The return of global dealmaking

It has taken 36 months, but M&A bankers finally have real reason to declare that global dealmaking is well and truly back.

In spite of fears that the US and Europe could be sliding back into recession, a burst of deals across several sectors and countries over the summer appears to have given bankers just enough confidence to predict more activity.

August is typically one of the slowest months for dealmaking, as bankers shut up shop and head to the beach for the summer. But last month recorded the biggest monthly activity since 1995, with global deal volumes hitting a heady $286bn, according to data from Dealogic. It was also the biggest month for global M&A in the past two years.

These included BHP Billiton’s $39bn hostile bid for Potash of Canada, Sanofi-Aventis’ $18.5bn hostile offer for Genzyme of the US and a battle between Dell and Hewlett-Packard to acquire 3Par, the US data storage company that HP won after raising its bid.

Bankers say this surprising resurgence is being driven by companies that have spent the past three years cutting costs, repairing balance sheets and conserving cash that they are now ready to spend on growth.

At the end of the first quarter, US public companies had $2,000bn in cash and short-term investments, according to data from FactSet Research. This is roughly 57 per cent more than the figure held during the same period four years ago at the peak of the debt boom. BHP’s bid for Potash, for instance, marks a return to large-scale M&A activity following a two-year break after the Melbourne-based miner failed to complete a bid for rival Rio Tinto.

The company’s cash pile has risen from $10.8bn in June 2009 to $12.5bn today, and shareholders want to see that spent on acquisitions rather than on increased dividends or share buybacks.

In a sign that BHP is aware of shareholder anger at value-destroying M&A, the miner made clear it would only look at “long-life, low-cost, tier-one assets” that would add value for shareholders.

Potash appears to meet those objectives. Sanofi-Aventis’s bid for Genzyme is also borne out of necessity for growth. Like many of its rivals, the French pharmaceutical group needs Genzyme to replenish its pipeline of drugs as its future revenues come under threat from shrinking drug pipelines, increased competition from generics and patent expiries.

Low interest rates on investment-grade and high-yield bonds have helped acquisitive chief executives find the courage to launch bids, as they can now borrow long-term money to fund deals more cheaply. BHP’s $45bn loan for Potash is the most debt raised to finance a takeover since February 2008, and highlights how tightening underwriting standards for acquisition financing have eased in recent months.

Data from BNP Paribas show that lenders have cut five-year loan margins to companies with single-A ratings to roughly 85 basis points (0.85 percentage points) over benchmark rates, from about 125bps a year ago.

Banks are also slowly regaining an appetite for financing private equity bids, although not at the same pace as they have for corporate deals.

In July, Blackstone said the backlog of deals it was working on was the highest in years, but it was also quick to point out that securing bank debt for such deals was still challenging.

That may explain why Blackstone injected all the equity to pay for the cash component of its $4.7bn buyout of Dynegy, the US independent power producer, last month. To reduce some of the debt Blackstone is assuming, it will immediately sell four plants on both coasts to NRG for $1.36bn.

A growing trend among buyout groups, however, is to acquire minority stakes in each other’s companies, which allows the seller to return some cash to investors, but avoiding a change of control that would force a company’s debts to be repaid.

Earlier this month, Clayton, Dubilier & Rice, the US private equity group, took a 42.5 per cent stake in Univar, the chemicals distribution group, in a deal valuing the company at $4.2bn. CD&R is buying the stake from CVC Capital Partners, which took the Rotterdam-based chemicals group private in a €1.5bn ($1.9bn) deal three years ago and is retaining a 42.5 per cent stake in the company.

A similar deal was agreed in June by CVC , which bought a 28 per cent stake in Merlin Entertainments, joining Blackstone and the Lego Group as investors in the theme-park operator behind Madame Tussauds, Legoland and the London Eye. CVC had been planning an initial public offering of Univar, but changed its strategy and opted for a refinancing of the company’s debt and a sale of a minority stake to CD&R.

However, many European companies acquired by private equity groups during the recent boom may find it challenging to refinance their debt in the near to medium term as revenues fail to meet company projections.

In a recent report, Standard & Poor’s, the credit rating agency, said 80 per cent of the 78 companies it analysed did not meet their forecast for earnings before interest, tax, depreciation and amortisation at the end of 2009, compared with 69 percent a year earlier. S&P said that this refinancing risk meant it was too early to ascertain whether a recovery in the leveraged buyout market was in sight.

Until that risk is removed, bankers are likely to spend more time focusing on their corporate clients.