Submitted by PricewaterhouseCoopers
NEW YORK, NY – December 12, 2011 – Volatile equity markets slowed mounting U.S. deal activity in the third and fourth quarters, following growing deal momentum in the first two quarters of 2011. In light of concerns over European debt and a pullback in financing, U.S. merger and acquisition (M&A) activity in the second half of 2011 was driven by well-prepared dealmakers focused on executing acquisitive growth strategies and availability of businesses with strong fundamentals– a key trend expected to continue into 2012, according to PwC’s Year-End U.S. M&A Outlook.
Should current macroeconomic conditions and limited financing persist into the new year, U.S. M&A activity will remain steady with continued activity while some dealmakers with capital stay on the sidelines. However, if the lending environment eases and access to capital becomes more readily available, PwC expects dealmakers in “wait and see” mode to unleash a wave of pent-up demand that will result in an uptick in deal activity in 2012.
Steady deal activity
“Despite lingering concerns for the global economy and financing obstacles, there continues to be a steady pulse of deal activity in the U.S. through the second half of the year from both corporate and financial investors. The ‘hunt for growth’ remains a top priority for corporates of all sizes, while private equity also continues to put capital to work at higher levels than last year. Looking ahead to 2012, there will be a greater focus on being able to navigate global market conditions and having more certainty around final deal outcomes,” said Martyn Curragh, U.S. transaction services leader with PwC. “We’re also continuing to see buyers look towards the emerging markets, such as Brazil and China where local economies are in an upward cycle.”
According to PwC, the pace of deals is bifurcated. Sellers are looking for both speed and deal certainty, while simultaneously pursuing various alternative options and scenarios through the full deal timeline to maximize the value of the asset. With sellers in the driver’s seat, buyers must remain poised and ready when deal negotiations continue for a prolonged timeframe. Building stronger M&A processes, strategies and capabilities will enable buyers to capitalize on fast-moving deals and monetize new assets quickly after deal close in today’s volatile markets. PwC’s Curragh continued, “Savvy buyers and sellers that thoroughly prepare for and understand every option will be the most successful in executing on growth objectives and deal strategies.”
Corporates continue to grow cash reserves – almost reaching $1.5 trillion as of November 30, 2011. Shareholders expect this cash be invested or returned through dividends in the future. With bank lending tight, strong balance sheets and cash on hand have given corporate buyers an advantage over financial buyers in being able to move quickly on competitive assets.
Emphasizing due diligence
“With ongoing imperatives for growth and limited opportunities to do so organically, corporate buyers are doing more work earlier on in the deal process to ensure M&A success in today’s deal market. More than ever, corporates need to be nimble, agile and better-prepared to mitigate risks,” added PwC’s Curragh. “By strengthening corporate deal skills and applying more intense practices around front-end due diligence on synergy validation, integration, operations and IT, corporates will be in a better position to ensure successful outcomes and prepare for future deal activity.”
The proportion of divestiture volume to total disclosed deal volume continues to increase to 36 percent in 2011, reflecting corporate efforts to divest orphan or non-core assets to unlock shareholder value and free up cash for other acquisitions. Additionally, corporate spin-off volume has increased from 46 in 2010 to 67 in the last twelve months (LTM) to November 2011. Sellers, especially those preparing for divestitures and spin-offs, will need to thoroughly vet every aspect of the asset from financials to operations to ensure there are no surprises or potential issues that could derail their strategy and damage their commitments to shareholders. According to PwC, in doing greater sell-side diligence, sellers can facilitate a smoother sale, with the ability to better communicate the company’s story and improve financing opportunities for potential buyers. This is critical in today’s market given the sensitivity of buyers to financial and operating risks and the scrutiny on financial results by financing sources in an environment surrounded by economic uncertainty.
Using less leverage
Private equity buyers are putting more capital to work with less leverage (equity contributions as a percent of private equity deal value increased from 38 percent in 2010 to 40 percent in 2011), while at the same time looking to exit aging portfolio companies that are past their investment periods.
“Choppiness in the U.S. equity markets has created limited visibility for IPOs, removing a potential exit option for private equity funds, but creating opportunities for sales to corporates or to other private equity firms in some cases. Although dry powder has declined since 2009, there is still abundant dry powder to fund private equity acquisitions,” said Tim Hartnett, U.S. private equity leader with PwC’s Transaction Services practice. “Private equity players have shown savvy in their ability to get deals done with tight lending conditions, resulting in continued deal flow. However, once bank financing eases – which is more a question of ‘when’ – we expect greater private equity activity driven by pent-up demand.”
