US M&A fueled by corporate and cross-border activity
public-to-private transactions on hold
(NEW YORK) December 12, 2007 ―
M&A activity in 2008 will be dominated by corporate and foreign buyers and the middle market will continue to be active, according to the Transaction Services group of PricewaterhouseCoopers. “The era of public-to-private transactions is on hold for now. However, the downturn in mega-deals by private equity will be offset by an increase in international buyers coming into the US to take advantage of a continued weaker dollar. We also believe that more traditional private equity transactions will build momentum as 2008 progresses. We expect financial markets to quickly respond to put liquidity back into more balanced leverage lending,” said Bob Filek, a partner in PricewaterhouseCoopers’ Transaction Services group.
As of September, total troubled commercial loans at banks continued to be at record lows, and available cash (cash and short-term securities) at S&P 500 companies totaled $1.7 trillion, up from $1.6 trillion at the end of December 2006 (Bloomberg). Should rates of troubled commercial loans at banks hold steady and the credit overhang works its way down, Filek predicts that savvy corporate buyers and a few nimble private equity funds will take advantage of a lull in M&A activity to lock down transactions. “The core fundamentals of corporate borrowings on the leverage market are solid relative to historical standards. Leveraged lending caught a cold from the sub-prime mortgage market.”
According to Thomson Financial, announced US activity through November 2007 totaled $1.5 trillion compared to $1.3 trillion for the same period in 2006, a record year for M&A deal value and volume. Although activity by financial buyers has fallen dramatically in the fourth quarter, it has been offset slightly by growth in activity by strategic and foreign buyers. As we look back on 2007, private equity was the headline maker grabbing roughly 39%―up from 35% in 2006―of the US deal value. Besides private equity, international buyers have been busy acquiring US targets. For the first 11 months of 2007, cross-border deal value was $354 billion, representing 23% of the US total, a 73% increase from the annual 2006 cross-border deal value of $204 billion. Greg Peterson, a partner in PricewaterhouseCoopers Transaction Services foresees that cross border activity will be strong in 2008.
“We are likely to see buyers from Asia and the Middle East acquiring assets in the US and Europe, as they are not as tainted with the financial instability that the US and Western Europe are experiencing,” said Peterson. “The robustness of Asian and Middle Eastern economies, whether its government-sponsored money or oil revenues, will drive more investments in these markets. The US is particularly attractive because the US dollar is at an all-time low.”
Large deals dwindled in the second half of 2007; however, the middle market barely missed a beat. According to Thomson Financial, US middle market activity (deals up to $1 billion) stood at $355 billion, 23% of the US total, at the end of November. 2007 activity is set to eclipse that of 2006 and all indicators point to an active middle market in 2008.
“The middle market has exploded this year, a continuation of a trend that we have observed over the last few years. Financing for the middle market deals is generally not syndicated resulting in a different risk profile for the banks,” stated Peterson. “Financing middle market deals is also appealing because their businesses are predictable. They are close to their customers and their markets, making companies in this category inherently excellent risk managers.”
“In 2008, with private equity on the sidelines, strategics will be in the driver's seat. In early 2008 private equity firms will still be preoccupied with deals they committed to in 2007. Of the $350 billion to $450 billion credit overhang reported early in the second half, approximately $245 billion ($145 billion in debt and $90 billion in bonds) is left,” said Peterson. He forecasts, the backlog could clear during the first quarter of next year, and the marketplace will likely start to reset itself. “History shows us that it is during these times of uncertainty some of the best deals are done by private equity and corporate buyers. The key to the market returning will be seller's pricing expectations and liquidity,” Peterson added.
Most industries have benefited from an active M&A market in the last few years. However, activity has retrenched in the last few months and certain sectors will see less activity in 2008. Sectors that continue to present opportunities include…
- Energy―The energy sector continues to attract private equity capital across all sub-sectors as a result of strong commodity prices plus the major energy companies' increasingly narrow focus on reserve replacement. Equipment and service companies will seek acquisitions outside the US as they adjust their portfolios to geographic shifts in exploration and production spending. Continuing consolidation within the equipment and service industry is likely although major deals will still face technical challenges (i.e., relative valuations, anti-trust, Foreign Corrupt Practices Act considerations). Master limited partnerships will remain cautious about transactions until valuations, particularly in the midstream, return to more reasonable levels.
As for power and utilities, the capital needs of the industry to fund needed investment to replace an aging infrastructure and to comply with changing environmental regulations will create acquisition opportunities for private equity, domestic and international infrastructure funds and other financial participants. The ongoing implementation of renewable portfolio standards at the state levels will continue to create acquisition opportunities. Obtaining the approval of the state public utility commissions remains a significant obstacle for corporate transactions involving regulated operations.
- Pharmaceutical/biotech―Companies in the industry are faced with lack of new blockbuster drugs in their pipeline, patent expirations, increased generic competition and heightened government scrutiny on drug safety and approval. To cope with these challenges, pharma companies will continue to restructure and streamline their operations and divest non-core assets. They will also turn to acquisitions as a means to fill drug pipelines and drive growth, with a focus on biotech companies with promising drug pipelines.
- Financial services―Sub-prime mortgage and collateralized debt obligation exposures faced by financial institutions continue to cause a negative wave through the industry. As financial companies address their liquidity, rating, regulatory and shareholder concerns, opportunities will be available for investors. Opportunistic market leaders and investors will take advantage of the ripple to consolidate under-performing entities in consumer finance and regional banking. Watch for momentum in this area to grow as 2008 progresses.
