Cautiously optimistic – the M&A outlook for 2013

March 2013 | FEATURE | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

Across the markets, merger and acquisitions (M&A) activity in 2012 was subdued, and it is fair to say that the sluggish nature of the markets last year was caused by a number of factors. The eurozone crisis rumbled on, destabilising the region’s markets. Growth in the emerging markets –

formerly the darlings of the economic world – continued to stagnate. The US economy, much like the country itself, endured a particularly tumultuous year.

Regulatory and political uncertainty, largely brought about by the Presidential election, domestic natural disasters, and the confusion caused by the so-called ‘fiscal cliff’, all combined to muddy the waters in the US. Indeed, KPMG’s 2013 M&A outlook survey notes that in 2012, US M&A deal value decreased by 4 percent from 2011. The first three quarters of 2012 alone saw deal volume drop 9 percent and 18 percent in terms of global deal volume.

However, KPMG’s report tells us that many analysts and executives now believe that although 2012 was a mixed bag at best, “M&A will increase going forward”. Therefore, we should see M&A activity rebound nicely in the years ahead.

KPMG’s report, which surveyed over 300 M&A professionals in the US, notes that despite the many uncertainties surrounding the global economy, “the current economic environment appears relatively resilient”. Business membership group and research organisation the Conference Board in the US supports this claim. The group reported in January that consumer confidence had risen to 73.7 percent in November 2012 – its highest level in four and a half years (though this number fell drastically to 65.1 percent in December as a consequence of fears surrounding the impending fiscal cliff).

According to KPMG’s data, there seems to be a burgeoning consensus among respondents that suggests the environment for M&A deals is improving. Sixty percent of survey respondents feel that the overarching factor expected to drive deal activity in 2013 is the existence of large cash reserves. Although deal sizes are expected to remain on the smaller side, the sheer abundance of capital that many firms are sitting on makes it highly likely that the M&A market will pick up this year. Dan Tiemann, Americas Transactions & Restructuring Lead for KPMG, suggests that “financing conditions continue to be positive. Many companies are holding large amounts of cash”.

Increasingly favourable credit terms, increased opportunities in emerging markets and improved consumer confidence will all contribute to the increased optimism surrounding the M&A deal environment, according to KPMG. The steadily improving US economy will also help to stabilise the markets and hopefully drive activity in the year ahead. A key indicator of the growing confidence in the US can be seen in KPMG’s report: the data suggests 76 percent of respondents anticipated that their company will make at least one acquisition in 2013.

While it is very difficult to predict exactly what will happen in the coming months, there does seem to be genuine optimism surrounding M&A in 2013. However, while analysts may agree on the possible outcome, there remains some disparity over what form the resurgence will take. RR Donnelley’s Venue Market Spotlight report ‘2013 M&A Outlook’ similarly suggests that the M&A market will recover in 2013, yet the two reports differ in where they see the key areas of growth occurring, both geographically and in terms of industries.

Growth sectors

According to KPMG’s report we are likely to see growth in three key sectors. Most notable of those is the software, telecommunication and technology sector. Thirty-nine percent of KPMG’s respondents felt that they would be active in this particular sector of the market. Early signs in 2013 have supported this assertion. The $24.4bn leveraged buyout of Dell by its founder Michael Dell and his private equity partners Silver Lake, along with the $23.3bn takeover of the Virgin Media group in the UK by international cable company Liberty Global, both suggest that M&A in the technology sector may be on the rise. Both deals were announced within days of one another in February and, if completed, would represent two of the biggest deals undertaken since the onset of the financial crisis in 2007.

The healthcare and pharmaceuticals market is also expected to be a key area of growth in 2013. While the industry may have seen the end of blockbuster pills, niche drugs and treatments for rare conditions are due to drive up prices.

The adoption of ‘Obamacare’ will be a force behind M&A during 2013. The coming months will see greater clarification of precisely what Obamacare will mean for the healthcare industry, however healthcare reforms will bring new regulatory and tax obligations for companies. A new 2.3 percent excise tax contained in Obamacare will lead to a more difficult operating environment for smaller medical device companies in particular. Unlike federal income taxes, which are assessed after expenses and interest, this new tax will be based on revenue.

