It’s been said many times before, but 2014 may well be seen as the year in which the mergers and acquisitions market returned to its previous levels, at long last. The deals being done are not necessarily the type or size we saw before 2008, so investors will need to consider their options if they intend to jump back into the fray.
The M&A market is on the move. According to Mergermarket, global M&A was valued at US$599.1 billion in Q1 2014, up 33.2 percent from the same period last year. The average deal size over the same period was US$ 374.4 million, 33 percent greater than in Q1 2013. A closer look at the figures reveals an interesting trend: deal volume is slightly down, but deal value is up.
Fewer, bigger deals imply that investors are moving away from opportunistic purchases and focusing on larger, longer-term plays. For Oliver Brahmst, a partner in White & Case’s M&A practice group in New York, the reasons behind these trends are clear.
“On the buy side, the main driver of M&A in the past two to three years has been private equity (PE),” he says. “These players have a trillion dollars in equity to invest. Add a couple of trillion dollars of debt to that, and you’ve got a US$3 trillion war chest.”
But now, with strategic investors returning to the market to make acquisitions, it’s a very different picture from just a short time ago, as Brahmst points out: “Six months ago, the CEO of a public company or an aligned strategic company may have been hard pressed to say where his customers would be coming from 12 months out. There was a lot of global uncertainty: political divisions in Washington, DC, issues in the EU, volatility in North Africa and the Middle East. For most of 2013, strategic investors were rather shy of stepping fully into an M&A deal.”
On the sell side, IPO markets are experiencing increased activity from PE investors looking to exit.
“Due to historically high valuations, there’s no reason to think it’s not going to be a good year for PE exits into the public markets, even if the trajectory of stock market gains of the recent past does not continue,” Brahmst adds. “Valuation levels are so attractive that PE firms don’t mind continuing to have part of their investment tied up in the public company.
“On the trade sale side, many people in the market—including PE professionals—have told me they are going to sell as much of their investments this year as they can, because valuations are again very, very favorable, and debt markets support them,” he says. “It’s clearly a seller’s market right now, so I expect the trend of increased exits will continue.”
While PE is driving much of this activity, strategic investors remain a vital part of the story. According to Chris Stadler, managing partner at CVC Capital Partners Advisory, there has been an increase in M&A activity from corporates over the past 12 to 24 months—“one reason for the emphasis on M&A is the need to augment rather anemic organic growth. As a result, companies that are in a good position with their capital structure would certainly have the wherewithal to do it, so the corporate side is significantly deep here, and I think they have sufficient cash. Corporate balance sheets around the world are in great shape, and they have access to cheap funds.”
However, Stadler points out that doing deals is never straightforward for strategic investors: “Everything has to line up, it has to be the right time to do a significant deal, and they have to feel good about the integration. They can often be more conservative, due to the fact that the businesses need to be operationally and culturally integrated, and most corporates don’t like to give away their synergies in the form of a higher price.”
Brahmst agrees that strategic investors do struggle to match PE for speed and agility when doing deals. He adds that strategics can find themselves on the losing side of an auction process because of sellers’ concerns about a prolonged or ultimately failed sale due to regulatory issues the strategic bidder faces, such as antitrust approvals, an issue that PE houses that do not bid with a strategic, or through an existing portfolio company, do not have.
“Strategics loathe signing onto a covenant that requires them to do whatever it takes, including divestitures, to get a deal through the antitrust authorities. If there are real antitrust issues in a proposed transaction, the strategic buyer’s ability to pay a higher purchase price, because of the realization of synergies, may be outweighed by perceived deal uncertainty on the antitrust side.”
Watching the horizon
Even though we are not yet entirely out of the woods, both New York and London emanate optimism over the future of the M&A market. Mark Dickinson, a London-based PE veteran most recently at investment firm Arle, believes the economic data is encouraging.
“If you look into Europe, particularly the UK angle at the micro-level, the economic recovery does genuinely seem to be on the way,” he says. “Inflation is steady, and unemployment is down. But when you go into Europe and see some of the issues being drawn out around national debt, it’s going to take a long time to resolve. Despite that, confidence seems pretty high at the moment.”
The signs remain strong that M&A recovery is ongoing. The growth in dual-track processes suggests that vendors are increasingly using IPOs as a pressure point to increase the valuation for the trade sale.
In a dual track deal, the seller prepares the companies for a trade sale and an IPO. In doing so, Brahmst says, “they’re telling bidders that want to buy the company as a whole, that they had better come with a valuation that approaches public market multiples, otherwise they will just take the company public. It’s an additional arrow in their quiver to get a good price, even in a seller’s market.”
Europe also offers increasing opportunities in distressed or restructured assets whose owners need to exit in the near term. Ian Bagshaw, partner and co-head of White & Case’s EMEA private equity group, notes that “southern Europe is attracting a lot of US investor attention at present, much like Ireland did two years ago.” Investors in these markets tend to be more opportunistic, and the greater risk allocated with these economies and businesses is “particularly attractive” to alternative capital providers in the United States.
“These types of investors are a new force emerging in European leveraged M&A,” Bagshaw adds.
“I’m convinced that many in PE believe it’s a good time to exit their existing assets: they’ve held on to them for a long time, perhaps longer than they originally anticipated,” says Dickinson. “Now you’ve got corporates that have money on their balance sheets and low levels of debt—they can afford to go shopping— and a red hot IPO market (albeit one that has cooled a bit in the past couple of weeks), a strong debt market and PE houses with plenty of dry powder.”
“It’s an exciting time,” agrees Bagshaw. “I’ve not seen a market as dynamic as this in years. One thing we should see in the next 12 months will be the strength of the local banks throughout the United States and Europe especially. If you look at the London market, it’s not great for traditional finance, so anyone looking to raise finance now might be better off looking in the local market of the target asset.”
Bagshaw recounts a recent deal in Poland that involved raising nearly a billion euros with three Polish banks: “There are privately placed bonds happening, so you can see that alternative financing structures are becoming more popular, and those local banks are central to local deals, especially in central Europe and the Nordic regions,” he says.
Of course, all this activity and optimism will be more evident in certain sectors than others. The perennially attractive sectors—healthcare, telecoms and media—will certainly expand to include energy.
“There’s been a lot of private equity money going into that sector and will continue to do so,” says Dickinson.
Whatever happens, the signs seem to be clear: capital markets, the PE industry and the IPO market are all open for business. Given all that, the remainder of 2014 should be anything but quiet.