The majority of IPO activity and value year to date has been largely driven by financial sponsors. The IPO pipeline remains robust with several high-profile IPOs expected to come to market in the near term, many of which are private equity-backed.
Middle-market deal volume and total value has declined slightly from 2010 to LTM November 2011, but EBITDA multiples are at the highest levels in the past 10 years. According to PwC, this reflects strong demand for financeable targets of middle market private equity funds (where financing liquidity is available) and strong business fundamentals that exist at middle market targets. According to PwC, private equity middle market deals are being driven by both initial fund level investments, as well as bolt-ons to existing portfolio companies.
Fundamentals in certain industry sectors are likely to continue to drive deals in 2012. Industrials saw a shift in preference toward smaller, bolt-on, niche transactions, and away from larger, more transformative acquisitions; yet those with solid balance sheets, combined with prospects for growth in emerging markets, present an outlook for 2012 that is cautiously optimistic. The Financial Sector continues to navigate structural and regulatory changes which will continue to drive activity in the coming year.
Sectors ripe for consolidations in the year ahead include:
Retail & consumer products –The retail and consumer (R&C) sector will continue to see its share of deal activity following a year where global R&C deal value in emerging markets nearly doubled, and grew from 22 percent of total R&C deal value in 2010 to 29 percent of total R&C deal value (year-to-date as of October 2011). Consumer goods and the food/beverage subsector in particular will be active in the year ahead, notably in higher growth areas such as private label food and emerging markets. PwC expects this trend to continue with a number of businesses who will restructure their operations, and either spin-off or divest of non-core product segments in the process.
Technology – For more than a decade, M&A volumes in the technology industry have led all other sectors – a trend PwC expects to continue into 2012. PwC sees three broad dynamics driving the increase in deal activity for technology: (1) enterprise vendor consolidation, (2) convergence of computing, communications and entertainment on consumer devices, and (3) the disruptive impact of cloud computing. In addition, high liquidity and generally lower debt positions of the leading technology companies have and will continue to enable them to navigate difficult credit markets in the face of global economic uncertainty. Key sectors to watch for deal activity include storage, mobile devices and social networking.
Energy and power – In the last year, U.S. oil and gas deal activity was centered primarily around the major shale plays and the otential of shale gas/liquids to revolutionize the industry and U.S. oil and gas exploration. PwC expects that trend to continue as upstream companies, both domestic and foreign, look to increase their shale positions and oil field services companies look to service the expanding exploration activities in these new regions. Favorable liquids pricing will likely result in large national oil companies and global integrated oil companies pursuing acquisitions and increasing exploration budgets. This should also drive M&A activity and capital spending in the midstream, downstream and oil field service sectors.
Private equity involvement will accelerate in upstream, midstream and oil field services, especially in the middle market, as favorable commodity pricing outlooks and shale activity make the industry more attractive. Currently, low U.S. natural gas pricing makes it likely that investors with a long-term outlook may view U.S. natural gas properties as attractive investments. Meanwhile, power and utilities (P&U) deals are being deferred until the capital markets settle down. However, several fundamental factors should continue to drive P&U transactions into 2012 as financial markets, regulatory and legislative actions and economic outlooks stabilize.
Healthcare & pharmaceuticals – Healthcare reform, new models of care delivery, and the struggling economy have all been credited with causing significant consolidation in the healthcare arena. Convergence among payers and providers has uprooted legacy business models and opened up new opportunities for the sector to build scale and eliminate inefficiencies in the value chain that were previously inaccessible. Pharmaceutical companies are likely to continue to reshuffle their portfolios. Divestitures of non-core assets will be driven by the need to unlock value and focus on pharmaceutical assets, freeing up capital for acquisitions of new technologies and broader portfolios of products and/or new offerings that can leverage existing distribution networks. Pharmaceutical companies will also keep a keen eye on opportunities for deals in emerging markets that will
help expand global reach. Private equity will also continue to play an important role in healthcare M&A activity across all sectors – payer, provider, pharma, and life sciences. As private equity investors screen the global economy for growth, healthcare emerges as a rare bright spot, according to PwC.
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