Bankers had high hopes for a pick-up in dealmaking in Europe at the beginning of the year, but sovereign debt worries and continued market volatility have done little to encourage chief executives to make acquisitions.
So far this year, $262.4bn-worth (£177bn, €212.9bn) of deals have been announced – a decrease of 4.4 per cent on the $274.5bn transacted during the same period last year, according to Dealogic, the financial data provider.
Giuseppe Monarchi, head of the Europe, Middle East and Africa mergers and acquisitions group at Credit Suisse, says the year started off with strong hopes of an increase in M&A activity in Europe. But with the months passing, such hopes have progressively diminished.
“Year-to-date EMEA deal volumes are flat at best versus 2009, and it is difficult to predict anything different for the remainder of the year, in view of the continued weakness in the equity markets and general uncertainty on the broader economic outlook,” Mr Monarchi says.
Wilhelm Schulz, head of European M&A at Citigroup, says that, given increased macroeconomic uncertainty, transactions have been conservatively financed. “As a result, they are often executed with a concurrent equity raising,” he says, adding he anticipates European companies will increasingly become targets for US and emerging market acquirers. He predicts: “This especially applies to those targets with a global footprint or those whose core operations are concentrated in the stronger euro-area economies.”
M&A activity in the healthcare and consumer sectors has helped prop up deal volumes during the first half of 2010. Notable deals include German drug and chemical group Merck’s $6bn takeover of Millipore, the US laboratory supplies maker, and the decision by Grifols, Europe’s largest maker of blood-plasma products, to acquire US-listed rival Talecris Biotherapeutics for cash and stock.
Danish brewer Carlsberg, meanwhile, paid $379m to become the leading shareholder in Chongqing Brewery of China, while Phillips-Van Heusen, the US fashion group that owns Calvin Klein, bought the Tommy Hilfiger brand from Apax Partners, the private equity group, for $3bn. French Connection, the British store chain, sold its lossmaking Nicole Farhi fashion label for up to £5m ($7.4m, €6m).
Bankers are predicting more corporate activity from global pharma companies as patents on blockbuster products expire over the next 2-3 years while fewer new blockbusters are approved.
“Ironically, that dynamic results in enormous cash-flow generation by those players over the same period,” says Rupert Hill, global head of healthcare at Bank of America Merrill Lynch.
He adds: “Given the trend towards reducing research and development budgets, the strong creditworthiness of these companies and the historically low [price/earnings ratios] of many large players, acquisitions involving cash will remain on the agenda.”
Ludovico del Balzo, global head of consumer retail industries at Nomura, says that in spite of the current dislocations in global financial markets, fuelled by the sovereign debt crisis in southern Europe, chief executives and boards in a number of industries have decided to go ahead with strategic opportunities focused on top-line growth.
“The risk of staying static in this market is not the best way to maximise value for shareholders,” Mr Del Bazo cautions.
To gain immediate exposure to new markets, consumer companies are increasingly turning to emerging markets for growth. Carlsberg’s increased shareholding in Chongqing Brewery, which took it from 17.46 per cent to 29.71 per cent, is part of its strategy to expand in Asia, particularly in China and Indo-China.
Companies in the mid-market have been increasingly active. In research by corporate finance advisers BDO, 80 per cent of mid-market companies surveyed were planning acquisitions over the next 12 months.
However, Brent Goldman, corporate finance partner at BDO, cautions that while there is evidently huge appetite for acquisitions to meet ambitious growth targets, there are still challenges to overcome. “While there is clearly optimism that the credit tap is going to be turned back on, there are still concerns around raising finance and an ongoing expectation gap on price between buyers and sellers,” Mr Goldman says.
The BDO research showed that most firms expected to fund acquisitions from existing cash reserves or existing bank facilities, with half looking to secure new bank debt or additional support from shareholders.
Josef B. Volman, who co-chairs the Burns & Levinson business law practice, says: “As we observe signs of emerging from recession, investors that had made it a practice of conserving cash over the past two years are now placing more confidence in their balance sheets, pursuing acquisitions and qualifying for financing that enables them to leverage deals in the lower middle market.”
After a two-year hiatus, private equity groups have also regained their appetite for dealmaking, albeit targeting smaller deals that are being financed with much less debt. During the credit bubble, debt would often make up 80 per cent, compared with an average of 30-50 per cent now.
PAI Partners, the French private equity group, for example, financed only half of its €500m (£416m, $617m) buy-out of Cerba European Lab, the laboratory testing group, with debt, while Cinven’s buy-out of Sebia, the French medical diagnostics company, and Apax Partners’ purchase of Marken, the pharmaceuticals distributor, were entirely financed with equity. Both deals were valued at roughly 12 times earnings before interest, tax, depreciation and amortisation – valuations reminiscent of the buy-out boom.
“Transactions in 2010 are going to be financed with a much higher equity ratio than before,” says Dieter Lauszus, senior partner and private equity expert at Simon-Kucher & Partners, the global pricing and marketing strategy consultancy. “Simply put, excessive leverages in this market environment will no longer be realised.”
Secondary buy-outs – where a private equity firm sells a company to a rival – have included KKR’s £950m acquisition of pet accessories chain Pets at Home from Bridgepoint, and Clayton Dubilier & Rice’s £400m takeover of British Car Auctions from Montagu.
Apax Partners’ £975m purchase of Marken from Intermediate Capital Group was a tertiary buy-out, with the company passing to its third private equity owner. Such pass-the-parcel deals can be unpopular with investors, who often have holdings in both the buyer and the seller. In such a case the investor ends up owning the same asset with 30 per cent of fees and carried interest – a profit share – taken out in the sale.
But while secondary buy-outs may help private equity spend the estimated $1,000bn of capital they are sitting on, they have done little to boost the volume and value of dealmaking worldwide, and it will take years before bankers are hired to work on the outsize leveraged buyouts to which they became so accustomed at the height of the recent debt boom.