The M&A Market: All the Right Conditions, but No BuyersPublished: March 28, 2012 in Knowledge@Wharton
"Everybody showed up to the party but nobody wanted to dance," is how Dan Tiemann, Americas transactions and restructuring lead for KPMG, describes the global merger and acquisition scene in 2011.
The party he is referring to is what many consider the perfect setting for M&A: companies with ample amounts of cash on hand, record-low interest rates and countless undervalued firms waiting for buyers. And while the first half of 2011 looked strong, the second half trailed off considerably, hampered in part by the European debt crisis and continued uneasiness about the U.S. economy. Last year ended with $2.81 trillion in global merger and acquisition volume, just a 3% increase from a very tepid 2010, according to data compiled by Dealogic.
Tiemann and other observers agree that the same scene is present in 2012, and although confidence is growing, they expect only a slight increase in dealmakers to hit the dance floor. "I think it's going to be a little bit sideways," he says. "There are the same fundamentals as a year ago, but then there are other factors like the [upcoming presidential] election that are uncertain." Wharton finance professor Pavel Savor, however, is "cautiously optimistic. I see a little more [activity] in North America as the economy is doing better."
Corporate executives are feeling the same hesitation. Forty-one percent said they felt neither more nor less optimistic than last year about merger and acquisition activity, according to a recent Knowledge@Wharton/KPMG survey of 825 executives at U.S. corporations, private equity firms and investment funds. Still, seven out of 10 respondents said their company would make at least one acquisition this year, compared to just over half of the respondents in 2011.
But most of this new activity originates from the private equity and investment firms. When just corporate CFOs were queried, only 18% said they expect to participate in an acquisition in 2012, down from 26% from last year, according to a recent survey of 600 such executives conducted by Bank of America and Merrill Lynch. And with just two full months of deal activity logged in 2012, results are not looking up. Although February's global merger and acquisition activity was strong, January was the weakest in five years. Overall, both months brought in $390 billion of deal volume, down 16% from the first two months of 2011.
Searching for Motivation
When a company does want to buy, the top reason this year will most likely be simply to grow. According to the Knowledge@Wharton/KPMG survey, nearly one-third of respondents said the main reason they plan to make an acquisition was to "expand geographic reach." Wharton management professor Lawrence Hrebiniak notes that organic growth is costly and time consuming, which makes buying another company a more attractive option. "Acquisition allows a company to move more quickly, acquire the technical and marketing know-how in one transaction, and avoid the retraining and capabilities enhancements needed under organic growth," he says. Hrebiniak adds that large amounts of cash reserves are also making acquisitions more attractive for some businesses in 2012. "Many companies are cash-rich -- money is burning a hole in the pockets of a lot of CEOs and CFOs."
Nonfinancial companies have more than $2 trillion of cash or other liquid assets on their books, up nearly 5% from last year, according to the Federal Reserve. This accounts for 7% of the assets of nonfinancial companies, the most since 1963. In the Knowledge@Wharton/KPMG survey, nearly half of the respondents said one of the key factors that would facilitate a deal would be "large cash reserves."
Still, the state of the economy will be the largest factor in determining deal activity, Savor says. He notes that no matter how eager executives are to grow or spend their cash, deals will not get done if another debt crisis-like scenario is looming. "It's hard to track down a single driver of M&A," Savor states. "One thing that is often a prerequisite is some minimum level of macroeconomics. When there is a stressed macroeconomic environment, there is typically much less M&A."
Savor adds that a favorable political environment also helps spur merger activity, noting that tense politics make for uncertain taxes and, typically, lower investments. Consequently, in the United States, merger activity has been slow to pick up pace because of political wrangling between the two parties and the upcoming presidential election in November.
Besides ongoing political party battles, recent legislation enacted by Congress is also likely to have an effect on merger activity. For example, implications of the Affordable Care Act of 2010 will start to hit the health care industry as providers find ways to give better service while making more money, according to John Kimberly, a Wharton management professor."My guess is that it's going to come down to incentives for consolidation for the provider side of the industry, and what you are going to see is the creation of integrated care networks," he notes.
On the research and development side of health care, Kimberly expects more mergers and acquisitions -- especially global ones -- as companies are pressed to create new products. Indeed, for 2011, health care saw $228 billion of merger and acquisition volume globally, nearly the same as 2010, according to Dealogic, making it the fifth most active industry worldwide. In the U.S., it was the top industry for deals with $164 billion of volume. Express Scripts' pending deal to buy Medco Health Solutions accounted for $34 billion of that total, making it the second largest deal for the year.
Recent legislation is also likely to stir up more acquisitions in the financial services industry in the United States. The Dodd Frank Act of 2010 increased the regulatory burden for banks of all sizes, which may now prompt many companies to consider selling out or merging to achieve economies of scale. "The rules in Dodd Frank really encourage consolidation for the smaller players," Tiemann says.
Hrebiniak also makes the economies of scale argument for the mining and utilities industries as operation costs are expected to increase in both areas. The utilities and energy industries had $253 billion of merger and acquisition volume globally for 2011, up 20% from the previous year, Dealogic reported. This included the third largest deal overall: Duke Energy's January announcement that it would buy Progress Energy for $25.8 billion. Mining saw a similar increase, with $165 billion of total volume.
The technology sector should also continue its merger and acquisition streak, according to Tiemann and others. He notes that because technology is an industry that experiences constant change and development, acquisitions are expected to continue as smaller companies make it big with the latest innovations, and larger companies seek to expand their reach. In 2011, the technology sector saw a 44% increase in volume from the previous year to $222.6 billion in deals, according to Dealogic. And while the sector recorded average overall volume, the number of deals -- 5,795 --was far and away the most of any industry.
How to Move the Market
Regardless of the specific industry, experts agree that M&A growth in 2012 will be most plentiful in the U.S. In 2011, M&A activity in the country was up 18% from the previous year, topping $1 trillion in volume, and eight of the 10 largest deals involved U.S. companies. Despite the still recovering economy, Savor says that the United States will continue to dominate deals globally simply because -- together with Europe -- it typically makes up three-fourths of all global mergers and acquisitions activity. And with Europe's economy on much shakier ground, the U.S. is likely to be the main M&A arena.
As Europe digs out of a far-reaching debt crisis and continues to experience a very difficult borrowing environment, experts note that deal activity there will continue to be very sporadic. For all of 2011, merger and acquisition volume in Europe was up 4%, to $811 billion, compared to the previous year. However, it was down 25% when comparing the fourth quarters of both years, according to Dealogic. "My sense is there is a lot of pent up M&A activity, and my guess going forward would be that levels are going to pick up in the U.S.," Kimberly says. "But it's not going to pick up in Europe bcause [that region] is still struggling."
Tiemann notes that China will also be a "big player" when it comes to mergers and acquisitions, adding that the government recently added $30 billion to the Chinese Investment Corp., a state-run fund that invests in companies around the world. In 2010, China had $188 billion of deal volume, up 5% from 2010, making it a very distant second to the U.S. when it comes to country rankings for merger activity.
The emerging markets are also places to watch in 2012, Tiemann adds. He notes the growing number of private equity funds in Brazil that are looking to buy companies in other parts of the world. In 2011, Brazil was the seventh most active country for deals, with $83 billion of volume, although it was down 45% compared to the previous year. Overall, emerging markets saw a 17% decline in mergers and acquisitions from 2010 to 2011, Dealogic reported. According to Tiemann, this is partly because there is more local competition in emerging markets, which means that global interest in these areas has leveled off. "The story around the emerging markets is how much capital is flowing out of these countries," Tiemann says. "It used to be how much was flowing into them."