- Rising interest rates put focus on corporate balance sheets
- Carve-ins involve parents integrating subsidiaries to improve their cost of capital
- Carve-outs, divestments, take-privates also likely to feature
Siemens Energy’s [ETR:ENR] ongoing process to end the independence of its affiliate Siemens Gamesa Renewable Energy [BME:SGRE] is likely to be a trendsetter as European dealmakers grapple with the implications of rising interest rates.
The deal is an example of a carve-in, the lesser-known cousin of a carve-out. Deals with these structures involve a parent company integrating or re-integrating a subsidiary. They often make sense when a parent company has a lower cost of capital than a subsidiary, dealmakers said.
“The focus on cost of capital is becoming much more acute as interest rates go up,” said Hyder Jumabhoy, a London-based partner at White & Case and the co-head of the firm's EMEA financial services M&A practice. This new focus in the corporate world means that executives will think hard about carve-ins, he said.
Economists define cost of capital as the minimum rate of return that an investment must earn to generate value. When interest rates rise, so do the cost of debt and equity financing. And as a company’s cost of capital increases, capital allocation must become more efficient.
Siemens Gamesa has a weighted average cost of capital (WACC) of 11.7% based on a simplified discounted cashflow (DCF) basis using the Capital Asset Pricing Model (CAPM) with inputs from observed market data, according to data compiled by Valutico. Using the same methodology, Siemens Energy has a WACC of 8.6%.
By contrast, Siemens Gamesa’s WACC was just 6.6% on 1 January 2022, while the same figure for Siemens Energy was 4.6%, according to Valutico. Since then, the Russian invasion of Ukraine and subsequent sanctions have led to soaring energy prices and inflation. The European Central Bank and the Bank of England have both ramped up interest rates to take control of soaring prices.
Supply-chain issues are also driving the trend towards carve-ins as corporates seek to secure their assets, according to Kristina Klaaßen-Kaiser, Linklaters' Düsseldorf-based European head of corporate M&A.
Indeed, when Siemens Energy announced a voluntary takeover of its Spanish turbines arm in May, it cited “manufacturing, supply chain, project and customer management” as key reasons for the change.
Shareholders at Siemens Gamesa last week approved a delisting. The parent company has a standing purchase order at EUR 18.05 per share, valuing its Spanish affiliate’s equity at EUR 12.3bn. Shares in Siemens Gamesa had plunged since the end of 2020 as the company hit a series of profit warnings.
A host of additional, potential carve-in transactions have been flagged by this news service’s The Morning Flash column in recent months. Industrial conglomerate Acciona [BME:ANA] has been steadily building its stake in Nordex [ETR:NDX1], another wind-turbine manufacturer, for example. Valutico’s data shows that Acciona has a WACC of 7.6%, while Nordex has one of 9.7%.
Another potential European carve-in flagged by The Morning Flash involves palm oil and rubber plantation owner KLK [KL:KLK] which has been rumoured to be mulling a bid for the shares it does not already own in chemicals specialist Synthomer [LON:SYNT].
Carve-outs, divestments and take-privates
As well as carve-ins, carve-outs can also make sense when corporates are thinking about cost-of-capital issues, White & Case’s Jumabhoy said. European corporates are actively looking at their balance sheets as interest rates rise, Klaaßen-Kaiser of Linklaters said, adding that this could be a catalyst for carve-outs and divestments.
Meanwhile, private equity funds still have a lot of dry powder, so buy-and-build strategies make sense when some corporates are in a selling mood, Klaaßen-Kaiser said.
Just Eat-Takeaway [LON:JET] (JET) is one of the more extreme examples of a business which has been forced to reverse course on its M&A plans in the new macro scenario. After outbidding Uber Technologies [NASDAQ:UBER] to acquire North American takeaway food delivery specialist Grubhub for USD 6.2bn in June 2021, JET put the business up for sale less than a year later in April 2022. It has yet to complete a sale, though reportedly received a bid worth only USD 1bn from financial sponsor Apollo Global Management [NYSE:APO].
Moves to take troubled listed companies into the private domain are also likely to be a feature of this year’s activity, dealmakers said.
“In general, valuations of listed assets have fallen and this could drive public-markets M&A,” Victor Manchado, a partner in Madrid with Linklaters, said. The Euro Stoxx 50, which tracks 50 liquid stocks across 11 countries in the eurozone, fell sharply in early 2022, but has since been creeping back towards previous levels.
Private equity funds are already involved in three European take-private offers above the EUR 500m threshold in 2023, according to Dealogic data. These include Triton Partners' rival bid on Finland-headquartered construction asset Caverion [HEL:CAV1V], worth EUR 1.4bn,; and a EUR 574m bid on media monitoring platform Meltwater [OSL:MWTR] from Altor Equity Partners and Marlin Management.
Meanwhile, financial sponsor Apollo is also in early-stage talks with Luxembourg-headquartered telco Millicom International [NASDAQ:TIGO] regarding a joint bid alongside Bolivian billionaire Marcelo Claure. The potential target has a market capitalization of USD 2.9bn.
Low stock prices have caused concern in executive suites across Europe. The continent’s corporates are taking defensive advice to prepare for shareholder activism, Klaaßen-Kaiser said.
The defining factor of the new macro-economic scenario has been uncertainty, particularly around the recalibration of valuations, Manchado of Linklaters said. The M&A downturn in 2H22 was due in large part to a pause while dealmakers contemplated the new situation, agreed Klaaßen-Kaiser.
“Despite the headwinds, there is still considerable appetite for M&A and we expect high M&A activity in 2023,” Klaaßen-Kaiser said, adding that US corporates looking to expand in Europe could drive dealmaking.
The combination of the war in Ukraine, inflation and rising interest rates has created an unusual market situation, particularly for younger dealmakers, Klaaßen-Kaiser said, adding that the situation is now increasingly seen as “the new normal.”
Although many sale processes are on hold due to problematic debt markets, sponsors are beginning to think about hybrid financing options, Manchado said. “Sponsors are embracing longer maturities on their investments and being more creative when it comes to deal structures,” he said, adding that deal activity could pick up in the second half.
Private equity and venture capital funds need to choose the right kind of funding in every deal, agreed Jumabhoy, adding that deal complexity tends to increase as interest rates increase.
That’s borne out by fourth quarter 2022 data which shows European M&A slumped to its lowest quarterly dollar volume tally since the coronavirus pandemic began to take hold in early 2020. But with junk bond spreads starting to ease from the highs of summer 2022 and signs of activity from financial sponsors early this year, it looks like dealmakers are starting to find a way to do business even as the “new normal” takes hold.
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