Like many people in the Australian business community, a number of us at GCI start our day with the Australian Financial Review (AFR). Last Friday, these words in an article by James Thomson caught our attention:

but in an uncertain world, the question of what is fair value looms large”.

In this piece, Thomson was highlighting the widening “valuation gap” between purchaser and vendor expectations in the current market. At GCI, this is a question we continually ask ourselves as we fund acquisitions of both businesses and assets, and work with companies to restructure their balance sheets – so how do we answer it?

Over the past two years, companies, purchasers, and their lenders have become adept at understanding earnings (and underlying values) adjusted for COVID-19. However, now add into the mix several other variables: sustained labour shortages, ongoing supply chain issues, increasing costs of goods (inflation), and rising interest rates, and the reason for the valuation gap becomes more obvious. It has therefore become even more challenging to assess what is likely to happen in the next 12 months, let alone what the business or asset will be worth in medium to long term. The challenge of assessing fair value is also more pronounced in the private market which lacks the benchmark provided by a publicly traded stock.

At the same time that vendors, purchasers, and their advisors have been grappling with this valuation gap, there has been a shift in the availability and cost of capital. Central Banks across the world have been reducing liquidity to try and bring inflation under control, with the flow on effects to capital availability becoming increasingly noticeable.

In recent months we have observed: a tightening in the availability of equity and debt for small-to-medium sized companies, particularly for newer companies who do not have the track record; and the cost of this credit, has ballooned over and above the increase in the  rising risk-free rate.

In our experience, overcoming the valuation gap means getting all parties involved in the deal early to ensure “buy into” the same view of the world – whether that be the strategy driving the acquisition, the defensibility of earnings or the strength of the turnaround plan. On this basis the transaction structure can be squared away and the necessary funding arranged.

From our perspective we find we can add more value and assist in overcoming the valuation gap through early engagement in the process. There are two key reasons for this:

  1. As providers of flexible capital and with experience in running various businesses, we work with our borrower clients to understand their specific requirements and can provide relevant insights into the transaction structure and ultimately provide an innovative funding solution. Our value-added credit approach is built on five pillars: insights; speed; flexibility; advice; and network. For example, in relation to assessing “fair value” we can use our network to provide the borrower (and us!) additional data points to support the value of the business or asset today, and in the future.
  2. In these “risk off” times vanilla financing options available a year ago may not meet the requirements today. The interplay between various parts of the capital structure can no longer be taken for granted, for example how seller’s notes interact with the lender’s position. To get to yes, in this tight liquidity world we now find ourselves in, it is desirable to tailor covenants, interest, amortisation schedules and earn outs etc. before the transaction structure mindset is set rather than after.

    At GCI, we have seen firsthand the benefit of early engagement in two recent transactions, one in the logistics space and the other in industrial services. Both businesses were materially exposed to the uncertainty in the economic environment, and both transaction structures required a variety of instruments to bridge the valuation gap so that a deal was workable for all parties. By working closely with purchasers and their advisors, in particular in the structuring phase of the transaction, we were able to offer a capital solution to both transactions.

    At GCI we have funding available and are always looking at ways we can work with borrowers to achieve their goals.

    Authored by Daniel Schweickle (Investment Director, GCI)