Since the last half of 2008, it is no longer possible to conceal the term ‘crisis’. New paradigms have become apparent and structural changes are predicted. Indeed market conditions have tightened, but industries and attractive regions are changing the face of the M&A world. For traders there is one solution: anticipation
Crisis or renaissance?
In 2007 the mergers and acquisitions market had hit its ‘peak’. Contrarily, 2008 was hit by the deteriorating market conditions that we are currently experiencing, but the uptake in the second half of the year lead us to believe there may be a possible rise in 2009. The last quarter in 2008 left no doubt; the downturn was evidently turning into a collapse of the market. Traders blamed the crash; volumes during the first half of 2009 amounted to 941 billion dollars, equal to a 40% drop compared to the first half of 2008. The decrease was ‘only’ 30% during the period between the first half of 2007 and the first of half of 2008 (Fig. 1)
The mergers and acquisitions market is at the lowest it has been for six years; in a short amount of time the actors’ appetite and capability has significantly reduced (Fig. 2). However, giving into the catastrophe is out of the question. Observers believe that we have now reached the bottom of the cycle; the upturn of the economy is expected as soon as the end of 2009 along with the re-balancing of company accounts and the revival of the credit market. The current crisis is much less a sentence than a clean-up phase conducive to a more strategic and realistic approach to trading. Moreover, traders demonstrate a real appetite and are increasing ambitious forecasts; Pfizer’s acquisition of Wyeth ($64,015 billion) and acquisition of the American firm, Genetech by the Swiss company Roch ($44.3 billion).
There is no doubt that the decline that began in 2008 is getting worse. All the indicators are in decline in all regions and all sectors. Companies are struggling to curb falling operational results coupled with persisting debt. The net debt/EBITDA ratio has also decreased by 14% going from 0.93 to 1.06 on average. Market appreciation is also affected; Africa, the Middle East and Latin America are heading towards the top of the list of the most affected regions (a decrease of 31.56% on average) whereas the Asia-Pacific region and Europe are managing to limit the damage (a decrease of 20% on average). A per sector analysis shows that 71% of trade is concentrated between the four following industries: finance, raw materials, energy and health. However, they are all victims of a decrease in appreciation (PER) and a decrease in the net debt/Ebitda ratio. Only the consumer goods sector displays a quite high PER level (14.6), but has a considerably lower debt/Ebitda ratio in some regions (14.9 in Europe) (Fig. 3)
A new world map for M&A
Broken down by region, the market figures confirm the analyses supporting the multipolarisation of international growth (Fig. 4). Once driven by the American and European forces, the economy now depends upon new intermediaries in the Asia Pacific region. Western powers, slowed down by the financial consequences of the subprime mortgage crisis, were the first victims of their excessive past. In the first half of 2009, the United States obtained a sales volume of 289.4 billion which represents a 49.2% drop in comparison to 2008. Western Europe is recovering from last year’s sharp decrease (-46.8%) to limit the reduction in deals to 37.4%, whereas Eastern Europe is no longer attracting investors as it was before with a 75.1% drop in value.
For the Asia Pacific region, 2008 was a year of recovery with a 23.6% increase in the deal value of and 59.9% for China. Although safe in 2008, the region showed a sharp drop in 2009 with a decrease of 28.4% in value (38.6% for China). Nevertheless, this decrease should conceal structural trends. According to KPMG, deals aimed at the Asia Pacific region has decreased by 37% in comparison to 28% in the opposite direction. Although trade from the Asia Pacific region remains in the shadow of trade in the opposite direction in terms of volume and value, observers predict a progressive narrowing of the gap. It would seem that the U.S and the UK’s capabilities to buy are increasingly rivalled by the strategic and financial potential of companies in the Asia Pacific region and particularly in China (Fig. 5)
Latin America is more subject to fluctuation; following a leap of 117% in the first half of 2008 compared to the first half of 2007, deals fell by 88.4% during the first half of 2009 compared to the first half of 2009. However, a detailed per region analysis showed that in 2009, the Asia Pacific region is the least affected by the decrease in appreciation rates (-19.9%) followed by Europe (-21%). In contrast, Africa/the Middle East is the most affected region (-31.6%), followed by Latin America (-28.7%), North America (23.6%) and finally North America (-8.7%).
Corporate companies versus investment funds: a new paradigm
Between 2005 and 2007, the global mergers and acquisitions market was shaken up by the increase in power possessed by private equity firms. Encouraged by a flourishing debt market and limited covenants; to say the least, funds rapidly became a category that could no longer be ignored. This situation has today been brought into question due to an unfavourable economic climate. In the first half of 2007, investment capital represented 27% of the M&A market; in the second half year, the percentage was reduced to 13%.... This was evidently a favourable situation of industrial traders who then monopolized 87% of deals (Fig. 6)
Unlike funds, corporate companies are equipped to deal with global economic downturn as they have cash at their disposal which enables them, in a context of financial crisis, to continue to trade. According to S&P 500, companies’ average cash surplus in 2008 was allegedly 56% higher than in 2000, which was a record year in terms of deal volume and value. In addition, the average profit taken by these companies is twice as high compared to 2000. In this context of private equity withdrawal, the pressure is also placed on multiples, at the same time making deals more attractive; this phase of economic turnaround therefore presents new opportunities to corporate companies.
