What are the prospects for M&A activity over the next 12 months? Given the turbulence in recent times, just what does the future hold – and how is the industry likely to respond?
David Brooks (DB), corporate finance partner at Grant Thornton, and Scott Moeller (SM), director of the Mergers and Acquisitions Centre at London’s Cass Business School, took questions from FT readers on June 23. A selection of the best questions and their replies are posted below.
How do you think the UK government’s emergency Budget proposals – including those for corporation tax and banks – will affect the M&A environment in the coming months?
George Townsend, London
SM: There will be a marginal impact on inward investment – but that is likely to be offset by other factors such as speed of recovery from recession and relative exchange rates. For outbound investment, this is likely to have a greater impact as UK firms assess over the next few months the full impact of the budget – not necessarily the direct impact of corporation taxes and the new bank tax, but the full impact of other changes as well on their clients, such as the increase in VAT. For UK companies contemplating an acquisition in the UK, this should have a greater impact along the lines of the outbound comment above, except that there is likely to be some relief by private equity investors over what was originally floated on capital gains taxes.
Nevertheless, the uncertainty over the budget is now over, and uncertainty has a very large impact on freezing deals. Now that there is some certainty about taxation, after a short period of planning, the deals should be underway again from the large back-log. Markets hate uncertainty – and this especially applies to the M&A market. We now have less uncertainty, at least here in the UK.
DB: Not very much. The banks are still cautious about M&A, especially for larger transactions, but mid-market deals are getting done (indeed there was a surge this last week of deals to beat the capital gains tax increase). I expect there to be a gradual increase in deals in the second half of the year especially in financial services and healthcare. Some will be driven by restructuring as the banks take more of a view on which assets are worth saving and those not.
Despite speculation about the revival in M&A, there seems to little sign of any major improvement. What are the chances of seeing some improvement in the second half?
Caroline Barnes, Frankfurt
SM: With the change in government and the waiting for the budget, there’s been uncertainty in the UK. Now with the delivery of the budget, even with some unpopular taxes such as the increase in VAT that may impact retail consumers, there is at least the basis for planning. This should help to stimulate the UK M&A market.
This question is from someone in Europe. Year-to-date, Europe (including the UK) is the only region to show a decline in M&A deal activity as compared to the same period in 2009. Activity, even in private equity deals, in other regions has increase, and in some cases by double digit percentages over last year. Globally, therefore, we ARE seeing signs of improvement.
Inward investment, especially with the weakness of the euro, should improve the picture for Europe in the second half. The global M&A tide just might raise all ships, including Europe.
DB: I expect some slow improvement in the second half driven by:
● Well funded corporates seeking to acquire a competitor and seeking
● Growth in new territories (Asia, Brazil etc)
● Restructurings driven by the banks
● Sell-offs by banks driven by both Brussels and a return to a core focus
● Private equity needing to spend their funds
I do not expect a great improvement in valuations, expect for scarce assets.
Have the motives for M&As changed compared with before the financial crisis?
SM: Yes. There are clearly more distressed deals and more consideration of alternatives to a full acquisition. We have seen an increase in joint ventures and strategic alliances, which is consistent with previous downturns in the 90s and early 2000s.
DB: Yes. M&A is now much more focused on a “must have” culture and only at the right price (look at the example of Prudential and AIA).
What are the main factors that make a successful M&A deal?
Gunel Guliyeva, Norwich
SM: Focus first on whether to do a deal in the first place (there are ALWAYS alternatives to doing a deal) and identifying the right target company (there is ALWAYS more than one possible target). Then put together the right deal team, including external advisors, and design the appropriate deal process, including anticipating the needs after deal closing. And don’t forget the due diligence, valuation process, raising the funding, etc etc.
While it is obviously helpful to get everything right about the deal, if you had to focus on one thing, it would be the post-merger integration.
This is because it is still possible to make a good deal at that point, even if it wasn’t the right deal in the first place or one that you paid to much for.
DB: Good question: In my view:
● A clear strategy for doing the deal
● The right price and funding structure
● Clear and agreed integration plan
● Very defined management role and responsibilities
● A 90-day plan
Why have cross border mergers and acquisitions between banks been so infrequent in Europe compared with other markets in the world? In what conditions do banks opt for cross border M&A?
SM: I am not sure I agree with the premise: look at what Santander has done in the UK with Abbey, then Alliance & Leicester and Bradford & Bingley. Also, there have been a number of consolidating banks on the continent, too … and not all from the rubble of ABN Amro (although that deal did spawn a number of deals).
