The appetite for M&A is growing again as cash-rich corporates and private equity firms seek to capitalise on the increased realism from vendors concerning pricing and valuations. That said, it’s probably too soon to think we are returning to the giddy heights of 2007 as the emphasis for dealmakers remains very much on quality and delivering long-term value to investors.
John Bishop, Non-executive Director of the insurance firm Berkshire Hathaway International, says: “Confidence in the market will largely determine your appetite for acquisitive growth, but provided you are not squeezed with low interest rates there are opportunities. From the perspective of the insurance industry, the market is difficult at the moment. We are in a down cycle and the simple truth is that growing organically is unlikely to be profitable. The corporate sector has strong balance sheets and, if there is an opportunity to get scale, bargains can be seized upon.
Carlos Keener, an M&A expert and founder of the corporate finance firm, Beyond the Deal, comments that investment banks and corporate entities are predicting global deal volumes to exceed $3 trillion this year as opposed to approximately $2.25 trillion in 2010, driven largely by a recovery in the global markets alongside the availability of distressed assets going cheap. “Key areas of activity being talked up by the M&A community are said to be energy, natural resources and, of course, Asia, especially China. Competition for quality assets in emerging markets, as well as more developed ones, will be increasingly fierce,” he adds.
Geraint Anderson, CEO of TT Electronics plc, says: “The conditions are ripe for M&A. Many companies have been putting their house in order since the recession and are now sitting on very healthy balance sheets. They either have to give the money back to shareholders through increased dividends or share buyback schemes or use their balance sheet strength to acquire. We are seeing all three today but, with the focus back on growth, companies are going to be put under pressure to acquire – particularly if they are in sectors with little obvious organic growth.”
It may be tempting to hope that we are now heading into a phase of steady economic recovery, but the business climate remains unstable and unpredictable. For Carlos, confidence is fragile, especially as inflationary pressures mount and market shocks – from Eurozone debt to geo-political upheaval to commodity price spikes – contribute to the atmosphere of uncertainty.
Aleen Gulvanessian, a partner at the international law firm, Eversheds, agrees: “An increase in acquisitions owing to diversification is unlikely as cash is still king and companies have been using it to reduce debt or return money to shareholders…Although opportunistic buyers are scarce, there are strategic buyers out there, provided they have, or can raise, the cash. Boards will be keen to do deals if the pricing is right. As things stand, pricing expectations continues to be an issue both for buyers and sellers – if this is overcome, then M&A activity will increase.”
Private equity firms, many of which are under pressure to invest funds before raising any new money, now sense that the time is finally right to enter the fray for deals. Aleen adds: “The last year has seen an increase in the auction process for M&A as very few deals are now agreed privately. This has had the effect of fewer trade buyers as they do not wish to spend significant time and money on abortive transactions. For PE houses, though, bidding for deals is their bread and butter – I have been involved in a number of auction processes recently when more than 90 per cent of the bidders have been private equity firms.”
In a sense, M&A has returned to a back-to-basics philosophy – no bad thing after the over-leveraged, syndicated debt of yester-year. Siva Shankar, Corporate Finance Director at commercial property and investment company, SEGRO plc, says: “Compared to pre-crisis times, M&A seems to be less driven by financial engineering and more by strategic fundamentals such as increasing economies of scale, eliminating competition, gaining access to new markets and new product lines.”
Moreover, the margin for error when executing a takeover or merger has to be almost zero. Siva continues: “Doing a deal is the relatively easy part; the difficulty is in successfully integrating the target and delivering the planned revenue and cost synergies. Many studies have shown that it has always been challenging to deliver value from M&A, but that there are some organisations that consistently deliver value, partly due to the military discipline that they apply to their M&A process.”
There will always be an element of risk when acquiring another organisation, not least in regards to cultural fit. What has fundamentally changed in the current climate is that the bullish approach to dealmaking, whereby a company or private equity firm will buy-and-build solely for the sake of achieving scale as an end in itself, has gone (until the next economic boom, at least). According to Carlos, if a deal is to be executed in the current climate, there are a number of steps which companies have to to bear in mind to avoid any potential pitfalls:
- Do your homework – Due diligence must comprehensively kick the tyres on (or if possible, disregard entirely) any vendor-provided estimates of future market potential.
- Don’t count on the market to bail out a bad integration. Countless acquisitions in the past have ultimately relied on steady, long-term market growth to deliver acquisition business cases, even when the integration itself did not. This is one trick that can no longer be relied upon.
- Highly-leveraged cash deals will remain high-risk for some time to come if such debt is contingent on base rates or currency fluctuations.
For Siva, there are a number of other equally crucial areas to assess the future impact of a deal on an organisation. These include:
- Agree ‘non-negotiables’ with the Board early on in the process. Document these and ensure that any pushing of the boundaries during the deal process has ongoing Board discussion and approval.
- Ensure that a C-suite executive is an integral part of the team responsible for post deal integration and the generation of revenue and cost synergies.
- Encourage contradictory viewpoints throughout the deal process and, even at the final signing stage, bring in a ‘three reasons why we must not do this deal’ session at Board level.
Deal or no deal
In the aftermath of Lehmans, there was a brief surge in accelerated M&A and a series of opportunistic, distressed purchases. This has continued up to a point, but a more cautious, sensible attitude has emerged as Boards opt for that approach of ‘military discipline’ when assessing the virtues and value of a deal. Eversheds’ Aleen comments that “2010 has seen fewer of these transactions” although she goes on to suggest that “if the market appears steadier, those who have been sitting on potential sale assets may have the confidence to sell.”
The prevailing mood of caution is preventing a return to what some have called a ‘golden age’ for M&A of a few years ago. “Companies have learned the lessons from the past,” says Geraint. “Deals will be done when the conditions are right and returns can be justified; shareholders are demanding that this is the case. Companies need to have a clear strategy and look for a clear strategic fit with the company they are looking to acquire.”
Ultimately, an acquisition is deemed successful when it sustainably generates a return on investment greater than the cost of its financing. What may be reassuring for dealmakers in the current environment is that transactions are occurring at the sweet spot for deals in the economic cycle. Siva explains: “It’s the period between the cyclical trough and mid-point, which helps acquirers have the wind in their sails as the extraction of anticipated revenue and cost synergies tends to be easier during a cyclical recovery.”
Given the high-level of scrutiny from acquirers, not to mention financiers, if third-party leverage is deemed necessary, riskier transactions are quite rightly not going to get the green light. Siva certainly thinks this is the case: “The current uncertain environment actually makes it less challenging to do successful M&A. This may feel counterintuitive, but my reasoning and personal experience is that the feeling of uncertainty forces organisations to apply even greater rigour to their M&A process, and thereby increase the odds in favour of doing successful acquisitions.”
John from Berkshire Hathaway says: “If costs are reasonably flexible, you can do it. Essentially, the opportunities are there, provided you can buy something that represents value…But I don’t expect a return to the perceived golden days of gung-ho multiples driven by financial engineering.”
So, we may not be witnessing a deluge of buy-and-build M&A activity in the near future, but deals will definitely be done as ambitious companies with well-thought out strategies for growth seek to gain market share from their rivals.
After all, no business can afford to stand still for too long.
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