BNP Paribas: Safety in Numbers – Fabrice Famery and Bernard Fievet
While the M&A market is witnessing a slow but steady return, the emphasis is now very much on less leverage and more on control of the deal. BNP Paribas' Fabrice Famery and Bernard Fievet speak to FDE about the three-step methodology that can effectively manage volatility and risk throughout a deal's lifecycle.
The first quarter of 2010 saw worldwide merger and acquisition activity with a combined value of $401.5 billion, a rise of almost 8% on the same period last year. Kraft's high-profile purchase of Cadbury for $18.9 billion and Heineken's $5.7 billion acquisition of Femsa were early indications that large-scale, cross-border M&A activity is very much back in business.
Bernstein Research has forecast a 35% hike in global activity this year and a report from the Boston Consulting Group and UBS has found that 50% of large companies intend to make an acquisition in 2010.
The landscape in which these firms will attempt to get deals done has shifted markedly since 2007 – and risk is now much higher on the agenda.
"After a crisis you need a migration of assets and that is what we're seeing now," says Fabrice Famery, head of corporate solutions, fixed income structuring, at BNP Paribas. "It's taken time. While corporates are now ready to execute acquisitions, they are doing so in a risk-conscious mode. The crisis has magnified these risks and CFOs want to know how to measure, assess and mitigate them."
Risks under the spotlight
While a flurry of corporate acquirers such as Kraft, Heineken, Roche and Merck KGaA have made the headlines, Bernard Fievet, BNP Paribas’ director of derivatives marketing for Germany, Switzerland and Austria, observes that FX, interest rate and credit risks have come under the spotlight. Accurate risk management is now key to ensuring that market fluctuations do not affect the economics of a transaction throughout its lifecycle.
"The crisis certainly highlighted the dangers," acknowledges Fievet. "For instance, we have seen implicit interest rate volatility more or less double for many currencies. Furthermore, credit spreads before the crisis were only a tiny portion of a bond coupon for an investment-grade issuer and volatility was low. In the first quarter of 2009, credit market volatility exploded, with credit spreads representing one-half to two-thirds of the cost of a new bond. Things have improved since then but even now they still account for one-third of a bond coupon. We’re not yet out of the woods and it will not take much for credit spread volatility to spike again."
The emphasis is now very much on less leverage and more control. CFOs are doing far more hypothesising and wish to now what might happen in the most extreme scenarios.
"The risk management benchmark has changed," says Famery. "We've always advocated studying all aspects of risk very closely - and the market has demonstrated that volatility can be extreme and has made people stand up and take notice."
To serve clients better in these volatile times, BNP Paribas has developed a holistic, bespoke M&A risk management offering that complements its corporate finance and corporate acquisition finance capabilities. "We'll put a deal team in front of the client, coordinated by its banker and composed of corporate finance, acquisition financing and fixed income specialists - including bond, interest rate and FX specialists, as well as ratings and risk management experts," explains Famery, adding that confidential information is tightly controlled and secured. "It allows us to understand every aspect of the transaction and be much more efficient in finding solutions: you can't talk about risk management if you don't know the structure of the deal."
The M&A one-stop shop
The ability to offer an integrated package is invaluable given the amount of work the client is expected to get through and how small the project team can be. "Even for the biggest organisations, it's a real period of stress," observes Famery. "The decision-making is often concentrated among a few people and they have a huge amount to get through in a short period of time. Our role is to make their lives easier and try to provide ideas, analysis and structures so that they can make a decision knowing they have the right knowledge behind them."
Dialogue is critical in understanding a client's needs and developing mutual trust to find the right solution. "First we must understand the structure of the deal and get a good idea of what is important to the client," says Famery. "What have they sold to their stakeholders? What are the KPIs? What is the objective? Sometimes they'll know exactly what they want from the outset. Sometimes we must help them find where they want to go. Clients will always be in the best position to know what is good for them, but we are ideally positioned to see where the market risks lie and how best to manage them."