Banks look outside their home market when they are so large in their home market that expansion in that market would cause competition concerns – this certainly has driven Santander and Deutsche Bank in the past. Also, there is a diversification effect by going out-country. In the current market, distressed assets will drive some future deals: look at the volume of divestitures that are required of RBS and Lloyds TSB (the latter as it digests, and then spits out, parts of HBOS).
DB: So many country and cultural barriers in Europe. Europe has also not been seen as a growth area by many. That said, I do expect to see more M&A in the financial services sector in the next 12-24 months, driven by Brussels and a return to core services
Do you foresee buyout or M&A activity picking up in the biotech sector?
SM: The pharma companies outsource a large part of their research and development by buying smaller companies that have borne the brunt of the risk of new drug development and approval. This can be expected to continue, especially as they see more of their existing products going off-patent. These deals do occur early in an M&A cycle, so this may be imminent.
This industry should also be one where there is increase interest from the non-traditional buyers, such as China, India and other emerged markets, looking for a larger footprint in this sector, especially if there’s a continued weakness in the pound and dollar.
Why are boards so keen to do M&A deals with the vast majority of M&A transactions destroy value for the acquiring company?
SM: M&A can often be seen as the quick fix to a problem: market share, aging product portfolio, lack of a particular geographic footprint. Doing a deal to solve these problems can appear simpler – and faster – than doing business the old fashion organic growth way.
We did a study at Cass Business School recently about new CEOs, which was reported in the Financial Times. We found that when a CEO is appointed there is a strong likelihood that he or she will initiate a deal (usually an acquisition, but possibly a divestiture as well). During this honeymoon period the CEOs are taking the initiative to drive change. This is especially important as the average CEO is only in office for about four years, so they need to make an impact quickly.
And yes, it is true that most deals destroy value. Studies put this at 60-70 per cent of all acquisitions. Not great odds!
DB: Companies are seeking growth and one way is through M&A.They hope that their deal is in the 30 per cent that add value. Sometimes scale is the driver, sometimes the ego’s of CEO’s are involved.
China is becoming hugely influencing in the global economy, yet the country have been strangely quiet on the M&A front. Why is this, and do you think China will become more active in M&A going forward?
Peter Smith, Brighton
SM: Many Chinese deals are private, and comprehensive M&A data from the government is not available. From anecdotal evidence talking to advisors there, there is a tremendous amount of activity within the country in terms of Chinese companies buying and merging with other Chinese companies. There is also a fair amount of activity within Asia that doesn’t get the headlines in Europe that a Chinese company purchase of a European company would. Regarding inward investment, there is some evidence from looking at Foreign Direct Investment figures (a large proportion which would be M&A) that activity in that market remains robust and has avoided the market plunge that we’ve seen in the US and Europe. Properly, however, companies are very careful when contemplating deals into China given the mixed history of others who have already done such deals.
Many Chinese acquirers tend to avoid the sunlight of big, popular brands, as these would attract attention from regulators and unfavourable reaction from the public. Again, this would mean that you wouldn’t hear as much about these deals, but they are there. I suspect the weakness of the euro, pound and dollar, especially as China takes a more liberal policy on it’s currency, will increase purchases of companies in North America and Europe.
DB: Agreed. We can all see the role that China is likely to play on the world economic stage so it is strange that there has not been much M&A from China – especially when compared with India. One aspect of challenge has been as to why should China buy European companies when growth in that region is likely to be pretty anaemic over the next few years. I expect to see Chinese companies look at European targets to gain exposure to key technologies, such as waste, engineering, greentec etc etc.
Where do you think the failure of the deal between the Pru and AIA leaves M&A and consolidation in the insurance industry?
S Watkins, London
SM: This sector is ripe for consolidation, but the failure of the Pru / AIA deal was one of valuation (which might really have been an issue of market timing and misfortune) and shareholder / investor relations, not one of strategy.
DB: Failure was probably due to poor selling of the strategy, price and a deal that was too big too soon for the CEO. Consolidation and M&A will happen, driven by the hunt for growth and cost savings.
Which sector would be your tip for the most M&A activity in the short and medium term?
Mike Jones, Boston
SM: Technology is showing strength, and should continue to be one of the leaders. Healthcare and financial services (the latter because of the regulatory and balance sheet pressure for many banks, especially those who bought distressed banks) will also be strong in the near- to medium-term.
DB: My tips would be:
● Financial services – driven by Brussels and the need to conserve capital
● Healthcare – a safer haven long-term driven by demographics
● Support services – as both companies and the public sector seek cost saving and greater value for money