The familiar figure of Hal Harrigian has been banging around Southern California corporate finance circles since the 1960s, long associated with the old accounting outfit Arthur Young, and then brokerage Crowell Weedon & Co.
Now Harrigian, 66, has resurfaced from semi-retirement to join forces with business valuation and advisory shop Duff & Phelps Inc., in its Century City offices, where he will help engineer business mergers, and perhaps fund a few private placements.
Like many other investment bankers, Harrigian says financing is tight now for acquisitions, and that business values are squishy.
“If you could get senior lending (bank loans) for an acquisition deal at three or four times EBITDA (earnings before interest, taxes, depreciation and amortization) a couple of years ago, today you can only get two and a half or three times EBITDA,” Harrigian says.
That means banks would have lent perhaps $40 million on a company with EBITDA of $10 million in 1998, but maybe only $30 million or less today. Thus business buyers have to cough up more equity, and drive down prices, to consummate a deal. They can also lay down with the debt wolves, those mezzanine funds that also provide funding for buyouts, but on a junior level to banks. But the “mezzies,” as they are called, command a pretty penny for their dollars effective interest rates of 20 percent or more, and equity kickers to boot.
That being said, there may be some sizzle in the M & A; game in the second half of this year, conjectures Harrigian, due to pending changes in accounting rules. Through June of this year, what is known as “goodwill” a company’s intangible value, such as the value of its brand name, or business relationships has to be “written down,” or depreciated after a merger, usually in a 20-year time frame or less, in many transactions.
But caving into modern-day financial realities, the Financial Standards Accounting Board has issued a new rule effective mid-year, which allows goodwill to just stay on the books, unmolested, after a merger.
The upshot?
“You won’t have that depreciating goodwill eroding reported earnings,” says Harrigian. “That’s no longer a disincentive to make an acquisition.”
The issue of depreciating goodwill is bigger than ever, as even Fortune 500 companies come to be little more than groups of people huddled in rented office buildings. According to CPA giant Arthur Andersen, in the early 1970s, more than 90 percent of a Fortune 500 companies’ market capitalization on Wall Street was “book value,” or its liquidation value. Today, that figure is about 25 percent. In short, the lion’s share of a typical publicly held company’s market capitalization is not tangible anymore.
Capital Conference
“You saw a lot more suits, and a lot less ponytails.”
Those are the words of Byron Roth, chairman of Newport Beach-based Roth Capital Partners, describing the recent Los Angeles Venture Association Investment Capital conference downtown. Roth was presenter at the annual bash.
Attendance was off this year from last, said Roth, and the spirit far more sober. “The angel investors are not even there. It’s only institutional money now,” said Roth, describing not only the event, but the venture scene in general.
Still, there are emerging warm zones, if not hot spots. Biotech investing is getting some action, and companies that have some sort of track record, and pathway to profits, can expect at least passive interest, said Roth.
With values of small-cap public tech companies especially the “orphan stocks” that have no institutional backing having been beaten into submission, there is growing institutional investor interest in “PIPEs” (private investment in public equities), said Roth.
In a PIPE, a company places a large block of stock directly with an institutional investor, usually at a discount to market.
“These are what I call businessman’s deals,” said Roth. “You have some small-cap tech companies trading at 10 times earnings, but showing 20 percent annual growth in earnings. There is no way an institutional investor could assemble a large block of stock in a small-cap like that without driving the stock price up (during the buying spree). So a PIPE makes sense.”
PIPEs offer even venture-oriented investors a chance to buy in, while still getting the rigorous reporting standards of a public company, the corporate governance, and some liquidity, said Roth.
Bottom Time?
The old joke is that President Dwight Eisenhower once threatened to chop off the arm of an economic adviser with a machete. Why? “So he can’t say, ‘On the other hand, anymore,'” said Ike.
Investors might wish that market gurus could lose an appendage also. Certainly, many were asking last week if a “market bottom,” had been reached, and answers were generally equivocal.
“We are either in a bottoming stage, or the bottom is about to fall out,” said Larry Katz, editor of the Westlake Village-based Market Summary & Forecast newsletter (marketsummaryandforecast.com). Katz, who tracks technical indicators such as the Elliot Wave, says the Dow Jones Industrial may sink below 7,500, unless there is a rally soon, which “could be a strong rally,” he said.
Or maybe not, said Peter Eichler, of the Santa Monica-based Aletheia Research and Management money management shop. He said that the lack of current insider buying on Wall Street might augur poorly for investors. “In 1987 and 1990 and 1994-5 and 1998, you had a lot of insider buying after each market drop. You don’t have that now,” said Eichler, who is mostly bearish as a result.
But Paul Rabbitt of Hermosa Beach-based Rabbitt Analytics said last week, “It is very difficult to envision the market will be going down very far from here, with the Fed cutting rates (which it did last week).”
The Fed knows that consumers today are tied into the stock market like never before, said Rabbitt.
With the Fed fighting recession, the stock market is set to rise again, he said.
Where is Ike’s machete?
Contributing columnist Benjamin Mark Cole writes about the local investment community for the Los Angeles Business Journal. He can be reached at [email protected].
