Financing in a growth environment

A renewed appetite for expansion and acquisition

Financing in a growth environment

Positive economic news is generating increased confidence among UK
corporates and, along with improving credit conditions, means now is a good
time to explore expansion plans.
Improving conditions
Corporate borrowers in 2013 have been taking advantage
of supportive loan markets to refinance and renegotiate
terms, with some extending their current deals ahead
of an expected spike in refinancing activity in 2014-15.
With the cost of funds in terms of base rate and Libor
at 60-year lows, relatively low current demand for debt,
and competition between banks driving down margins,
France Services PMI
structures are seen as favourable
for borrowers at present.

Services Sector Purchasing

Europe Composite PMI

Italy Services PMI
UK Services PMI
Germany Services
PMI
Managers
Index

Recent months have brought a succession of positive

economic data as the UKs recovery has proved
increasingly robust. According to the Office for National
Statistics, UK GDP grew 0.8% in the third quarter
of 20131 the fastest pace since 2010 with output
growing in all four main areas of the economy.
Further afield, the eurozone emerged from its 18-month
recession, global equity markets rallied, the US debt
ceiling crisis was narrowly averted and the Federal
Reserve announced it was to continue its programme
of quantitative easing for the time being.

(PMI)2

65

France Services PMI

Europe Composite PMI
Italy Services PMI
UK Services PMI
Germany Services PMI

60
55
50

60

Source: Bloomberg

55

No
ve
m
be
r2
01
3

The Services Sector, which comprises 78% of the countrys GDP, has
demonstrated strong performance with the UK PMI hitting a 16-year
high in October.
20
13

Ju
ly
20
13

M
ay
20
13

20
13
M
ar
ch

Jan
ua
ry
20
13

No
ve
m
be
r2
01
2

20
12
Se
pt
em
be
r

Ju
ly
20
12

M
ay
20
12

20
12
M
ar
ch

Jan
ua
ry
20
12

40

65

Se
pt
em
be
r

45

50

1www.ons.gov.uk
2

Purchasing Managers Index. A reading above/below 50 indicates expansion/contraction compared with previous month.

45

M
ay

20
13
M
ar
ch

Jan
ua
ry
20
13

ov
em
be
r2
01
2

pt
em
be
r2
01
2

Ju
ly
20
12

M
ay
20
12

20
12
M
ar
ch

2 of 9

Jan
ua
ry
20
12

40

Signs of increasing confidence

This positive outlook appears to be generating a new
sense of confidence among major UK companies.
According to the Deloitte CFO survey for Q3 2013,
a record 54% of CFOs believe that it is now a good time
to take risk onto their balance sheet. Optimism rose for
a fifth consecutive quarter and is close to a three-year
high, while CFOs rated expansionary strategies as more
important than defensive measures for the first time
since Q2 2011.1
In short, there is a renewed appetite for growth and
expansion and an increased willingness to put the
500bn of cash2 that UK non-financial companies have
been accumulating on their balance sheets during the
downturn back to work. Weve looked at patterns of
cash balances in the FTSE 350 and we are starting to
see a reducing trend for the first time in many months,
says Ian Tetsill, Director of Debt Finance at Barclays.
Our conversations with clients are turning, more often
than not, towards expansion and acquisitions again.
Anecdotally, we certainly feel sentiment is improving.

Net percentage of CFOs reporting that credit is

costly and credit is easily available
100%

Our conversations with clients are

turning, more often than not, towards
expansion and acquisitions again.

80%
60%
40%
20%
0%
-20%
-40%

Correlation between cost of credit

100%
and perceived risk in the market.
80%
Sep-07

60%
40%
20%

-60%

0%

-80%

-20%

-100%

-40%

Ian Tetsill, Director of Debt Finance at Barclays

Mar-09
Correlation between cost of credit
and perceived risk in the market.
Sep-07

Sep-10

Mar-09

-60%
Improving macroeconomic conditions have helped abate the pressure in the loan
-80%credit to its cheapest and most available levels in six years.
markets and pushed
-100%
Source: Deloitte Q3 2013

