M&A bankers still waiting for a boom
Conditions haven’t looked this good for M&A since before the 2008 crash. Yet volumes remain stubbornly low. Perhaps corporate executives are still shell-shocked and need prolonged stability – rather than a one-quarter stock market rally – to spur them into action. Deal makers hope the good times are just around the corner.
Talk to M&A bankers and you hear plenty of stories of activity bubbling away beneath the quiet surface of a slow quarter for announced transactions.
Hermann Prelle, chairman, M&A EMEA at UBS, recounts shuttling in the first two months of this year between three sizeable European companies that had been subject to unsolicited, informal approaches from potential acquirers.
"Each company had recently issued a profits warning," he says. "In each case we helped management develop their case to the board that this was a blip caused by temporary economic weakness, that corporate strategy remained sound and the companies on track. In each case, boards of directors rebuffed the approaches, in one case suggesting that the company might be open to a bidder taking a minority stake if it believed in the company so much."
He concludes: "None of these deals became public. But there is plenty going on."
Henrik Aslaksen, global head of M&A at Deutsche Bank, points to the bank’s backlog of mandates to buy and sell companies that have not yet emerged into the public domain. "The business of providing advice has been around for a very long time," he says. "It is a cyclical business driven by a host of factors: the psychology of senior decision makers, prevailing market valuations, and the cost of capital, to name a few. On that basis, 2012 looks better than 2011, and we’re seeing evidence of that in our pipeline, which is meaningfully up year on year."
Skip McGee, head of investment banking at Barclays, also sees much to be optimistic about. "It is not just that many corporations have strong balance sheets with plenty of cash that could be a catalyst for M&A and that the financing markets are now wide open again for both high-grade and high-yield names," he says. "Many companies have done almost as much as they can in terms of organic growth to drive earnings and margins and are now beginning to look externally."
He adds: "That dialogue is not stopping at national borders. I think cross-border M&A will be a big theme. And so while there are not many very big deals out there right now, there are plenty in the $3 billion to $15 billion range that can become very meaningful for advisory firms from a revenue perspective.
"Our view is that M&A volumes will be flat to slightly up. The surprise would be to the upside."
Adrian Mee, head of international M&A at Bank of America Merrill Lynch, similarly sees the discussion around M&A opportunities simmering towards the boil. "While each sector has its own set of drivers, when M&A activity heats up it tends to do so across the board," he says. "Right now our clients in many sectors are looking actively at M&A deals that can help to drive growth in an otherwise low-growth environment."
Last year, after a reasonable first six months when hopes built up among the investment banks that rising M&A revenues could provide a welcome offset to markets revenues that have never recovered their 2009 highs, disappointment followed. Uncertainty stemming from the US debt negotiations and the sovereign crisis in Europe froze M&A deal activity. The equity capital markets also ground to a halt and secondary markets sold off, spreading caution even among senior executives at sound companies who could see bargains all around them.
|Global M&A volume by region|
|2005 to 2012, all YTD|
This year has started with the European Central Bank appearing to remove the worst of the fat-tail risk from the interlinked fortunes of eurozone sovereigns and banks with its Long-Term Refinancing Operations, risk markets rallying strongly, and signs emerging of a US economic recovery beginning to bolster employment and an outcome in Europe not quite as bad as the doomsters were predicting at the end of 2011. It’s an oddity that for M&A volumes to pick up, the equity capital markets have to be open too, often as an indicator of confidence but also for technical reasons. Take private equity sponsors wanting to exit mature positions, sell portfolio companies and return cash to investors in their funds. They will be much happier that they are achieving the best price if, as well as soliciting bids from other sponsors, they can also cross-check such valuations against what might be achieved in the IPO market and through sales to strategic industry buyers.
The IPO market is just beginning to hit its straps once more, with much excitement around the Facebook IPO in the US and Dutch cable company Ziggo achieving a €3.7 billion market valuation at the end of March. Its heavily oversubscribed flotation of 21.7% of the company, priced at the top of the indicated range, was a big success for its private equity owners.
