Have The Markets Really Improved?

Glimmers of light are breaking through on the dark and cloudy financial horizon, and investors across the country – and around the world – are starting to hope that an economic dawn has finally arrived.

But despite the bright patches, it’s unclear whether the global markets will loosen and open enough to start generating meaningful growth that energizes companies, funds innovation and puts legions of people to work.

The most important reality here is the fact that we are beginning to see signs that there is some more debt financing available today than there was a year ago. However, most of the deals that are getting done right now are largely equity financed.

We continue to see a steady stream of distressed deals, a full year after the financial meltdown. Distressed sellers increasingly realize that if they don’t do a deal, they’re going to end up out of business. That mindset helps explain why people have become much more rational about valuations, multiples and prices.

It’s difficult to assess which way the market is headed at this point in time. Is the deal flow that we’re currently experiencing akin to “Cash for Clunkers” – a temporary financial shot in the arm that ultimately loses punch and impact? Our lack of insight is compounded by the seasonal norms; autumn is traditionally a busy time of the year for transactions, and it’s usually followed by a fall-off in January and February. So, we won’t get handle on the state of the markets until March. That’s when we’ll have our first solid readout on whether normalization has returned.

We can, however, offer several observations at this juncture. First, distressed and strategic deal making will continue. Second, a lot of people are thinking long and hard about exiting from investments. Third, non-distressed deals are moving slowly because buyers are patient and digging in when it comes to due diligence and examination of assets and terms. Negotiations in these transactions are also extremely exacting these days. And finally, we are seeing a growing number of buyers use the down market to their advantage; one way, for example, is by pushing escrow onto the seller or to use large earnouts as insurance policies for performance. Of course, buyers have to be careful about piling on because the market could shift and deals could then be shopped around to other prospective acquirers.

So, there’s a fine line that has to be walked. With distressed deals, which represent about half of the current uptick, the parties tend to expedite the process and try to get the transaction done as quickly and prudently as possible. With non-distressed deals, it’s better to proceed with caution and read the market carefully.

Looking forward, we believe that the global markets will be up and down over the next year, but the good news is that we anticipate less volatility in 2010 than we were forced to experience in late 2008 and early 2009.

And, as we move ahead, it’s important to remember that the banking world has changed significantly; and it’s pretty obvious that fast and cheap money isn’t coming back for a long time. It’s unclear when the banks will actually loosen up; our belief is that they’ll need to deliver strong and sustained performances for a number of quarters before they feel comfortable enough to lend in a substantive way again.

In the meantime, we expect to see distressed deal making persist for at least another year. This is the net result of the financial collapse, and companies are still struggling across the board to hold on to their top and bottom lines. Until they can feel safe, solid secure financially, most firms are going to keep battening down the hatches. That means stringent cost controls, limited borrowing, careful monitoring of operating budgets, curtailed hiring, and a sharp-edged focus on the art of the possible.

The companies that mange conservatively and well; the buyers who purchase strategically and at a good discount; the sellers who know when to let go and give way to an acquisition; and the banks that repair their tattered balance sheets and loan portfolios in a forthright and directed way – these are the key players to watch in 2010. If all goes according to plan, they’ll rebuild and ride through the next year; and then, because of the actions they’re taking today, they’ll be in a good position to truly prosper during the second decade of the 21st century.

Cheresh Casinelli is a partner at the accounting firm of Moss Adams