Mar-12

Cost of credit
Sep-10
Availability of credit

Sep-13

Mar-12

Cost of credit
Availability of credit

3 of 9

Sep-13

1www.deloitte.com
2www.ons.gov.uk

The Deloitte CFO Survey

Seizing the moment

But the current favourable climate wont last for ever. As a
result, Tetsill says that Barclays is encouraging borrowers
to carry out their refinancing or expansion activity now.
We think conditions are approaching a pricing floor, he
says. Increasing regulation, such as Basel III, will increase
banks funding costs in the medium term, which will
eventually be reflected in the cost of borrowing. If the
economic recovery continues, we could see an uptick in
demand, which could also move pricing into an upwards
trajectory. Finally, the gradual removal of central bank
liquidity support may also result in a rise in the cost of
funding, he adds.

Increasing regulation, such as Basel III,

will increase banks funding costs in the
medium term, which will eventually be
reflected in the cost of borrowing.

M&A volumes in 2013 are well below the peaks seen in

2006-7. High-profile deals such as Vodafones sale of its
stake in Verizon Wireless and Microsofts acquisition of
Nokias mobile phone business may have caught the eye,
but the crisis remains fresh in peoples minds.

Ian Tetsill, Director of Debt Finance at Barclays

Theres a sense that corporates are looking for the perfect

acquisition scenario before making a move. Nevertheless,
Karl Nolson, Managing Director of Debt Finance at
Barclays, believes the outlook is improving. He says that
Barclays has enjoyed consistent dialogue with clients on
possible event financing, despite the flat M&A markets of
the past few years.

The path to expansion

Momentum is slowly building in the M&A markets as
companies become more confident and eye opportunities
for growth. Despite more favourable credit conditions,
corporates cash piles and increased interest in expansion,

Refinancing landscape: with demand for refinancing

likely to rise, increased competition for finance capital
may put upward pressure on the pricing curve

54%

of
of CFOs
CFOs in
inmajor
major UK companies
UK
companies
believe
believe
that now
is a good time to
that
a good
takenow
risk is
onto
theirtime
balance sheet.
to take risk onto their
Source: Deloitte CFO Survey Q3 2013
balance sheet

700,000
Rest of Western Europe
UK
600,000

500,000

M 400,000

It has been a question of waiting to see when the stars

align, when they can get deals done and when the
necessary ingredients such as the availability of capital
are there to enable that. They certainly are coming together
at the moment. Nolson adds that boards have begun to
factor market volatility into their models and have greater
confidence in the projections for businesses that they are
acquiring or selling.

300,000

200,000

100,000
0
2014

2015

2016

2017

2018

Source: Dealogic

4 of 9

2019

A positive outlook
Tetsill says that Barclays is proactively drawing up
acquisition scenario ideas at the request of clients,
including looking at the impact on a company of acquiring
a particular target and how they could finance the deal.
This way, if they decide to move quickly, the finance
package is there already. Were saying to clients that the
best time to talk about M&A financing is when youre not
buying; youve got time to talk to your bank, get the right
advice and consider all the financing options.
Looking ahead, he believes that significant pent-up demand
for consolidation in a wide range of sectors, coupled with
the need to meet shareholder growth ambitions, should see
a gradual recovery in M&A.

Nolson is also optimistic about the outlook although

he acknowledges that there are many variables in play.
There is an increased level of dialogue now, and I am
confident that it will lead to transactions in 2014. Deals
that are currently happening as we head into the end of
2013 will certainly give confidence to others to come to
market next year.

Financing structures
A companys scale, its appetite for leverage and the
resulting debt quantum will be central to the way it
structures a transaction.
So what options are available to corporates looking to
finance M&A transactions and what drives the quantum
of debt they can achieve?

Correlation between global M&A volumes and

the S&P 500 Index

Forecast
S&P 500 index

$6

1,500
1,250

$4.6
$3.9

$4

$3.5
$3.1

$2.9

$3
$2.3
$2

$1.5
$0.8

$1.1

$2.1

$1.8
$1.3

1,000
$3.3
$2.7
$2.3

$2.8

$2.7

$2.6

750
500

$1.4

250
0

$0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Source: Dealogic and FactSet, through 31/10/2013

5 of 9

S&P 500

$ trillions

$5

$1

Were saying to clients that the best time

to talk about M&A financing is when
youre not buying; youve got time to talk
to your bank, get the right advice and
consider all the financing options.

