A time to mourn-or a time to mine? The credit crisis is unearthing a wealth of acquisition opportunities in Europe and Asia

Chief Executive, The, April-May, 2008 by Jake Cohen, Joerg Nuernberg, Anne Yang

"This is a gem!" exclaimed the MD of a renowned European technology firm as he examined the sample of a perfectly formed piece of plastic lens shown to him by the chief technology officer of a Singaporean plastic injection company. "Why would your parent company want to sell the company away now that it has finally built up all these technological capabilities?" The CTO could only shrug and explain that the parent company was facing cash flow problems and had little choice but to sell its subsidiary to raise cash to pay its current bank loans.

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Like the sample of the cut plastic, many "gems" can be unearthed across the world, especially in Asia and Europe, due to the current credit crisis. They are companies that have great growth potential when cut and polished and are fundamentally solid, but have been affected by the credit crunch. This presents opportunities for strategic acquirers to dig and buy the gems at a discount, especially now that the miners who had been most active in digging them out over the past four years--the private equity firms--are finding it increasingly difficult to finance their acquisitions with cheap bank loans.

For example, in Europe, the valuations of private company sales to private equity has fallen by 14 percent in the third quarter of 2007 to a multiple of 15.3 times a company's earnings. Meanwhile, the valuations of private company sales to corporates fell by just 2 percent to 13.4 times earnings. The private equity buyout premium--which pushed up the price/earnings ratio on the MSCI-600 of "median" stocks to a record high of 20 in May 2007--has vanished. The P/E ratios on the DOW 30 big stocks are much lower--because they are too big even for the large private equity firms like KKR and Carlyle.

Mining for Rubies in Europe

A decade of corporate restructuring, economic integration and international expansion in Europe has created a region with many hidden gems. The European gems are like rubies--the second hardest gemstone after diamonds--in that they have built up strong foundations over the years and are generally well-run. Europe's economic fundamentals are also sound. Its rate of unemployment fell to the lowest level in 25 years, which should boost domestic spending, while strong growth in emerging market economies should compensate for some of the impact on exporters of a U.S. slowdown. However, European economic growth in 2008 will be curtailed due to three primary factors: the strong euro, which will be especially painful for exporters; higher oil and borrowing costs; and the impact of inflation on consumer spending.

Powered by exports, Germany's gross domestic production (GDP) rose by 2.6 percent in 2007, which was one of its highest rates of growth since the start of the decade. However, the German companies are highly dependent on the U.S. economy and customers and are hit as a result of the slowdown in U.S. customer orders. U.S. consumers, instead of buying high-quality, more costly German products like Sienhauser earphones and Puma shoes will switch to less expensive substitutes like Samsung earphones and Wal-Mart brand shoes. Magazine Euro Am Sonntag predicted that more than one-third of all companies in Germany will feel the effects of the credit crunch. It also says bankruptcy filings are expected to increase as economic woes cascade down to the corporate sector. Germany's Chamber of Industry has been flooded with distress calls from family Mittlestand firms unable to roll over credit lines.

The restructuring of distressed companies as an alternative to a breakup has a long history in the U.S., where the Chapter 11 procedure offers protection while balance sheets are rebuilt and operations overhauled. In recent years, this approach has spread to Europe, where legislative changes now permit companies in distress to be rescued rather than extinguished. However, few German companies have taken advantage of the changes, which has also led to opportunities for foreign buyers to swoop in to buy them. Companies, predominantly in the cyclical areas of industrials and materials, are most vulnerable to the current credit crunch and slowdown in the U.S. economy. These companies are capital intensive, heavily export-oriented and have less flexible productions.

One such example is ThyssenKrupp AG. As part of its continuous portfolio rationalization process, it decided to sell off a subsidiary: ThyssenKrupp Prazisionsschmiede. The German-based manufacturer of high-tech auto components generated revenues of [euro]290 million in fiscal year 2006-2007. In January 2008, Sona Okegawa Precision Forgings Limited, the India-based manufacturer of forgings, announced plans to acquire the Germany-based manufacturer of high-tech plants and components for an undisclosed sum. By acquiring ThyssenKrupp, Sona Okegawa achieved immediate capacity expansion and international exposure, leveraging on ThyssenKrupp's network into China, Russia and South America, thus adding a ruby to its crown.