Sentiment about a recovery in global dealmaking has swung between optimism and scepticism throughout 2010 as chief executives struggled to gauge the economic outlook.
In January, bankers were full of hope that companies would start to spend cash piles accumulated during the previous two years. Kraft’s $18.9bn takeover of Cadbury, the chocolate maker, gave impetus to the idea that more US companies would attempt equally big acquisitions – particularly of UK companies, which looked relatively undervalued compared with other regions.
When, just weeks later, Prudential, the UK insurer, announced a $35.5bn bid for AIA, the Asian assets of US rival AIG, bankers were convinced the outlook had turned. But Greece’s sovereign debt crisis in March caused managers to put their merger and acquisition plans on ice.
Confidence – a key driver of deal volumes – was further eroded when negative investor reaction to the Pru’s M&A strategy, which ended after investors panned the AIA deal, sent even the bravest chief executives back to their desks.
In August, a few acquisitive business leaders were coaxed out of their offices to announce two substantial cross-border hostile bids: Sanofi-Aventis, the French pharmaceuticals group, launched an offer of $69 a share for Genzyme of the US, while BHP Billiton, the Anglo-Australian miner, bid $39bn for PotashCorp of Canada.
Those were not enough to convince other companies to press the M&A button, and hopes of a recovery were dashed when BHP withdrew its bid after Canadian regulators ruled the deal with Potash would not be of “net benefit” to the country.
The risks of doing large, cross-border deals hit home and – coupled with austerity measures, increasing taxes, currency conflicts and regulatory concerns – confidence in the global economy fell once more.
Now, with only a few weeks left before the end of the year, bankers are still split over what 2011 will bring.
So far this year, the volume of global M&A stands at $2,450bn – 20 per cent higher than during the same period last year, according to Dealogic, the data provider, but still well below the volume at the peak of the debt boom in 2007.
Optimists believe chief executives’ appetite for growth through acquisitions is being outweighed by macroeconomic fears and market volatility.
Frank Aquila, M&A partner at Sullivan & Cromwell, the law firm, says that while most chief executives and their boards continue to be concerned about the fragility of the recovery, there is an increasing view that the worst is behind them.
“On a macro level, all the key conditions are in place for a strong resurgence in dealmaking,” Mr Aquila says. “Multinational corporations have an unprecedented amount of idle cash, debt financing is available at historically low rates, equity valuations remain cheap and cost-cutting has made most corporations lean and efficient.”
Philip Noblet, co-head of European M&A at Bank of America Merrill Lynch, echoes these sentiments. “The availability of acquisition finance in size, at very attractive pricing, must eventually overwhelm macro concerns about Europe as boards choose growth acquisitions over returning cash to shareholders,” he says.
However, he predicts deals will look markedly different from those struck during the debt boom, and most likely will be capped at roughly $10bn as investors remain averse to risky mega-mergers financed with large amounts of debt.
“There will be a lot less financial engineering and more focus on targeted acquisitions with much greater commercial overlap between acquirer and target, which ultimately means higher multiples will be paid,” Mr Noblet says.
Others are more pessimistic about the immediate outlook, citing Ireland’s debt crisis and fears that it may spread as investors lose confidence in policymakers’ efforts to stem it.
Cary Kochman, head of Americas M&A at UBS, who recently advised Bucyrus, the US mining equipment manufacturer, on its $8.6bn sale to Caterpillar, the maker of earth-moving equipment, urges caution. “The outlook for M&A is one of cautious improvement,” he says. “While discussion and activity is creeping up, everyone has an eye on the broader environment. A key driver is simply volatility, which is the nemesis of dealmaking.”
Private equity deals are unlikely to lead the way out of the recession, as they did following the collapse of the dotcom boom in 2001. But buy-out groups, which have substantial equity capital available and a healthy appetite for deals, will help increase the flow of transactions. “This means that corporate acquirers can expect to find an outlet to unload unwanted business units and surplus assets following significant deals,” Mr Aquila says.
Although secondary buy-outs, where private equity firms sell assets to each other, have accounted for half of Europe’s €30bn ($39bn) of private equity deals in the year to September, bankers expect this to change as strategics, or trade buyers, become involved in auctions and banks lend more.
The average debt component of buy-outs has increased this year, from 30.4 per cent of deal financing in 2009 to 44.3 per cent, according to data from Mergermarket, the research company.
Industry participants are also concerned about the overhang of capital left from the last buy-out bubble, which, they argue, is causing some groups to pay “extraordinarily high” prices for deals.
Speaking at the SuperInvestor conference in Paris in November, Michael Queen, chief executive of 3i, the UK’s biggest listed private equity group by market capitalisation, said buy-out groups were paying 10-13 times earnings for businesses that were not even underperforming, meaning buy-out investors could end up being disappointed by the returns on those investments.
But while rainmakers may be divided over how quickly dealmaking will take off in the new year, nearly all agree that the focus will continue to be on cross-border deals, between companies in developed markets as well as the Bric countries of Brazil, India and China.
The US was the most targeted nation so far this year, with $783.7bn of deals, up 13 per cent on the same period last year, according to Dealogic. China, which saw volume increase by 10 per cent to $160bn in the year to date, was the second most targeted nation, followed by the UK with $158.1bn of deals thus far this year.
“There will be a continuation of 2010’s focus on cross-border combinations, especially where the target has exposure to growth economies and from the resurgence of private equity as the well of equity is spent relatively rapidly,” Mr Noblet says.
A rise in global protectionism, however, will continue to make these deals hard to complete. BHP witnessed this trend with its bid for Potash.
In spite of failing to close three multibillion-dollar deals in the past two years, BHP says it will not give up its pursuit of resource assets. But its size – it is the sixth-largest company in the world, with a market value of roughly $250bn – means that any deal of any size in almost any jurisdiction will come up against regulatory obstacles.
Large-scale transactions have been noticeably absent this year, with BHP’s offer for Potash marking only the third bid this year valued at more than $30bn. Still, bankers can earn more fees from a steady stream of deals valued at between $1bn and $5bn, which still provide growth for a buyer and stand a better chance of closing than riskier transformative transactions.
Smaller, strategic deals with synergies are also easier to get past investors who have been vocal about the value of deals since the crisis took hold.
Institutional shareholders have suffered from below-par returns for several years and are seeking enhanced returns, which could give rise to more shareholder activism. Bankers say hedge funds, and even traditional institutional holders, are likely to push managements and boards to accept significant premiums when they are on offer.