1,750

$7

According to Charles Mace, Director of Capital Structure

Advisory, Debt Finance at Barclays, size is an important
determinant of a businesss leverage capacity. Generally,
as a companys EBITDA grows, it also becomes more
stable, he says, So when we consider an appropriate
capital structure and debt capacity for a company,
regardless of what metrics might be most suitable for
the industry, growth through acquisition confers greater
leveragability upon the merged entity. Rating agencies
frequently react to strategic acquisitions positively,
formally stating that the improved business profile
increases their tolerance for leverage at any point on the
rating spectrum. This ability to leverage the enlarged
EBITDA provides a theoretical debt capacity, which can
then be compared with practical debt market capacity
and drive the size of equity contribution required to
match the companys risk appetite.

Ian Tetsill, Director of Debt Finance at Barclays

Mace adds that its not only in the publicly rated sphere
where this effect is seen. To attract investment from the
US Private Placement (USPP) market, companies with
EBITDA in the 50-75m range might typically be expected
to sustain under 2.5 times debt to EBITDA to be perceived
as NAIC-2 (investment grade equivalent from the National
Association of Insurance Commissioners), whereas the
100-150m range might more frequently be permitted
3.0 to 3.5 times, he says.

Financing options
If a boards risk appetite is central to a businesss approach
to leverage, its the absolute scale of debt that informs the
choice of sources. Some businesses will be restricted to
the bank market alone, owing to their relatively small scale.
Some in the next tier will choose to access alternative
funding markets to diversify risk, and others will be forced to
when they exhaust bank capacity. Where that diversification
comes from is a function of the overall requirement, as each
market has its own drivers of minimum and maximum
amounts available, Mace says. The investment grade
public bond markets have indices for sterling and euro
denominated bonds with minimum requirements of 250m
and 500m respectively. Although there are a few exceptions,
as a rule, investors are reluctant to invest in instruments that
fail to enter the index due to a lack of liquidity.

In fact, Mace believes that a sub-investment grade route is

also a viable and potentially cheaper approach to funding
growth. There is often a reluctance among the UK
companies we advise to be perceived as sub-investment
grade, which I think as a goal in itself can prove expensive,
although we recognise situations where it is driven by
overriding external factors, he says. Its clear from the
scale factors in the rating agencies methodologies that
many small businesses couldnt secure an investment
grade rating with any meaningful debt, but this doesnt
preclude them from having robust fundamentals.
Logically, the decision to raise equity to fund an
acquisition to retain a quasi-investment grade perception
is likely to be expensive compared with the more leveraged
route and, with BB range spreads where theyve been
recently, it is easier to buy into that.

Its clear from the scale factors in the

rating agencies methodologies that
many small businesses couldnt secure
an investment grade rating with any
meaningful debt, but this doesnt preclude
them from having robust fundamentals.
Charles Mace, Director of Capital Structure Advisory,
Debt Finance at Barclays
That is one of the reasons why growing companies with a
desire to be seen as investment grade often access the USPP
market as the first source of diversification of debt, Mace
explains, Although even there, where liquidity is not
important to these long-term investors, there is a soft lower
limit around $75m driven by investor willingness to invest
time in the credit for potentially small tickets.

6 of 9

Exploring bond markets

The high-yield bond market is more flexible on size. The
question for companies again is whether the investors are
prepared to do the credit analysis for a small issue, of less
than 150m175m. This may vary from time to time and
from sector to sector.
The convertible bond market is another source of
diversification, and potentially a low cash cost solution for
most public companies, including those stretching overall
leverage beyond investment grade norms. Here though,
companies are more frequently restricted to a maximum
size rather than a minimum requirement, governed by
their market capitalisation.

Analytical pitfalls
Of course, there are other factors that companies need to
consider when financing a transaction, particularly the
pitfalls which often evade the M&A advisers initial
analysis. Rating agencies, banks and capital markets have
differing views on the impact of pensions and off-balance
sheet liabilities, but all acknowledge there is some. In
particular, operating lease obligations can have a large
impact on the acquisition credit metrics and therefore
debt capacity; issues which are high on the rating
agencies agenda and increasingly on those of lenders
as the accounting bodies intend capitalising all leases
in 2015.

