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With the economic background making it increasingly difficult to launch mergers, you’d have assumed that there would be little appetite for companies to do deals. Yet a number of compelling reasons, and the weight of history, may be on the side of the optimists, says Lawrie Holmes

By 2008, the financial crisis had become a grim reality across the globe and the spiralling volume of mergers and acquisitions, which saw a bumper $4.7trn-worth of deals the previous year, according to Dealogic, quickly fell away.

Roll on four years and there is still fear, most acutely felt in the eurozone, about another potential collapse in world markets. Yet at the same time companies have hoarded vast amounts of cash – £754bn in the UK according to the ITEM Club economic think tank, $1.8trn in the coffers of US corporates, according to investment bank Credit Suisse, and up to £2bn across eurozone companies.

So is it likely that we could see a new surge in M&A as cash-rich companies seek to capture relatively undervalued peers? Or is the fear of another global economic crisis weighing down on management teams, especially as the eurozone teeters close to a break-up?

The headline numbers make for interesting reading. According to FT Mergermarket, global M&A volume dropped from around 16,000 deals in 2007 to around 10,000 in 2009. This recovered by about half at the end of 2011.

However, the deal rate has slowed through the latter half of 2011 due to increasing uncertainty about eurozone sovereign debt and political upheaval, not to mention the situation in the Middle East.

The result has been that the first quarter of 2012 is the lowest quarter in terms of deal volume globally for seven years.

In April, Ernst & Young’s global Capital Confidence Barometer Survey said: “While most of the ingredients necessary for a deal recovery are now in place – plentiful cash reserves, adequate credit availability and rising economic confidence – the M&A market continues to be restrained by conservatism. Only 31 per cent of respondents stated that they plan to pursue acquisitions in the next 12 months, compared with 41 per cent in October 2011.”

Fear in the markets
Stephen Morrissette, adjunct associate professor of strategy at University of Chicago Booth School of Business, says that although corporates have excess cash and access to low-cost capital to fund acquisitions, the actions of their boards are often irrational.

He says: “Animal instinct is the primary factor determining strategy and will often reflect the optimism of acquirers that economic opportunity is increasing, which leads to perceptions of higher profits and cash flows and less risk. Abundant cash and low-cost capital cannot overcome a lack of economic optimism and uncertainty regarding tax and regulatory policy.”

The result, according to Ali Aneizi, an M&A and private equity partner at Baker Tilly, is that “many companies may be conserving cash as a capital buffer against external shocks, such as the eurozone crisis, France’s downgrade, Greece and the increased uncertainty that may bring.”

Sir David Walker, an investment banker at Morgan Stanley, adds to that, saying: “Corporates will be very careful about their cash until present strains in liquid debt markets ease, which could be quite a time.”

A UK-based investment banker, who declined to be named, says the impact of what’s going on in the eurozone is being felt around the world. He said: “This increased volatility makes it difficult to have visibility of cash flow and earnings forecasts, so there is a certain degree of paralysis.”

He says the reticence to do deals is as much a result of how the eurozone crisis is affecting global banks that have struggled to rebuild since 2007. “There’s a lot of cash in corporates and private equity, but not in the banks,” he says.

“Private equity can’t leverage up to do big deals because of this. Most big private equity houses aren’t doing the deals they would like to do as a result, so there aren’t that many deals taking place with a value of more than £1bn, unless they’re involving companies with an exceptional cash-flow stream.”

But why deals are not getting done is also down to a number of factors, aside from macro-economics, such as shareholder activism, according to FT dealReporter Europe editor Lucinda Guthrie.

She cites Roche’s recent failed $6.2bn bid for Illumina as an example where the Swiss pharma giant’s shareholders refused to back a higher offer when the board of the US genetic analysis services provider refused to budge.

Another is Anglo-Danish security company G4S’s failed takeover of Danish cleaning group ISS last year, when shareholders decided they wouldn’t put up more cash in the form of a rights issue.

