A confidence paradox – Canadian executives believe economy is improving, but remain cautious when it comes to M&A

(As originally published in the Financial Post, May 2013)

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By Tony Ianni, EY Partner and President of Ernst & Young Orenda Corporate Finance Inc.

Twice a year, Ernst & Young surveys senior executives from large companies around the world and across industry sectors to gauge corporate confidence in the economic outlook, understand boardroom priorities over the next 12 months and identify the emerging capital practices that will distinguish companies that build competitive advantage as the global economy continues to evolve.

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The latest results show a clear rebound in corporate confidence. In particular, confidence in credit availability has rebounded significantly.

But, while the fundamentals suggest that we should be seeing a lot of M&A, the reality is that increased confidence isn't translating into increased transaction activity. Instead, companies are focused on organic growth, and are taking a cautious approach to M&A — at least in the short term.

Fifty-six per cent of Canadian executives believe the country's economy is improving, up from only 29% in October, with access to capital, employment growth and corporate earnings all showing positive gains.

Meanwhile, 81% of Canadian respondents view the global economy as either stable or improving — up from a mere 35% in October 2012. We saw this improved sentiment across most countries. Even the U.S. — often an economic bellwether — has seen a significant improvement in its perspective on the state of the global economy.

In addition to their improved outlook on the economy, Canadian companies are more confident than ever about their ability to access the global credit markets. In Canada, 45% of respondents reported access to capital is improving, up from only 20% in October. Only 15% report a decline — the lowest level in two years.

According to global and U.S. respondents, we may be near an inflection point, with companies' large-scale changes to capital structure now nearing completion. Debt-to-capital ratios remain fairly constant today, but the appetite for leverage is expected to decrease among Canadian respondents, whereas global and U.S. respondents are expected to increase their leverage.

The mix of cash and credit to fund deals will move toward traditional levels as valuations start rising and companies gear up to do larger and more transformational deals that cannot be funded principally with cash. However, 42% of Canadian companies expect to decrease their leverage over the next year, raising the question of why more companies are not taking greater advantage of available credit.

For the next 12 months, the 23% of Canadian companies that plan to refinance debt say that in doing so, they will focus on retiring maturing debt and optimizing the capital structure (in non-stressed situations).

Almost half of Canadian respondents (49%) point to cash as their primary source of deal financing in the next 12 months. Despite abundant credit availability, just over one-third (38%) say they plan to use debt as their primary source. The predominant use of cash to finance deals may be indicative of companies' ongoing cautionary mindset and evidence of their need to deploy cash currently earning low rates of return.

The good news, though, is that with improved access to capital, businesses are in a better position to create jobs, invest in innovation and implement plans to grow.

In Canada, 37% of survey respondents expect their business to create jobs and hire talent. And when it comes to growth strategies, while fewer Canadian companies expect to pursue an acquisition in the next 12 months (33%, down from 44% in October and 48% a year ago), they’re more likely to exploit technology and develop new markets and products than their US and global counterparts.

Looking forward, a supplemental survey shows 67% of Canadian respondents report that they're worried about the effect of continuing uncertainty in the global economy on their business. However, while they plan to exercise caution over the next 12 months, they’re optimistic about the longer term.

More businesses report seeing expansion in the next 24 months, and even more in the next three years. And for those companies planning expansion, 83% expect it to come from existing markets.

The bottom line is that Canadian businesses are assessing deal opportunities more rigorously. While they're confident in the Canadian economy, they’re waiting to see what happens on the global scale.

Ernst & Young’s eighth semi-annual Canadian Capital Confidence Barometer is a regular survey of senior executives from large companies around the world conducted by the Economist Intelligence Unit. More than 1,000 executives, from 40 industry sectors in 62 countries, were surveyed in February and March 2013.


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