensure that people will be judged in 10 or 20 years on that, and not just on IRR as it is defined today. So, it's a real shift that starts with teaching.
I agree with Cécile, there is an issue of assessment by the financial sphere. It is at the root of the most serious crisis people have ever experienced, and from which we have not really emerged, which has given power in most financial institutions to the compliance and risk management departments for obvious reasons. These people do not necessarily want us to be innovative, and that's perfectly normal since that's the reason they're in place.
I'd say that today, we've actually entered a new phase, this could even be a new economic regime, with negative interest rates. This will contribute in a major way to stimulating reflection on how financial assets are valued. Right now, we're distorting the models by behaving as if its business as usual. At some point, we'll have to ask ourselves whether it isn't something else. The worst possible situation is for paralysis to set in. You're a life insurer today. Does my business model hold up well over the next 5 years? You're a pension fund, you're on the brink of collapse if zero rates last ten years. A situation of paralysis could arise. In these cases, zero rates are the worst thing, and you'll continue to buy German Bunds and lose money, but you'll tell yourself that it's OK, because at least you'll get something in the end. Or, and this would be the best thing, if it forces everyone to say: OK, we've got 10 to 15 years of very low interest rates ahead of us. So the current model doesn't work. So we need to think differently, to think about other options to review the regulations, to accept a slightly different approach to risk taking, to review a number of criteria. Maybe zero rates will force us to be a little smarter than usual.
Vernimmen.com: Very optimistic.
Bertrand Badré: This is the factor that has changed in people's minds this year. We thought there would be some kind of standardisation on interest rates. Today, we see that the United States is lowering them, that the ECB will not be raising them for a long time. Before, we had hoped that it was only a phase. Now we believe that it's a new economic regime. So now, we're really going to have to think about it.
Vernimmen.com: Does being virtuous in ESG terms make it possible to recruit better, to hire candidates with better CVs? Does Danone have the impression that it's much easier to hire, or even cheaper to attract the best skills?
Cécile Cabanis: The answer is yes.
Every two years, an external organisation conducts a Danone People Survey. What we've noticed is that being virtuous in ESG terms as you say, pushes up the rate of engagement very high, we've been at the top of the Best in Class for years in terms of the rate of engagement. Danone employees, beyond coming to do a job, feel that they are co-owners of a project.
We then decided to take the process a step further, by involving Danone's 100,000 employees in defining and setting the agenda for our strategic goals for 2030. They are fully involved through consultations twice a year. Of the latter, more than 75,000 responded, 300,000 items of feedback. And when this feedback comes from 100 countries and from all of the people in our companies, it's extremely rich. Because yes, there are global issues, but there will be local solutions.
So it's really very important to be connected locally since the issues and priorities are not the same depending on where you are. And we've even linked this to the Board of Directors with a committee of volunteers who share all of the feedback from our 100,000 people. So we've really made them co-owners in the definition of goals. This has an extremely high engagement value.
Vernimmen.com: Bertrand, so we're blowing up the current model. What model will replace it? You talk about mark-to-planet. What do you mean by that?
Bertrand Badré: Those who have done some accounting know what mark-to-market is all about. This is one of the pillars of the IFRS adopted collectively some 20 years ago, which means that, even if you think in the very long term, every quarter you look at your balance sheet in terms of net asset value. So you have to split yourself into two people. Every quarter, you close the balance sheet as if the business were going to shut down tomorrow, and at the same time you have to make preparations for the next 20 years.
What do I mean by mark-to-planet? This comes back to what I said about the Milton Friedman tenet: "the social purpose of a business is to make profit", or in its variant form "profit for shareholders". We forget a little footnote that Friedman added: all this requires social acceptability, we're not just free-floating entities Shareholder value theorists have somewhat forgotten this part by pushing the reasoning around the shareholder, which has resulted in a number of biases. Cécile talked about the short term. We've talked about extremely financial definitions and about IRR. And we realise that this leads to a capitalism that I'd call a little above ground, PowerPoint or Excel capitalism, it works, but we forget that there are real people behind the figures. I'm a Director of Getlink (Eurotunnel) and it was thought that the United Kingdom would remain part of the European Union forever. It was great to have factories on both sides of the Channel and to send parts from France to the UK and vice versa. Nobody thought of including in the PowerPoint presentation that there was a real risk that in real life real people would decide: "that's it, we're off".
We must move from a system of "the social purpose of business is to make a profit", to "the social purpose of business is to find profitable solutions for the planet and its people". This is not to say that profit is bad, I'm not preaching Thomas Picketty, I'm not looking for profit to be abolished. But profit is not an end in itself, nor are IRR and bonuses. Profit is a means, and that's the only way that it can sustainable. If you provide solutions, you allow the model to become sustainable. If your motto is "take the money and run", you're saying that you're not the custodian of this planet and the people who live on it.
That's the quantum leap we need to make. I think Danone and Antoine Riboud were very much ahead of the game in this regard. To make the quantum leap from profit as an end in itself, and to look at ourselves in the mirror, which is how we work today, and to see to profit as a means to an end, which is this planet. Because, as Antoine Riboud has said, there are no
other planets for the moment and none within human grasp. And the inhabitants of our planet. These are the ones that matter, because if these people aren't happy, things will turn out very badly indeed. That's what's happening around the world, we have a form capitalism that no longer responds to orders and we've become a bit like headless chickens. The time for change has really arrived.