Today, the value of companies, which is measured both by multiples and PER, is proportionally lower compared to what it was during the last wave of M&A deals which took place in 2000. According to S&P 500, since 2001, the PER average apparently fell by 61% going from 46.5x to 18.1x. What were the consequences? If less mega-deals were being made, today’s trend is the increase in medium sized deals, which create value for both the assignor and the buyer. In fact, according to the BCG study, deals carried out during the economic turnaround are, paradoxically, more susceptible to create value in the long term than deals made during periods of growth. The buyers, who acquire ‘cheap’ and relatively small targets, noticeably increase their value by accessing weaker multiples. However, not everything can be reduced to the proverb ‘buying low and selling high’; buyers must demonstrate a certain skill to substantially improve the value of the target once it has been acquired (Fig. 7)
Cross-border M&A deals: sustained business activity, a new geographical opportunity
Cross-border deals constitute the most adapted form of external growth in terms of development and in terms of the growth of companies seeking to reach a critical size. In a context of uncertainty, as much economic as financial, does one need to anticipate a redistribution of roles? Based on the Global Cross Border M&A Forecast study, professionals have faith in these deals that they still consider as strategic; however, the new economic opportunity noticeably impacts the geography and energy of these deals.
Cross border deals have not escaped market contraction after years of continued growth. During the first six months of 2009, cross-border deals made up 20% of all M&A deals - a 10 point fall in comparison to 2008. Over the period going from 2007 up until, and including, the first half of 2009, the Asia-Pacific region, forecasted as leaders in cross-border acquisitions, experienced a 37% drop in volume and a 48% drop in value. Over the same period, deals from the United States declined by 49% in volume and 54% in value. Europe is performing better, curbing significant contraction in the number of deals (56%) by maintaining large-scale deals (21% decrease in value).
Despite these alarming figures - to say the least - the pessimism isn’t necessary. While 75% of professionals interviewed (83 financial advisory MDs, CEOs and professionals from the private equity field) foresee a decline in cross border M&A business from the United States, only 65% of corporate company professionals consider it as unavoidable. The Asia-Pacific region continues to attract investors, as 74% of people interviewed believe that these deals would be targeting countries in that region. Asian traders are the champions of optimism; 65% of people interviewed envisage increasing business for M&A deals, whilst only 11% foresee a decline. Due to the weak dollar, the majority of people interviewed (78%) expect the United States to be the Asian firms’ first target. European traders are also affected; 45% of professionals surveyed expect an increase in European M&A business over the next 12 months, whereas only 29% believe that the market would continue in its decline. Lastly, although deals are being targeted to increasingly distant geographical zones, the percentage of deals in close geographical proximity is increasing. The reason for this is not only transport and management costs but also the need to better control the acquisition and set-up market (Fig. 8)
Conclusion: putting an undefined crisis into perspective
The figures say more than any long speech. The M&A market is in decline as are all of the regional indicators. According to KPMG Corporate Finance’s M&A Global Predictor, no region or industry has simultaneously experienced an increase in market appreciation and net debt/EBITDA ratio. Does that mean that we have to lay a headstone on the mergers and acquisitions market? Observers are almost unanimous in their conclusions; absolutely not. Neither corporate companies nor investment funds plan on giving in to defeat, but rather choose to adopt a strategic and prospective view. According to McKinsey, this crisis is full of information on future trends in the market. 4 trends have become apparent: the increase in mega-deals, the strong return of Private Equity, the cleansing of the market thanks to the decline in hostile deals and, in particular, the renewal of strategic deals that create value. For investors, these trends will overcome the purely financial concerns. It is no longer about acquiring whatever, whenever and paying over the odds for it; the upturn of the market will favour those buyers who have vision and are more concerned with the synergies which result from deals and the future response rate. From this perspective, there is a vast amount of opportunity thanks to the numerous sub-assessments of the companies in crisis. The current economic crisis would profit from increasing management and shareholders involvement; deals would be more structured and prior solid research and development work would be carried out regarding the management of ex post companies.
Far from being as severe as what we could have feared, it remains true that the market is subject to too many uncertainties. European and American bank assessments continue to record new depreciations. Considered by professionals as a year of transition, 2009 has not yet taught all of its lessons. Will the recovery, which is expected in the second half of 2009 and the first half of 2010, be as strong and radical as is hoped for? What is the future for investment funds which are still limited in their access to debt? There are so many questions that the next few months will provide answers for. One thing is certain; the mergers and acquisitions market will never be the same once the crisis has passed.