Capital Confidence Barometer for CFOs

Innovation, complexity and disruption define the new M&A market

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  • Introduction

    Innovation, complexity and disruption define the new M&A market

    Welcome to the fourth edition of the CFO Capital Confidence Barometer. Every six months, we survey senior leaders from companies around the globe for our Capital Confidence Barometer. In February and March, we surveyed some 1,600 business leaders across 18 industry sectors and 54 countries. This report represents the outlook of the 433 CFOs among that group.

    EY - Rick Fezell

    Rick Fezell
    Americas Vice Chair - Accounts

    EY - Julie Linn Teigland

    Julie Linn Teigland
    EY EMEIA Accounts Leader

    EY - Patrick Winter

    Patrick Winter
    EY APAC Deputy Area Managing Partner

    A note from EY leadership

    The global data reveal a significant rise in optimism from our previous Barometer, but, surprisingly, CFOs continue to be relatively guarded and conservative in their outlook on M&A.

    Many CFOs do appear to be eager to transact. Nearly half (45%) expect their companies to pursue a deal in the next 12 months, the largest proportion in the two-year history of the Barometer. But with increased interest comes increased competition, and good deals may be harder to find and more difficult to close, requiring greater CFO diligence. Accordingly, our respondents are less confident in the likelihood that they will be able to close deals and in the quality of acquisition opportunities. Thus, the majority (53%) expect to complete only one deal in the next 12 months. Several factors are driving this. One is that CFOs are focused on pursuing more innovative deals (rather than simpler bolt-on acquisitions) that will shift the scope of their business, but are more complicated to source and close. Other issues include the rising dollar, which is hampering growth for US-based companies, along with regulatory scrutiny over acquisitions.

    CFOs’ confidence in the global economy is surging, with 81% saying conditions are improving. This is a sharp increase over the 50% who felt this way six months ago. In a sign that CFOs expect prolonged progress — and are sensitive to the resources needed to ensure growth — more than half (52%) say their primary focus is reducing costs, while 73% of them expect to retain their workforce size.

    At regional levels, optimism is rising. In Europe, the combined effects of quantitative easing, low energy prices and the weak Euro are encouraging CFOs to put their capital to work. In Asia-Pacific, too, finance executives are buoyant. Australia and Southeast Asia are seeing an influx of international investment, which is helping to fuel M&A and drive expansion. In China, CFOs remain upbeat, even while outside observers mark the slowdown in GDP growth. In North America, CFOs report stability, but progress and dealmaking may be somewhat muted by stagnant GDP growth in Q1, the rise of the dollar and volatility in emerging markets where they do business. Two-thirds of the CFOs who are targeting acquisitions overall are doing so mainly in their home geographic regions.

    In sum, CFO confidence is very strong compared with just two years ago. But finance executives have become more guarded and more meticulous about M&A. This tension reflects both the CFOs’ traditional role as the caretaker of corporate capital and their expanding responsibilities for growing their companies in innovative ways.

    Photo of Pip McCrostie, EY Global Vice Chair, Transaction Advisory Services

    Pip McCrostie,
    Global Vice Chair, Transaction Advisory Services

    A note from Pip McCrostie

    Innovation, complexity and disruption define the new M&A market

    Our 12th Global Capital Confidence Barometer finds the global M&A market maintaining the positive momentum that developed during 2014. For the first time in five years, more than half our respondents are planning acquisitions in the next 12 months, as deal pipelines continue to expand. Executives express increasing optimism in the global economy, with much broader consistency across geographies than in 2014. This economic optimism, combined with steady confidence in corporate earnings and other leading market indicators, is fostering an environment where companies are preparing bolder moves, including M&A, to generate future value. Our survey reveals three key reasons for the sharp increase in dealmaking intentions. First is the arrival of new entrants — both start-ups and companies returning to the market after staying on the sidelines for several years. Second, divergent economic conditions are accelerating cross-border M&A, as existing momentum in many developed markets is further fueled by falling oil prices and currency fluctuation. And third, disruptive innovation is driving dealmaking at every level of the enterprise. Of course, challenges remain prominent on the boardroom agenda. Greater volatility in commodity and currency markets, geographic divergence in economic conditions and monetary policies, and lingering geopolitical concerns all present complexity. As well, rapid technological change is creating new risks such as cybersecurity, which has emerged as a core business issue that must be managed as part of the dealmaking process. Notwithstanding these risks, the overall view in this Barometer is of a global M&A market on an upswing after years of crisis. Companies are learning to create opportunity and drive growth amid a more competitive economic and geopolitical landscape. After a half-decade of stagnation, we are seeing the bold beginnings of a new kind of M&A market — one marked by innovation, complexity and disruptive change.