 National Conference of the Federation of French Employers, on 25 October 1972 in Marseille. https://go-management.fr/wp-content/uploads/2016/07/Discours-dAntoine-Riboud-aux-Assises-nationales-du-CNPF-le-25-octobre-1972-à-Marseille.pdf
This graph shows the share of financing provided by banks in the overall financial and bank gross debt.
Trend shows a decrease over the years of bank debt in the overall financing since 2000 both in the US (from 40% to 30%) and in Europe (from 90% to 80%). France shows the largest proportion of market (vs bank) financing for corporates. This illustrates the strong position of large corporates in the economy (vs Germany or Italy).
We can note that the decrease in bank financing seems to have stopped mid 2010s. This graph also shows that the share of bank debt tends to rise before a financial crisis, since for both French and American companies, it stops falling and rises again in June 2004, i.e. 3 years before the first difficulties. However, in our opinion, this does not mean that it should be used as a leading indicator of future difficulties. A single observation is indeed a little short to draw a law from it!
With Simon Gueguen, lecturer-researcher at the University of Cergy-Pontoise
This month we look at the results of the first wide-ranging academic study on activist risk arbitrage, an activity that has developed over the last decade. During an M&A transaction, risk arbitrage (we also talk about merger arbitrage) involves buying shares in the target following the announcement of the deal, and taking advantage of the upward convergence of its share price towards the price offered by the buyer. This convergence is not immediate given the uncertainty hanging over the deal which makes it possible to bet on its success.
Traditional risk arbitrage is an active transaction in terms of share selection, but passive in terms of governance given that the shareholder (very often a specialised fund) merely votes in favour with the shares it holds but does not get involved in the deal. Activist risk arbitrage involves trying to get a higher price for the target after the shares have been acquired. The activist attempts to rally the passive shareholders around it and threatens to block the deal unless a higher price is offered. This practice was extremely uncommon in the 2000s but had occurred in close to 10% of M&A deals in the US by the end of the period covered by the study (2104).
Jiang and Mei studied a sample of over 4,000 M&A deals in the US between 2000 and 2014. Their empirical study compares transactions without risk arbitrage, with passive risk arbitrage and with activist risk arbitrage. While both types of risk arbitrage favour large transactions and targets with a big institutional shareholder base, activist risk arbitrage is more frequent in transactions where delisting is involved (especially MBOs and LBOs), and friendly transactions. When management is in favour of the acquisition, it is possible that it may not have done all it could have done to push up the price. Out of the sample studied, profitability (on an annualised basis) in cases of activist risk arbitrage is 16.3% compared with just under 6% in cases of passive risk arbitrage. Over and above target selection, activists exploit their private information which involves their own intention to push the price up (information of which the market is unaware when activists buy their shares). We can however assume that there is quite a high cost associated with this practice, with this activism cost being added to the traditional costs of risk arbitrage. This cost is not measured by the study (profitability is calculated based on the price of shares).
Another interesting result concerns the probability of the transaction being completed. Jiang and Mei show that the involvement of an activist arbitrager increases this probability when the transaction is well received by the market (i.e. when the target share price is very close to the purchase price at the time of the announcement). They conclude that this practice is good for all of the target’s shareholders, and not only the activist. It’s worth noting that one of the co-authors of the study, Wei Jiang, is a well-known specialist in the field of shareholder activism and has contributed to many articles on the topic, always in favour of activism in its different forms.
 W. Jiang, T. Li and D. Mei (2018), “Influencing control: jawboning in risk arbitrage”, Journal of Finance, vol. 73(6), pages 2635 to 2675.
We note here the incorrect use of the word “arbitrage”. A key feature of true arbitrage is the absence of risk. The term is nevertheless widely used to refer to transactions that involve betting on the convergence of two prices (here the target share price after the announcement and the acquisition price). This use is acceptable on condition that we do not lose sight of the fact that these are in fact speculative operations, which means that they are risky!
An initial reflex is to use factoring, which involves securing debt backed by customer receivables, especially if the financial standing of your customers is better than yours. If this is insufficient to finance your working capital it means that your inventories are too high. If your inventories have a value on the secondary market (raw materials, Champagne being aged, etc.) it should be possible to put in place bank financing backed by inventories, or securitisation if volumes are high. In other cases, and if your company generates positive free cash flows, a general loan (linked to the company and not its assets) could be considered, as long as your acceptable debt level has not yet been reached. If it has, then you can always use your shareholders’ equity.
Regularly on the Vernimmen.com Facebook page we publish comments on financial news that we deem to be of interest.
Auction or private negotiation?
A few weeks ago, the listed investment company Wendel announced that it had taken control of Crisis Prevention Institute, a US company, for 23.3 times its EBITDA. This is obviously not cheap, but a double-digit growth company, resistant to the crisis and with high margins (EBITDA is $39m for a turnover of $86m) does not come cheap nowadays.
This acquisition was made by mutual agreement, without a private auction process, which shows once again that the price obtained does not necessarily depend on the chosen negotiation process and that private negotiation also makes it possible not to sell off a company!
In fact, in the minds of many, private auctions are synonymous with value maximization, much like Christie's with the Salvatore Mundi painting of Vinci. The scientific analysis has shown that this first impression is false and that the price obtained for the sale of a company does not depend on the sales process, as the example of Wendel illustrates again. For the scientific reference, see The Vernimmen.com Newsletter of November 2007, n° 28. Our 38 years of cumulative experience in mergers and acquisitions does not tell us a different story.
On the other hand, if you want to demonstrate to third parties (a shareholder, a board of directors, a regulator, etc.) that you have made every effort to obtain the highest price for a subsidiary, the choice of private auction will of course be the easiest to defend, even if it is not based on reality.