Canadian Capital Confidence Barometer - April-October 2013

Mergers and acquisitions outlook

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Deal volumes expected to improve, but Canadian appetite for M&A wanes

There is a strong consensus among Canadian respondents that global and local M&A volumes will increase as confidence in the overall economy climbs. In total, 66% of Canadian companies expect global deal volumes to improve over the next 12 months.

What is your expectation for Canadian and global M&A/deal volumes in the next 12 months?

What is your expectation for Canadian and global M&A/deal volumes in the next 12 months?

While deal volumes are expected to improve, fewer Canadian respondents are expecting to pursue an acquisition in the next 12 months. Only 33% of Canadian respondents expect their company to pursue one or more acquisitions in the next 12 months, down from 44% in October 2012 and 48% in April 2012.

While Canadian appetite for acquisitions remains higher than US or global respondents, there is no mistaking the downward trend over the last year, emphasising Canadians’ cautious and conservative approach — at least in the near term. Though Canadian acquisition plans are down, Canadians are more positive when asked about the likelihood of closing an acquisition, the quality of acquisition opportunities and the number of acquisition opportunities.

87% of Canadian companies expect to do deals of less than US$500 million

Bias towards smaller deals as conservatism persists

Consistent with sentiment six months ago, deals are likely to remain smaller in size despite record amounts of cash available and improving credit conditions. In total, 87% of Canadian companies planning acquisitions expect deals to be US$500 million or under. The pursuit of smaller transactions aligns with companies’ overall strategy toward organic growth and lowerrisk sentiment.

Sectors likely to see the most activity are those providing growth opportunities in emerging markets and/or North America.

Valuations increasing

Expectations for valuations to increase have rebounded in the last six months, with 34% of Canadian companies anticipating a rise in prices or valuations in the next year, up from 27% in October 2012. Only 14% of companies expect valuations to decline, compared with 31% six months ago. Confidence among US respondents is even higher, suggesting the market has stabilized.

The majority of Canadian respondents (68%) say the valuation gap is 20% or less. In total, 75% of Canadian respondents expect the gap to remain the same or widen in the next 12 months.

Deals to span developed and emerging markets

Investment destinations continue to evolve as companies challenge their growth strategies and underlying risk tolerance. The top five countries Canadian and US respondents are targeting are similar, and include emerging and developed markets.

Companies remain optimistic about deals in emerging markets but are exercising more caution. In light of slowing growth in emerging markets, 84% of Canadian respondents have changed their approach to investing in those markets. Forty-six percent say they will “apply further rigour” when assessing deals in these markets, and a surprising 18% of Canadian companies have discontinued their emerging markets strategy for now.

Divesting for value

Divestments are now an established tool for creating shareholder value. Respondents in the US suggest that divestment activity may increase slightly over the next 12 months. Meanwhile, the trend among Canadian respondents has continued downward over the past two years, despite a temporary recovery in April 2012.

In total, 80% of the Canadian companies planning divestments expect that those divestments will involve the carve-out of one or more business units. These transactions — whether structured as an outright sale, spinoff, IPO or contribution to a joint venture — are highly complex and will require companies to employ formal and rigorous processes around divestment.

Viewpoint

A possible inflection point in asset valuations

A contributing cause to the ongoing slowdown in dealmaking is a perceived gap in asset valuations between buyers and sellers. Companies pursuing divestments are seeking high valuations for their assets, while potential buyers are primed for discounts and reluctant to pay a premium.

However, we may now be nearing equilibrium between what buyers will pay and what sellers will accept. This equilibrium is vital, signalling the deal markets may be at an inflection point and ready to rebound. The pendulum is primed to swing the other way — toward stronger valuations by buyers and more profitable exits by sellers. This also suggests a comeback in market fundamentals, corporate health and a stable foundation for deal-making.

With 34% of respondents expecting M&A assets to increase in value over the next 12 months (and only 14% calling for a decrease), companies should consider taking advantage of this inflection point now.