Why is KKR and Global Infrastructure Partners buying CyrusOne (CONE) in a $15 billion deal?

CyrusOne provides mission-critical data center facilities for approximately 1000 customers. Over the last five years revenue has grown annually by 20%, earnings every year by 20%, and funds from operation too have grown by almost 12% annually . They have a strong presence in US markets where they have created a national footprint & they’ve also gone into Europe. They received an investment grade rating on their debt and the long-term outlook is pretty good – largely because one expects the usage of data to grow, the trend towards enterprise outsourcing, increased reliance on technology, as well as newer things are happening such as data hungry artificial intelligence and in the future the arrival of autonomous vehicles. Most enterprises are now outsourcing their  data centers – it is expected that almost 80% of enterprises will have shut down the traditional data centers by 2025. There is a lot of reliance now on technology and e-commerce, on remote work, in collaboration platforms, technologies such as video over Internet are mainstream, growth in mobile traffic and connected devices all of which drive a lot more consumption of data.

They have a high-quality portfolio of primarily owned assets and most of their customers are in the fortune 1000. In Europe they have a presence across most key markets. They’ve exhibited development and operational expertise and have a good track record. While it is true, they have scaled but they’re not huge – still small enough to generate meaningful growth. With investment grade risk and a customer centric focus they are going to be well-positioned for profitable growth in coming years. The portfolio of assets is good : almost 92% of their operating income comes from the assets that they own, 80% of their customers are in Fortune 1000, and the average credit rating of their large customers is almost 80%. Their leases have rent escalation clauses, the weighted remaining lease term is over four years . When it comes to Europe they have an attractive set of assets across key markets with an emphasis on Frankfort and London. Importantly they have a new data center in the portfolio and long standing relationship with the fast growing customers . With a track record of on time delivery, they also have capacity to significant increase their footprint to support  growth in short time. They have capacity and access to land across key markets to support growth. All this is expected to produce attractive equity for they have access to capital which is critical in a capital intensive business to ensure continued growth, especially where there is market volatility. What speaks volumes is that their customers have entrusted them with mission critical assets,  partnered with them they’re going to grow with them.

Concerns

This said, there are certain things one needs to look out for. For example, demand is concentrated with large customers which is a disproportionate part of their portfolio. They therefore need to diversify this portfolio and execute long-term leases. Another issue of concern is prices in this segment have continue to decrease so they do need to build efficiencies to protect returns against pricing decrease. And of course they are development challenges that come from resource scarcity, local regulations and public sentiment – so they will have to be very deeply local to secure line, water, power permits and leverage their global platform for environmental, safety and regulatory, considerations. They will need to secure long-term capacity pipelines in markets that are going to grow, so this injection of capital will help them to continue to invest in global digital gateway markets to support growth. They ought to emphasize their development and operational expertise story, maintain their strong balance sheet, strive for low cost of capital and grow their funds from operations.

Public to Private Equity Transaction Considerations & Process

This month I reflected on the many public to private equity transactions I worked on over the last 20 years and gleaned some lessons. I collated the gestalt of my take-aways into a deck. The essential issues to wrap one’s hands around include:

Going Private Considerations; Should Companies Go Private?; Is a Company Better Off Being Private?; Going Private Considerations; Board Considerations; Director Responsibilities; Board Considerations;  Pre-Signing vs. Post-Signing Market Check; Going Private Transactions; Going Private Transaction Process Alternatives; Transaction Timing Alternatives; Role of the Special Committee in Negotiated Transaction; Special Committee Obligations in Negotiated Transactions; Leverage Considerations for Going Private Transaction; Comparable Credit Analysis; Indicative Timeline; Legal and Governance Considerations

Privatization

This report discusses various privatization best practices. We address key issues including:

The Public Sector as Stakeholder

Why do Governments Privatize?

Privatization Best Practices

Determine Privatization Objectives

Determine Privatization Strategy

Institutional Framework

Efficiency Factors

Corporate Governance

Corporatization

Role of Board of Directors

International Examples

Monetization Of Public Sector Real Estate: Why Sell The Family Silver?

Global Privatization Trends

PPP/PFI

Acquisition of a Minority Interest from Financial Sponsor—-

Much is spoken about private equity and financial sponsors making minority investments, but very little is known about the other way around – when firms or other funds acquire interests in financial sponsor portfolios.  I had participated in such deals and summarize my general thoughts in this deck. I discuss the rationale, structuring considerations, the types of securities will have impact on ownership, governance and pricing. I talk about governance conditions and willingness to accommodate minority investor’s requests, liquidity and exit considerations along with pathways to exit. I also provide examples of transaction diagrams for visual clarity. I conclude by highlighting timing considerations and typical process followed.