This assessment of the acquisition structure and a detailed analysis of the financial model, the capital structure, the refinancing strategy and the credit metric constraints all feed into the first stage of BNP Paribas' three-step M&A-related risk management methodology.
"Using Monte Carlo simulations, we can observe how the key performance metrics could move. This highlights the areas that need to be addressed and allows us to answer questions on the tenor currency mix or the fixed and floating mix for the refinancing," says Famery. If the acquisition is done in a currency other than the company's operating currency, the exchange rate has a significant influence on the underlying economics of the transaction. "Given today's highly volatile FX environment, mitigating the associated risk cannot be emphasised enough," adds Fievet.
"We then present alternative asset-liability management scenarios to the client so that it can assess its best course of action," continues Famery. "Once we know that we can decide where the risk lies between intention, closing and refinancing and outline mitigation strategies."
As an example of this second step, Famery looks at a hypothetical example of a UK company looking to acquire an asset in the US. "The obvious choice would be whether to finance in dollars or sterling," he begins. "Both have pros and cons: go with the latter and there will be equity volatility due to changes in the dollar rate, but debt would be stable. Fund in dollars, however, and equity would be stabilised at the expense of the debt.
"The aim is to optimise the key performance metrics not only between intention and closing but during the lifetime of the asset. Once you know that you can define where the risk lies. If you decide to fund the deal in sterling, we'll look at the FX mismatch as well as the market risks and effects on the key performance metrics of the acquisition."
The solution depends on what has to be hedged. Three issues must be addressed: uncertainty, market disturbance and bond take-out risk.
The three hazards
"The client cannot be entirely sure the acquisition will go through until closing," says Famery of uncertainty. "This creates a dilemma: you can either do nothing and endanger the entire transaction or hedge at no cost with a forward and take the risk of unlimited loss should the deal not get done. An alternative is to buy options."
To help clients solve this dilemma, BNP Paribas has developed a methodology to measure the effectiveness of a hedging strategy with respect to a client's risk-reducing objectives. "We look at three criteria: the sensitivity of an acquisition to market risks; the likelihood of the deal; and the client's risk/return guidelines. We can then design hedging solutions that range from finding the appropriate delta of a vanilla option to structuring a deal-contingent hedge that matches the conditions preceding the sale-andpurchase agreement."
The second danger, market disturbance, is that the size of the transaction may significantly exceed market liquidity and cause disturbance against the client's interests. "This happened during the financial crisis," says Fievet. "Liquidity suddenly dropped as some market players either disappeared or saw their capacity to find counterparts reduced, while others were forced to manage limited availability of credit lines in the interbank market. This had a negative effect on the liquidity of the long-dated interest rate or cross-currency swap market - making it impossible for clients to carry out large hedging programmes as they had done previously.
"Clients are now looking to find ways to avoid creating market disturbance. That means working with a major bank in the fixed income derivative market – one that can very quickly warehouse a large position and manage it in the market with a minimum of fuss."
The rating of a bank counterpart is more important than ever before, not only because it implies a wider access to market players and the capacity to work a position quickly and efficiently. With large volumes of long-dated hedging, it also leaves the client more secure in the knowledge that its partner is more likely to be around in ten years' time.
"The combination of those two points actually achieves a third benefit," Fievet says: efficiency of cost. "When we discuss how we are going to process the transaction, the price is discussed up-front and pre-negotiated. Clients know they are working with a bank that has access to the best pricing and liquidity, as well as offering security of execution. In scarce-liquidity conditions, a bidding war between many banks is not desirable as the whole market becomes aware of the transaction and positions itself accordingly - causing significant price slippages detrimental to the client."
The recent large-scale FX hedge for Merck KGaA, for example, went through flawlessly without moving the market.
"We have demonstrated our capabilities in the design of products, in offering bespoke solutions and in execution," says Famery. "We can absorb risks on behalf of clients, allowing us to take those risks they want to avoid. It all comes down to a methodology and combined expertise that is invaluable and gives us much more of a chance of finding the right solution for every scenario."