“Many deals are being pulled over fears of overpaying of the kind that took place in 2006 and 2007, especially as shareholders of acquirers and target companies are far more vociferous now,” she says.

Guthrie says that a further block to deals being done are regulatory and political hurdles: “An example of a regulatory roadblock came in February when Deutsche Boerse failed to acquire US-based rival NYSE Euronext for $9.3bn after it was blocked by the European Commission. Shell’s efforts to acquire Cove Energy for £1.1bn has been slowed down by the Mozambique government’s decision to impose a capital gains tax on the deal, a sign of increasing political risk in such deals. If you’re paying advisers large fees, you want to be sure you are going to close the deal.”

Urge to merge
Despite the headwinds, there are plenty of compelling reasons for deals getting done, says Dr Ruth Bender, a lecturer in corporate financial strategy at the Cranfield University School of Management.

She says that a large build-up of profits by American companies outside the US incentivises them to consider M&A.

“If they try to bring it back into the US they will have to pay tax on it, so they would rather spend the cash on an acquisition. Companies like Apple and Google are good examples of big US companies that have large assets outside the US that they may want to deploy in this way.”

US companies are also keen to build up market share overseas once their domestic market is saturated, and UK companies often fit the bill as they may have a strong global presence.

Michael McDonagh, an adviser at KPMG, says: “Examples of corporates that have acquired strategic assets we have sold in the UK include Caterpillar and Amazon. My view is that large corporates are well capitalised and have, by and large, done much of the internal work required to position themselves for the post-financial crisis world.

“As a result, over the past 12 months we have seen that trade bidders have been prepared to invest in assessing and buying businesses that are strategic for them. In such cases the corporates have paid excellent valuations to secure the deals.”

For Asian companies looking to take advantage of their relatively strong position there are plenty of opportunities in the West, but success has been varied.

“Chinese companies have tended to be outbid in a lot of situations, while Indian companies have been looking at opportunities. Tata is one that has been very opportunistic buying UK companies,” says Cranfield’s Dr Bender, referring to the company’s acquisition of Jaguar Land Rover and the former steel company Corus.

John Fordham, chairman of Baird International, the UK-based investment banking arm of the US bank, says: “We are seeing increased interest from Asian buyers, particularly where outbound M&A accounts for nearly 40 per cent of all M&A activity.

“There are also signs that Asian buyers are stepping up to the plate in Western-style auctions for attractive assets and are prepared to go toe to toe with US and European corporates – this is a significant change from previous times.”

Writing on the wall
Raymond Fagan, a banker at mid-market specialist Cavendish Corporate Finance, says that buyers from Asia and other emerging markets have a variety of motivations for seeking targets in the UK.

“Often, overseas firms will pay higher multiples, as they are prepared to pay a premium to secure a base in an EU economy, with strong contract law and a robust business framework,” he says.

Many boards will take the view that the tough macro-economic environment, and its dampening effect on available sources of funding, will prevent any upturn in deal-making.

But Professor Richard Schoenberg, senior lecturer in strategic management at Cranfield University School of Management, has amassed data on deals in recent years and believes there will be another boom.

“In 13 years, 56 per cent of acquisitions had been divested, with the average period of divestment being nine years.

“Given that the last major wave was in 2007, we would expect there to be another uplift in M&A activity nine years from then simply because, on average, more than half of divestments take place within nine years. You’ll inevitably see a pick-up by then.”

Schoenberg acknowledges that a lack of acquisition finance has made conditions more difficult for private equity-led deals that contributed a significant proportion of transactions in the last M&A boom, but insists the writing is on the wall.

“The M&A peak year of 2007 saw global transactions worth $4.7trn,” he says. “The previous peak of 2000 saw deals worth $3.5trn, according to Thomson Financial.”

If Schoenberg’s models are right, a boom could be on the way, but the likelihood of that happening may well depend on the degree of fear stalking boardrooms right now.

Lawrie Holmes is editor of Financial Management

Illustration: Karsten Petrat

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