- Technology―Customer driven vendor consolidation continues to drive activity among enterprise hardware and software providers, though remaining consolidation plays are progressively getting larger. Transition to service-oriented architecture will lead to growth-oriented acquisitions as existing software companies acquire platforms to leverage intellectual property and customers. Convergence in voice, video and data services will continue to drive deal activity in networking and communications equipment providers and online services. Other key trends include more global activity across all three major geographies and increasing divestitures as slower growing companies rationalize their portfolios.
- Media and entertainment―Technology continues to create convergence among the various outlets for content aggregation and consumption, providing media companies and advertisers with new and potentially profitable opportunities. While private equity buyers are expected to show continued interest in this industry, we believe that the trend of increased corporate activity during the past two years will continue.
- Consumer Products―In an ever-consolidating retail environment, companies in this space will look to divest and cull orphaned brands and acquire higher growth brands, with a strong focus on emerging markets.
Other factors influencing M&A activity in 2008 will include:
- Decrease in deal multiples―With the decrease in eligible buyers and less debt available, prices will go down. Several distressed companies will be picked up by savvy buyers. However, remember sellers are often slow to accept the realities of a downturn in pricing.
- Private equity and corporate strategic ventures―Combinations will continue to evolve where strategic buyers will seek out an acquisition and a private equity firm will supply the cash and know how in certain industry sectors or take on non-core aspects of the acquired entity.
- PIPE transactions on the rise―Private investment in public equity (PIPE) deals have increased over the last several years. In terms of deal value, 2007 is on track to best the 2000 high of $24.3 billion?$22.4 billion was raised in the first quarter of 2007 (source: PlacementTracker). Watch for the greater increase in the use of this investment vehicle by corporations to drive liquidity if the tightness in the debt market continues.
- Alliances and joint ventures back in favor―With emerging markets and supply chain integration high on strategic priority lists, watch for a return to joint ventures and alliances. While harder to execute, these structures are the tool of choice for aggressive growth oriented companies.
- Sovereign wealth funds to play an active role―Flushed with cash, these funds are on the hunt for investment opportunities whether they be direct investments in private equity firms or acquisitions. The tightening of the credit markets will afford these investors ample opportunities.
- IPO activity expected to be strong in early 2008. Financial sponsor-backed IPOs continue to grow―2007 IPO activity is on track to best 2006 results. Driving 2007 results are financial sponsored-backed IPOs. Of the 179 IPOs completed in the first nine months, 94 or roughly 53% were financial sponsored-backed deals (source: PwC US IPO watch). We expect the strong IPO market to carry into 2008 and financial sponsors to play a greater role.
How accurate was our 2007 forecast?*
M&A will set a record in 2007 so long as the “Goldilocks” economy continues
Economic factors, especially the credit crunch brought on by the sub-prime fall-out, upset the “Goldilocks” economy that was ideal for M&A transactions; none the less, we should be close to the record by year-end.
Healthcare, media, financial services, energy, technology and telecom will fuel M&A activity
The five most active sectors, measured by deal value, were consumer products, energy, financial services, industrial and technology
Private equity firms will continue to be a major player in the US deal market
Correct. Despite the significant decline in private equity activity at the end of 2007, for the first 11 months, these players contributed nearly 39% to total deal value, up from 35% for the same period last year, a record by all accounts. Despite the slow down in the fourth quarter of 2007, for the first nine months, there were 1,591 private equity transactions, up from 1,394 for the same period in 2006. (Source: Thomson Financial)
More public companies will choose to go private
Correct. The number of companies that went private has been increasing since the third quarter of 2005 and hit record highs in number and sizes of transactions in 2007.
Private equity will move into infrastructure
Correct. An increasing number of private equity firms had raised infrastructure funds. In August 2007, Reuters reported a dozen major infrastructure funds were raising at least $50 billion and were eyeing state-owned assets.
More money will chase the quality assets of the middle market
Correct. The average middle market EBITDA multiple for the last twelve months, as of October 15, 2007, was 10.3x, up from 8.6x for the same period in 2006. (Source: Thomson Securities Data Corporation)
The favorable lending environment should continue into 2007. However, delinquencies among sub-prime lenders could affect the broader market
Correct. The lending environment was favorable until August when the credit crunch stalled lending activity caused in part by sub-prime mortgage issues. The prevalence of CMOS and derivatives accelerated the drop beyond expectations.
Opportunities for continued consolidation in the automotive sector will abound for private equity firms and strategic buyers with strong balance sheets. Correct. 2007 included a break through event when a private equity fund acquired one of the big 3 automotive manufacturers.
*The accuracy of our previous forecast does not guarantee future accuracy.
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transaction services group of PricewaterhouseCoopers offers a deal process that helps clients bid smarter, close faster and realize profits sooner on mergers, acquisitions, sales and financing transactions. For companies raising money on US or overseas capital markets, we offer a strategic perspective, practical solutions and a holistic service approach that helps management anticipate and resolve a broad array of transaction, financial reporting, and registration process challenges before they can have a negative impact on deal value or timing. Our global network of over 4,000 transaction professionals and more than 400 capital markets specialists operate from 16 US cities and some 90 locations in North America, Latin America, Europe and Asia.
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