There were six M&A deals worth over $1 billion from financial sponsors in the first quarter of 2012, compared with just nine in the whole of 2011. "The sponsor business is at a very different scale now from what it was in 2006 and 2007 when it was 20% to 25% of total M&A volumes. However, sponsors have raised a lot of capital and they will be active, particularly in the sub-$5 billion deal size," says Mee. "We expect sponsors to represent around 10% of M&A volumes and they remain a very important part of the client base." And strategic industry buyers, like private equity sponsors, know that finance is available to them. Bankers suggest that a handful of European companies could launch $30 billion deals tomorrow with utter confidence of financing them.
"The factors are all in place for a multi-year expansion in M&A volumes," says Antonio Weiss, global head of investment banking at Lazard. "It would be extraordinarily unusual to see a sustained stock market rally not followed by a pick-up in M&A, although the question is: when will that start in earnest, because it certainly hasn’t yet."
Mark Shafir, co-head of global M&A at Citigroup, points out: "M&A correlates with three indicators: the S&P500, consumer confidence and an inverse correlation to the VIX [measure of stock market volatility]. All look as good today, or better, as they did at the start of April 2011. So M&A volumes should improve. Dialogue has increased and all it needs now is for clients to start transacting more aggressively."
But as that final note of disappointment suggests, M&A volumes are actually down in the first three months of 2012 compared with the same period in 2011, even while corporate animal spirits ought to be picking up amid rallying equity markets, abundant liquidity, strong corporate earnings and, to many eyes, reduced macroeconomic risk and uncertainty.
M&A bankers got a big boost in February when Switzerland-based Glencore announced its stock-swap merger plans to recombine the mining and commodity trading and logistics company with the remaining 65.92% of Xstrata that it does not already own. In a market starved of big deals of over $10 billion, this was a $48 billion standout that will boost the revenues and league table scores for the nine banks advising on either side: JPMorgan, Deutsche Bank, Goldman Sachs, Barclays and Nomura on the Xstrata side; Citigroup, Morgan Stanley, BNP Paribas and Credit Suisse for Glencore.
The timing of that deal, coming so soon after Glencore’s IPO last year, which had handed losses to buyers when it priced just before a stock market sell-off, surprised some. For those advisory firms using probability-adjusted algorithms to budget resources to devote to their M&A pipelines, it would have probably appeared a low-likelihood deal. When it materialized, some hoped that one big deal might sound the starting gun for other acquisitive companies to move into action. But that hasn’t happened yet.
|Global M&A volume by targeted sector|
|2010 to 2012, all YTD|
Glencore and Xstrata fall into a category that M&A veterans call unfinished business. Technically and tactically it might prove interesting to watch. Glencore’s IPO was always considered a key step in gaining the acquisition currency with which to win Xstrata. But bankers around both companies saw obstacles to this deal coming together quickly. Some of Xstrata’s institutional shareholders are not well disposed towards Glencore, feeling that it played too smart a trick in the sale and repurchase of Prodeco to finance its own share of Xstrata’s rights issue early in 2009 and that it has used its 34% in the company to scare off other potential bidders that might have offered a hefty premium.
There had been an assumption that Glencore would have to offer a healthy premium itself to win them around, as it cannot vote its own shares in support of the proposed merger. And when it came with a stock offer in February, at a time when most M&A deals are being done for cash, one or two large Xstrata shareholders immediately signalled their discontent.
Other bankers – and not even just those on Glencore’s side – say that when one company already holds 34% in a target, enjoys representation on its board and has contractual agreements to market its products, it might be optimistic for shareholders to expect the usual large premium for control.
In addition, some bankers say that the fact that Glencore’s shares didn’t fall on announcement is revealing. Its shareholders do not expect it to overpay. They also see a clear future for Glencore even if the Xstrata deal doesn’t go ahead. Before the quarter ended, Glencore has already announced plans for another large deal, to acquire Canadian grain company Viterra in a bid that values it at just over C$6 billion. "If the Xstrata deal doesn’t go through, Glencore will continue in its own sweet way. I wonder if the same can be said for Xstrata," one banker says, "or whether it would be just the slightest bit tainted." This all means, however, that Glencore did not fire the starting gun for a wave of multi-billion dollar M&A deals by bringing forward its plans to roll up Xstrata. The deal is a bit of a one-off.
