Why do private equity firms do deals?
So far, it appears that none of the firms in the consortium that plans to buy Solera Holdings (SLH) owns a competitor to Solera, which makes antitrust analysis easy. Yet this means there are no synergies to extract either.
As a general rule, private equity firms take over stocks because the target’s multiples are either depressed, or they think they can wring out efficiencies from the company by operating it better or by cutting costs.
The consortium—which includes Vista Equity Partners, Koch Industries, and Goldman Sachs—hasn’t elaborated on what they hope to achieve with Solera Holdings, but neither did they indicate that they believe the transaction would be a turnaround situation.
Robert F. Smith, Vista’s founder, Chairman, and CEO, recently explained in a press release that the consortium is “thrilled to be partnering with Solera,” because “for almost half a century, Solera has been serving the insurance and automotive industries with innovative software and information solutions.
Smith went on to say that with the portfolio of products the company “has built and acquired, combined with the vision of its leadership, we believe Solera is incredibly well positioned for the next fifty years.” He added that “the mission is clear and the opportunity is there to continue to transform how physical assets are managed and insured.”
As a general rule, private equity firms look to take out a company, use leverage to extract equity, improve the business, and then sell it at a higher exit multiple than what they paid for it. It’s an internal rate of return play.
In fact, that’s how you construct a basic LBO (leveraged buyout) model. Notwithstanding the “next fifty years” comment, Vista is probably looking at a 5- to 7-year horizon to get in and get out. Because Koch Industries will have an equity stake as well, they would be the natural buyer if Vista chooses to exit the position in the future.
Merger arbitrage resources
Other important merger spreads include the deal between Baker Hughes (BHI) and Halliburton (HAL) and the merger between Freescale Semiconductor (FSL) and NXP Semiconductor (NXPI). For a primer on risk arbitrage investing, read the series Merger Arbitrage Must-Knows: A Key Guide for Investors.
Investors interested in trading in the technology sector should look at the S&P SPDR Tech ETF (XLK).
In the next part of this series, we’ll look at the risks versus rewards of the Solera Holdings transaction.