As always the devil lies in the detail. If you are considering making one such investment and need help do contact me.

An Earnout is a Useful Tool to Bridge a Valuation Gap

  • An earnout is an acquisition where the purchase price is partially contingent on the future performance of the target
  • Bridge a valuation gap
  • Used when possible, to measure target’s performance post-closing
  • Retention and incentive mechanism for owners/operators to stay past closing
  • Typically used in smaller deals (less than $500 million)
  • Usually tied to an accounting metric
  • Revenue, gross profit, EBITDA, EBIT, net income
  • Accounting metrics need to be able to be verified and audited
  • Earnouts are highly customized for each situation
  • Typically negotiated later in the M&A process
  • Structure can have tax and accounting implications
  • Time period can range from 1-5 years
  • Shorter time is more common (3 years and less)

Bridging the Value Gap

There are three key issues that will drive the value gap:

  • Expected operational performance of the asset
  • Valuation multiple to be applied to the operational performance
  • Buyer and/or seller requirement for a “headline” value for various relevant constituencies (i.e. limited partners, shareholders, banks, bondholders, etc.)

Two of the mechanisms that can be used to bridge value gaps are:

  1. Earn-Outs: Potential future cash or stock payments based on achieving pre-determined operating/financial targets
  2. Contingent Value Rights (CVRs): Potential future payment (usually of stock) based on stock price performance

Earn-Outs

  • The successful execution of an Earn-Out agreement requires simple and measurable criteria:
  • Careful selection of criteria and structuring of the pay-out formula
  • Agreement on accounting methodologies so neither party can manipulate base data
  • Agreement on who controls the business during the Earn-Out period
  • An arbitration system to resolve any future arguments

Advantages

  • Reduces risk of overpaying if poor operating performance post-acquisition
  • Only structure that “tests” Target Parent’s convictions of Target’s potential
  • Could help Target Parent state a higher headline value for the sale

Considerations

  • Not a common structure for public companies
  • Adds complexity to deal
  • May result in Acquirer paying for value that it creates within Target
  • Potential for manipulation in areas of management (short-term gains) and accounting
  • Potential for litigation if future value not achieved

Board Duties of Directors in M&A Situations

Amongst my great learning privileges on Wall St was to be deep in the weeds as Managing Director at NYSE: RCS Capital Corporation (RCAP) in 2014. A firm into investment banking, capital markets, transaction management services, wholesale broker dealer and transaction manager.. inter alia. The only investment banking and capital markets business focused primarily on the specialized needs of the direct investment program industry then, and with exceptions none today.

That’s when I developed practitioner expertise in listings, mergers and acquisitions, tender offers and capital markets fundraising. An important part of that learning was I figured out – what is the role of Board members or of appointed directors in frequent M&A?

Here are my takeaways from that period in my career.

Trends in Corporate Governance, Proxy Fights & Poison Pills

In this study I examine activism trends, proxy fights issues and success rates, as well as arrive at defense and poison pill analytics. Poison pills in force are declining and companies are increasingly letting pills expire naturally – and with that there are fewer plans in force, resulting in a decline in the number of shareholder proposals in favor of redeeming or removing plans.

It appears that companies have seen little impact on stock price as a result of adopting or renewing a poison pill. I also shed light on triggers and historical precedent rights plans. My study reveals that historically, only a handful of companies increased the exercise price of their poison pills and in most cases this resulted in excess abnormal returns. Counterintuitively and interestingly, a targets’ ability to fend off a hostile acquirer is not dependent on having a poison pill. I then describe with examples structural defense and takeover defense.

Poison Pills – Overview & Mechanics

U.S. companies are dismantling their takeover defenses. The decrease can be attributed to companies switching to annually elected directors from staggered board terms, companies removing poison pills, and less companies providing that directors can only be removed for cause. The pace at which companies are erecting barriers against proxy contests and enacting rules to maintain tight rein over shareholder meetings has slowed significantly too. Also companies are increasingly allowing poison pills to expire.

I tackle these and other issues in our M&A series. Here I explain the general idea behind poison pills; in the event of a hostile takeover attempt, poison pills give shareholders (except for the would-be acquirer) the right to buy stock in their own company or in the acquiring company at a deep discount, if the bidder acquires a certain percentage of the outstanding shares. With other shareholders then able to buy shares at discounted price, the target company would become financially unattractive and the voting power of the potential acquirer would be diluted -i.e., acquiring the company under those terms would be like swallowing a poison pill.