As the first quarter drew to a close, Dealogic provided figures comparing the first two-and-a-half months of 2012 up to March 16 with similar periods in previous years. By number of deals, activity is down by 10.5% in 2012 compared with 2011. By deal value, the decline is even more marked. The absence of large deals, Glencore aside, leaves volumes down by 23.3%. Fees are down by some 14.5%.
"If you take out Glencore as a bit of a one-off – although all years have their one-offs – then weekly M&A deal volume in EMEA is running at around €8 billion," says a despondent European M&A banker. "That’s down even on the €11 billion to €12 billion a week we were seeing in the second half of 2011 and far below the €20 billion a week in the first half of last year."
Does he fear that some banks, subject to so many pressures from shareholders, might baulk at the cost of retaining expensive troops of global industry experts and local deal executioners, if M&A volumes remain slack for much longer? "One or two firms may blink," he says. "M&A is a wonderful business in that it does not consume much capital, though many large multinationals employ a pay to play rule and so there are associated risk-weighted assets that show up in the loan business. It’s tough. We’re seeing some fee-cutting, which is a bit desperate in a low-revenue environment and doesn’t say much for the value of your offering. To be fair, though, we cut fees ourselves when we’re trying to cement a key target corporate relationship that we think might offer us a lot of business in future."
Of course, last year started strongly and then volumes collapsed, whereas the first quarter of 2012 might yet mark just the first stage of an initial recovery from the dire second six months of last year.
"Sentiment is trending in a positive direction in the equity market, and volatility has subsided considerably. However, lower volumes in the equity markets indicate a lack of conviction," says Michael Carr, head of Americas M&A for Goldman Sachs. "M&A activity typically lags the equity markets by three to six months, so we may see a busier second half of the year if sentiment continues to improve."
|Wilhelm Schulz, head of EMEA M&A at Citigroup|
Some advisers to companies report a continuing worry on the part of boards and managements even of healthy, cash-rich companies that the sovereign crisis in the eurozone might break out again at any moment. "One day Greece is all tied down: the next day, it’s not," says one. Others suggest that even while that concern is now receding new big-picture concerns have appeared to take its place, including the geopolitical question of dealing with Iran’s nuclear weapons ambitions, signs of economic slowdown and a potentially turbulent political transition in China, the US elections and potential for renewed focus on the US fiscal position in 2013. This translates directly into the types and structures of M&A deals that are likely to be seen for the rest of the year. Wilhelm Schulz, head of EMEA M&A at Citigroup, says: "Somewhere around 80% of deals have a full cash consideration, and that is likely to continue. Given the current state of the market, hostile deals are very few and far between."
Most bankers agree that this is the sort of market in which willing sellers might submit to a well-financed cash bid bringing certainty of proceeds and bidding companies’ shareholders might well support acquisitions with clear industrial logic based on either or both of taking out cost and capturing revenue growth. Stock markets are recovering and earnings are strong but multiples are far below their historical highs in many sectors. "While prices have gone up with the stock market rally this year, there is a technical factor supporting activity in that required premiums have come down," says Schulz. "So the boards and shareholders of bidding companies draw some comfort from that."
Shareholders being open to the idea of companies pursuing M&A deals to secure non-organic growth is not quite the same as shareholders pressing executives to execute those kinds of strategic transactions.
|Gregg Lemkau, head of M&A for EMEA and Asia at Goldman Sachs|
"There’s less shareholder pressure on corporate executives to put cash to work in search of M&A opportunities than you might expect," says Gregg Lemkau, head of M&A for EMEA and Asia at Goldman Sachs. "Having lived through 2008 and 2009, shareholders have seen the benefits of conservative balance sheets and high cash balances. Now the pressure may grow, as cash balances increase, to return cash. But for there to be more large M&A transactions the stock market first has to return to a mentality of searching for growth." Emerging market buyers being attracted into the developed world by low valuations on companies with cutting-edge technology and developed world buyers seeking growth in emerging markets will play an increasing role, most M&A bankers agree.
"In cross-border M&A, those emerging-market-to-developed-world and developed-world-into-emerging-market streams used to be around 20% of the flow. Right now, they account for around 38% of cross-border deals," says Schulz.