The increased pressure imposed on companies by the new tax obligations will undoubtedly lead to more small to mid level buyouts, as healthcare services, distributors and manufacturers are forced to seek strategic partners. Korean technology giant Samsung Electronics has been making big strides into the medical equipment sector. In January it acquired NeuroLogica, a US based producer of medical equipment, for an undisclosed sum. This represented the company’s third acquisition in the healthcare sector since 2010.

Marc Moyers, national sector leader for private equity at KPMG, notes that “the constantly evolving world of technology and investment opportunities that arise as we get more clarity around Obamacare will create attractive opportunities”.

The third most likely area for growth according to KPMG is the energy sector. The ongoing shale gas revolution should help drive down energy prices across the board. Readily available, cheaper gas has the potential to drastically alter the energy supply chain, which in turn will cause businesses to re-evaluate their energy and growth prospects in the future. Furthermore, the maturation of the solar energy sector in 2012 will also help drive M&A activity in 2013. Thirty percent of respondents surveyed felt that energy would be the industry in which the most activity is recorded.

The Venue report, on the other hand, suggests that the key growth area in 2013 will be the energy sector. Eighty percent of respondents expected to see the most activity in this sector. The report states that the energy sector “continues to be the rock for global M&A, remaining a resilient source of deal-making”.

Furthermore, the Venue report suggests that “energy is expected to lead as the sector with the most attractive targets in the year ahead. New exploration and production projects in the Americas and the increase in demand from the middle class growth in emerging markets have made energy prime space for deal-making worldwide.” The energy sector is seen by many analysts as vital for M&A in 2013 and beyond. Valuations are attractive in this area, leading to greater margins of safety.

The Venue survey does support KPMG’s findings in some ways. Respondents also cited the developing shale gas industry as a leading driver of M&A activity in 2013.

The industrials and chemicals industries (with 33 percent of respondents) and the pharmaceutical, medical and biotechnology sectors (also with 33 percent) complete the top three most attractive M&A industries, according to the Venue respondents. An Italian senior M&A associate notes that “industrial companies spent the last few years restructuring operations and ramping up productivity, which has left them with significant cash reserves on their balance sheets. As output is also stabilising, the M&A environment looks promising for industrials looking ahead.”

North America and the emerging markets lead the way

Seventy-three percent of KPMG respondents expect North America to be the most likely deal destination. Twenty-eight percent of those surveyed expect Western Europe to also provide an attractive destination for potential M&A deals, particularly in the distressed sector. “North America’s relative fiscal health and recovering consumer markets make it a popular investment destination. The European debt crisis will also create investment opportunities, especially in the distressed sector,” said Marc Moyers of KPMG.

The Venue report, however, while acknowledging the importance of the North American market, feels that the emerging markets will once again rise to prominence in 2013. Seventy-three percent of respondents said the Asia-Pacific and Latin American regions in particular will “be home to the most attractive M&A targets”.

Caveats

Although there is cautious optimism surrounding the M&A market in 2013, there are still a number of caveats which must be considered. Lingering recessionary fears and slow growth environments were reported by many respondents to the KPMG report as being the biggest potential roadblocks to M&A recovery. Additionally, uncertainty surrounding impending tax code changes could inhibit M&A growth. Furthermore, apprehension surrounding the current European economic condition may negatively impact upon firms’ willingness to complete deals. Regulatory considerations were another area of concern for dealmakers.

One issue on which both reports appeared to agree was the importance of completing an appropriate level of due diligence. The volatility of future revenue streams, the quality of a target’s earnings, revenue and cost synergy analysis and issues surrounding the cultural assessment of the target, are all vitally important in today’s M&A environment. Tax issues and implications must also be thoroughly considered as part of the due diligence process.

Cautious optimism

While considerable uncertainty still surrounds the M&A market, green shoots of promise are beginning to show. The M&A marketplace has been challenging in recent years but global economic prospects are beginning to turn around.

The European debt crisis is abating, aiding the stabilisation of the continent. Meanwhile the US economy, fresh from increased levels of certainty surrounding new fiscal and tax policy, is continuing its modest recovery. These factors and others have led to greater consumer confidence. As this process continues, the M&A market should continue on its road to recovery.

The majority of respondents surveyed for both the KPMG and Venue reports feel that their firms will seek growth through acquisitions in 2013. With vast quantities of capital lying in wait, and the increasing accessibility of favourable credit terms (high-yield debt, investment-grade debt, and even bank debt) it seems entirely possible that, for M&A activity, 2013 will be a turning point.

Richard Summerfield