The simple way to make money in M&A sector

We went on to discuss a whole range of companies and their differing acquisition strategies to try and identify those strategies that have made sustained increases in shareholder value and those, despite perhaps being more active acquirors, achieving little net improvement in shareholder value.

In my view, making money is simple.

You buy within 15 per cent of the bottom of the cycle and sell within 15 per cent of the top.

Simple! But most people leave it too late.

The difficulty is to know where the top is and where the bottom is, hence the 15 per cent margin.

Not everything moves in cycles but most businesses are exposed to one or more of product cycles, economic cycles, funding cycles and stock market cycles, amongst others.

The more successful value creators are those that know which parts of the cycle to be acquisitive in and when not to be.

Equally, there must be different tactics for different points in the cycle.

A buyer should behave very differently at the bottom of the cycle than at the top.

Anyone who uses the same pricing matrix applies throughout the cycle doesn’t optimise returns for themselves or shareholders.

History shows that a more selective and a more bespoke approach has, on many occasions, generated greater shareholder value.

The funding cycle is also relevant.

Eight years ago debt was the primary driver of value creation.

Equity, always the most expensive form of consideration, was used sparingly, debt was maximised and cash generated was generally reinvested.

Over the last eight years, as a result of the credit crunch, corporates have reconsidered their optimal capital structure and now generally rely less on bank debt notwithstanding its low cost.

Cash generated from operations and disposals have been used to rebalance their balance sheets and reduce reliance on lenders.

Generally corporates, having completed the strengthening of their balance sheets, are now seeking to apply cash generated to acquisitions and other investments.

But the rules of acquisition pricing must change.

A lower proportion of cheap debt has meant that the average cost of capital has increased materially.

Those that think that pricing on the old models can be sustained will risk losing shareholder equity because, as the cost of capital rises, pricing must reduce if shareholders’ returns are to be maintained.

My friend the fund manager was not convinced that today’s young breed of corporate financiers, bankers and some finance directors understand the correlation.

Institutional and some private equity shareholders have, I think, picked up this risk and are now beginning to apply pressure for increased dividend yields to mitigate against higher risks and lower returns in equity portfolios.

Those with grey hair and real experience over a number of cycles will stand more chance of making money and maybe once again, the tortoise will beat the hare.

*David Forbes is one of our new columnists this year. Mr Forbes is best known as the founder and head of Rothschild’s Investment banking office in Leeds from its opening in 1995 until he turned plural in 2010.