In multi-bank situations, consideration should also be

given to whether a coordinating bank should be appointed
which can reduce the amount of management time
involved in negotiating terms and can lead to smoother
execution on transactions. For larger corporates,
depending on strategic objectives, thought should be
given to diversifying funding sources and maturities, for
example, accessing longer-term financing sources such
as the private capital or corporate bond markets.
At Barclays, we have the expertise and credentials to
tailor innovative funding packages to individual client

Mace adds: Its long been our approach to look at these

issues realistically, to measure their impact and to deliver
the analytical output as a range of options the company
might choose from to finance the transaction. When
thats combined with the knowledge we gain from
Barclays strong franchise in all the capital markets,
I think it gives us a powerful platform to give best advice
on acquisition finance.

Conclusion
In light of improving conditions, when reflecting on
their refinancing needs, UK corporates should give due
consideration to their overall strategy over the next three
to five years, says Nolson. Engaging with your bank
at an early stage is paramount, both to understand the
dynamics in the financing markets, and in terms of
shaping the structure of proposed facilities well ahead
of issuance, particularly if an M&A transaction is being
contemplated.

7 of 9

needs and have significant expertise, as one of the UKs

leading arrangers, in coordinating loan and/or debt
capital markets solutions.

In light of improving conditions,

when reflecting on their refinancing
needs, UK corporates should give due
consideration to their overall strategy
over the next three to five years.
Karl Nolson, Managing Director of Debt Finance at Barclays

A snapshot of the loan market

UK and European bank outlook has improved as measured by risk perception in the market through Credit Default Swap
levels. This steady improvement across both the UK and wider Euro area has brought some much-needed confidence
and resilience to the market.
5Y European bank CDS spreads

5Y UK bank CDS spreads

400

Santander

350

Barclays

RBS

Lloyds

450

HSBC

400

Intesa

Commerzbank

Credit Agricole

Natixis

Barclays

SG

BNP Paribas

350

300

300

250

250

200

200

150

150

100

100

50

50

0
Nov 12

Jan 13

Mar 13

May 13

Jul 13

Sep 13

0
Nov 12

Nov 13

Jan 13

Mar 13

May 13

Source: Bloomberg

Source: Bloomberg

UK vs Europe total loan volumes (m)

UK lender nationality by loan volumes (m)

1,400,000

50,000
45,000
40,000
35,000
30,000
25,000
20,000
15,000
10,000
5,000
0

1,200,000
UK

1,000,000

Rest of Western Europe

800,000
600,000
400,000
200,000
0
2007

2008

2009

2010

2011

2012

2013

Jul 13

Sep 13

United Kingdom
US & Canada
Asia
France
Germany
Australia
Switzerland
Spain
Netherlands
Nordic
Ireland
Sweden
Italy
Other
2011

2012

2013

Source: Dealogic

Source: Dealogic

Bank supply has outstripped corporate demand, leading to an imbalance in the loan market.
This has driven a borrower-friendly environment making it a good time to go to market.

Against the backdrop of an improving economic landscape, US, French and Asian lenders have
all continued to favour UK corporates, especially where a geographical ancillary overlap exists.

8 of 9

Nov 13

Key takeouts
With the cost of funds in terms of base rate and Libor at 60-year lows, relatively low
current demand for debt, and competition between banks driving down margins,
structures are favourable for borrowers at present

There is a renewed appetite for growth and expansion and an increased willingness

to put the 500bn of cash, that UK non-financial companies have been accumulating
on their balance sheets during the downturn, back to work

Much needed confidence and resilience is building in the market as the UK and European
bank outlook improves, as measured by risk perception indicated by Credit Default
Swap levels

The best time to talk about M&A financing is when youre not buying. It is important to

take time to talk to your bank, get the right advice and consider all the financing options.

To find out more about how we can help your business

refinance, visit barclays.com/corporatebanking, or contact
your Relationship Director.

Barclays is a trading name of Barclays Bank PLC and its subsidiaries. Barclays Bank PLC is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority
(Financial Services Register No. 122702). Registered in England. Registered number is 1026167 with registered office at 1 Churchill Place, London E14 5HP.

9 of 9