Mind the gap
Better conditions usher in keen financial buyers, but valuation gaps are holding up deals, Joseph Rodriquez reports.
Buyers seeking security
The second quarter saw the return of financial buyers to the market. Acquisitions by financial buyers accounted for 55% of the total deal value of US$47.9b and five of the top 10 deals in Q2– the biggest proportion of total deal value since the financial crises.
Participants included large financial groups such as Canada-based investment fund Brookfield Infrastructure Partners LP and Australia-based private equity firm Macquarie Group Ltd. Many buyers were taking advantage of utilities’ divestment programs to acquire assets with predictable cash flow, prized in a volatile market.
Despite this strong performance in Q2, financial buyer deal activity slumped to an almost two-year low in Q3 2012. Deal value declined 86% quarter-over-quarter and 40% year-over-year.
Asset-pricing challenges are keeping several financial buyers on the sidelines. But, as they are the logical owners for many of the available assets, they are expected to drive activity into 2013.
Current transaction trends
The trend of increased activity by financial buyers is increasing. Pension and infrastructure funds are seeking long-term, inflation-linked investments not currently offered by equities and government bonds.
Private equity and hedge funds are also seeking these secure investments, while also looking to take a view on the market that some listed corporates may not be able to offer. For example, the current economics of the US natural gas market means they are able to snap up assets at reasonable prices with an eye on rebounding gas prices and tightening reserve margins.
The divestment programs by several European utilities have created opportunities for financial buyers to invest in assets with predictable cash flows. The sale of UK-regulated water activities by Veolia to Infracapital Partners LP for US$1.9b demonstrates the underlying trend.
Financial buyers from Asia are likely to be particularly active in Euro divestments and also consider Latin America, particularly Peru, Colombia, Chile and Brazil, over the next six months.
Another factor shaping current transaction trends is relatively strong liquidity in the US and most European markets, ensuring plenty of available capital. Keep an eye out for any tightness in credit markets in the coming months, particularly in Western Europe, as a downside risk to M&A
Valuation gap holding up deals
The buyer/seller valuation gap negatively impacted deal activity in the third quarter of 2012, resulting in several deals falling over at the last minute. Privatization plans in Europe — including Greek and Czech divestment programs — have been delayed due to valuation standoffs.
The situation is similar with private utilities. RWE AG is still looking for buyers for its regional power group Suewag. To date, discussions have failed due to valuation expectations.
Also, the continued low price of natural gas in the US is squeezing profit margins and reducing power prices. Hybrid utilities –those with both regulated and unregulated businesses – are trading at a discount.
Selling unregulated generation assets has been an option, although there is a strategic vs. financial valuation gap on many unregulated assets. Valuations are being pulled down for companies that own unprofitable merchant generation in the US.
Uncertainty to continue
The continuation of valuation gap issues into Q3 has resulted in investors opting to sit on the sidelines until uncertainty subsides. This slowdown and patchy deal environment is expected to continue into Q4, with total 2012 total M&A value expected to be lower than the US$144.7b achieved in 2011.
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