China, most obviously, lacks natural resources and is desperate to acquire them. Ever since CNOOC’s bid for US oil explorer Unocal was blocked in 2005, Chinese state-backed companies have shown themselves willing to counter nationalistic political resistance to full-blown M&A in the US and other developed markets by engaging instead in joint ventures, partnerships and other tie-ups while securing full takeovers in more relaxed jurisdictions. "Buying a mine attracts a lot less attention than buying a publicly listed company," says one banker.
"The multinationals are very focused on emerging markets right now," says Prelle at UBS. "They are even looking to diversify into Africa, and not just for natural resources. It’s becoming attractive as a market to position yourself in for consumer goods, retail, building materials, general industries."
The prospect of an increased proportion of M&A deriving from cross-border deals with an emerging market acquirer or target raises questions about the increasingly interventionist tendencies of competition authorities in blocking recent deals between developed market companies.
Another inhibitor of M&A activity right now, even as risk aversion dissipates in equity and bond markets, assets rally and funding becomes available, is the list of noteworthy large transactions that have foundered recently either because of shareholder resistance or regulatory refusal. Executives might add fear of announcing a large deal and then failing to execute it to the career risk attaching to M&A activity, alongside the other macro uncertainties.
The deals that have failed to cross the finish line fall into two camps. M&A bankers still sound shocked when they talk about the failure of AT&T to get its $39 billion acquisition of T-Mobile USA past the competition authorities at the end of last year: a failure that required it to pay a $4 billion break fee to the target’s shareholders. The company is renowned for its general counsel’s mastery of the ant-trust brief. Bankers had simply assumed that AT&T had a plan – and the lobbying nouse – to get its deal through.
Similarly, the blocking by the European Commission on competition grounds of Deutsche Börse’s bid for NYSE Euronext came as a surprise to some who had seen the merger as primarily one of stock exchange consolidation and ignored the high percentage of European derivatives trading volume it would combine. It had been a long time since an important deal was blocked and so that possibility was not such a focus of attention.
"Major, cross-border transactions have been blocked on competition concerns," says Weiss at Lazard. "But that doesn’t mean we’re in a new regulatory environment."
Others sense a change. "It is harder now to get transactions approved on competition grounds," says McGee at Barclays. Shafir at Citigroup adds: "Psychologically, that has an impact. When decision makers see deals that make strategic sense closed down, that makes them think twice about the opportunity cost of the huge management time and resources M&A transactions consume."
Giuseppe Monarchi, co-head of mergers and acquisitions EMEA at Credit Suisse, continues: "Some of these recent decisions have put further focus on the regulatory risk associated with transactions, including how to allocate such risk contractually."
His fellow co-head, Vikas Seth, adds: "Clients will also have to pay more attention to the regulatory environment, especially in emerging markets where social issues like unemployment take on added significance. In certain African countries, regulators may insist on guaranteed employment. In some Asian countries, they could require minimum investment commitments. Legal and financial advisers need to help their clients anticipate these demands."
The other large and noteworthy transaction that came unstuck in recent months was security company G4S’s planned £5.2 billion ($8.3 billion) acquisition of Danish services firm ISS, which had been put up for sale after its private equity owners failed to undertake an IPO. G4S needed a £2 billion rights issue to fund the deal but withdrew it in the run-up to a shareholder vote that it looked unlikely to win. The deal recalled Prudential’s much larger failed bid for AIA at the start of 2010.
|Hermann Prelle, chairman, M&A EMEA at UBS|
This is not the time to surprise shareholders. Seth says: "Our equity team recently did a survey of 50 or so large institutional investors, including hedge funds, on attitudes to companies doing M&A deals. The mood was generally supportive as long as deals were sensibly priced, had strategic fit, with some preference for deals to acquire growth in emerging markets. It’s also important that deals fit with previously announced management strategy." One adviser to G4S, adds: "When you analyse the share-price reaction to M&A deals over the past 18 months, both on announcement date and 10 days later, it has looked positive for the overwhelming majority. We accept some criticism that we mis-read the market in this case and in particular the cost and challenge of financing participation in the associated rights issue for some hedge funds that were large investors in our client. This is certainly a time to think hard and carefully before you commit to any deal."
When will the boom times return for M&A bankers? "Right now, it looks to me like we’ve passed the low point," says Prelle at UBS. But the high point looks a way off yet. "Maybe 2014 will be a banner year for M&A."