Merger Arbitrage – Hedging the Time Period Deal Risk in M&A

In public market M&A transactions, where at least part of the consideration is stock of the acquiror public company, the value offered is subject to market risk as the acquiror’s stock price changes. Collars – long underlying, long put options, financed with short call options-  provide some degree of price protection to acquiror and target between signing (announcement) and closing.  Valuing the hedge correctly is key to making profitable M&A arbitrage trades.


Rising Protectionism in Cross-border Inbound U.S. M&A

Protectionism includes foreign investment restrictions, antitrust regimes and takeover rules that regulators use to block or influence deal outcomes. Protectionism and trade barriers and inward-looking sentiment is seeping into policy and regulation. There have been many changes in discussions between Congress and Committee on Foreign Investment in the United States (CFIUS). Opposition is no longer just vocal; a lot of activity is taking place behind the scenes in Washington. Constituency interests, too are crowding out traditional policy interests. I describe what’s happening:

Contents:

M&A Activity Especially Inbound Drastically Reduces

Protectionism Norms: Evolving

Protectionism in Foreign M&A Deals: U.S. Actors

Protectionism in Foreign M&A Deals: Rising 

Foreign M&A Deals: Typical Post-Announcement Timeline Delay

Reaction to Japanese Investment: Exon-Florio Amendment

Exon-Florio Overview

CFIUS Reform: FINSA and FIRRMA

Reform: Overdue

Due Diligence Check List Questions: Acquirer

Post-Announcement Timeline

Post CFIUS >SEC Review Process

Share Purchase Considerations


Investment Banking – How to Buy a Company?

I have spent the bulk of my career in wealth management, asset management, investment banking and more recently in entrepreneurial FinTech. To develop domain expertise and bridge the gap between theory and practice I’ve published extensively over the years – though never around investment banking. The investment banking practitioner space doesn’t have much literature and one learns on the job. It is an incestuous world, with high entry barriers, much like the guilds in the medieval age to preserve high rents and transaction fees. I bring sunlight to this space here by explaining the typical process of buying a company.

Contents: Buy-Side Process, Assessment, Bidding Strategy, Negotiation and Execution, Transaction Considerations, Structure, Regulatory Issues, Financing, Accounting Treatment, Takeover Defenses, Valuation Methodologies, Tender and Closing, Timeline, Role of Advisor

Special Purpose Acquisition Corporation – SPAC

October 2020 has 290 SPACs with $86.5 billion in cash that have either filed for IPOs, are searching for targets, or have announced proposed mergers. I put on my investment banker hat and describe how a Special Purpose Acquisition Corporation can be set up. I then put on my investor hat and describe by modelling a hypothetical deal how sponsors and IPO pre-merger investors stand to make money and post-merger investors loose.

Takeaways: (i) SPAC is not a  poor man’s private equity, much as Alternative Mutual Fund is not a poor man’s hedge fund; (ii)SPAC structure results in severe dilution of the value of SPAC shares : post-merger share prices fall and price drops are highly correlated with dilution or cash shortfall ; (iii) SPAC investors bear structural cost of the dilution band pay for companies they bring public; (iv) SPAC creates substantial costs, misaligned incentives, and losses for investors who own shares at the time of SPAC mergers: SPAC shares tend to drop by one third of their value or more within a year following a merger (iv) Only those who buy shares in SPAC IPOs and either sell or redeem their shares prior to the merger do very well ( typically 10-13% historical annual return): IPO investors who are pre-merger shareholders should exit at the time of the merger, either by redeeming their shares or selling them on the market; (v) Investors that buy later and hold shares through SPAC mergers bear the costs of the generous deal given to IPO-stage investors (vi) Sponsor’s promote, underwriting fees, and dilution of post-merger shares caused by SPAC warrants and rights transfer value from SPAC investors to pre-merger investors; (vii)Sponsor has an incentive to enter into a losing deal for SPAC investors if its alternative is to liquidate.

ActiveAllocator “summarizes” the imminent Aramco IPO

 

ActiveAllocator summarizes the imminent Aramco IPO- soon to become the world’s most valuable company. We touch upon the offering, the firm’s vision, status, synergies between its upstream-downstream business, competitive strengths, risks to investing and general prospects.

Listen in here:

https://vimeo.com/374307403

Disclosure: Inputs sourced from internet searches, offering docs, conversations. Shares are not offered in the USA and some other countries. This is not an offer to sell or a solicitation of any offer to sell any securities.