  • M&A outlook

    CFOs are becoming more strategic as market stabilizes

    The market for deals remains healthy, but CFOs’ outlook has leveled off somewhat. The upward trend in M&A activity that began last year is stabilizing, as 61% of CFOs expect the market to remain stable at the global level (see chart 2). While more CFOs (45%) expect to pursue an acquisition now than at any point in the past two years (see chart 1), they are less confident about the number of acquisition opportunities, the quality of opportunities and the likelihood that they will be able to close deals. The decline in expectations does not necessarily represent pessimism so much as a dip from a 2014 peak and increased competition for acquisition assets.

    Their non-CFO counterparts are more optimistic across the board. This difference reflects the CFO’s role as the stalwart of fiscal responsibility in navigating increasingly complex deals. More rigorous due diligence processes, fueled by more insightful data, enable companies to investigate the operational and commercial value drivers of individual deals. Companies are also prepared to walk away if a deal won’t create value for them.

    Chart 1: Do you expect your company to actively pursue acquisitions in the next 12 months?
    EY - Do you expect your company to actively pursue acquisitions in the next 12 months?

    Deal pipelines shrink, but not due to lack of interest

    The majority of finance executives (60%) expect their deal pipeline to decrease over the next 12 months — a sharp reversal from six months ago, when 57% of CFOs expected their deal pipeline to increase (see chart 2). While deal volume may be lower, on balance two-thirds (68%) of finance chiefs expect to complete more acquisitions this year than they did last year. Most of these deals will be in the lower middle market (see chart 3). Fewer CFOs are pursuing five or more deals compared to six months ago, but more have one or two potential deals in the works (see chart 4).

    Chart 2: How do you expect your deal pipeline to change over the next 12 months?
    EY - How do you expect your deal pipeline to change over the next 12 months?
    Chart 3: What is your largest planned deal size in the next 12 months?
    EY - What is your largest planned deal size in the next 12 months?
    Chart 4: How many acquisitions do you expect to complete in the next 12 months?
    EY - How many acquisitions do you expect to complete in the next 12 months?
  • More CFOs seeking innovative deals

    CFOs report a significant change in the types of deals they are planning. A large majority (78%) are interested in pursuing innovative deals that shift the scope of their business. They are moving into adjacent and/or complementary sectors because disruptive forces are affecting their sales and supply channels. Moreover, technologies are blurring their own clear sector definitions and spurring innovative dealmaking. Many companies anticipate future challenges to their business models; they are using M&A as a route to defend their competitive position by, for example, buying new innovators.

    Only 19% of CFOs are planning complementary bolt-on deals (see chart 5). Six months ago, most CFOs (60%) were planning bolt-ons. Innovative deals are generally more complicated and take longer to close, which may help to explain the marked decrease in CFOs’ likelihood to close deals shown elsewhere in the survey.

    Chart 5: Your planned M&A activity will mostly be:
    EY - Your planned M&A activity will mostly be

    Geographic priorities appear as companies focus on developed markets

    CFOs intend to invest the majority of acquisition capital in developed markets (see chart 6). Improving conditions in major developed markets and QE in the Eurozone, are prompting them to prioritize these regions.

    However, slowing growth across many emerging markets, driven by lower commodity prices, is impacting their M&A decisions in those regions.

    Chart 6: What percentage of your acquisition capital are you going to allocate to the emerging markets in the next 12 months?
    EY - What percentage of your acquisition capital are you going to allocate to the emerging markets in the next 12 months?

    CFOs look to increase share in existing markets

    CFOs list gaining share in their existing markets as the factor that will most impact their M&A strategy over the next 12 months, a sign that they are being strategic, yet cautious, about expanding their reach into new markets (see chart 7). This is particularly evident in Europe and in some areas of Asia-Pacific, where CFOs seem most interested in acquisitions within their home regions. These deals can be relatively easier to execute and integrate than inter-regional acquisitions. In Asia-Pacific, for example, leading economies, such as China, Japan and South Korea, are pursuing more strategic deals in Southeast Asia (e.g., Vietnam, Malaysia and the Philippines) that will add value over the long term.

    It’s important to note that many companies also continue to take advantage of changes and differences in regulatory and legislative environments. CFOs list their second-most important M&A driver as leveraging regulatory and legislative opportunities. Similarly, their M&A decisions will be heavily influenced by tax implications; their third M&A driver is improving structural tax efficiencies. These priorities reflect the mounting regulatory and tax issues that CFOs face around the world, and the importance they place on aligning their compliance and tax operations with their overall business strategy.

    Chart 7: What are the main drivers impacting your M&A strategy over the next 12 months? Select up to two.
    EY - What are the main drivers impacting your M&A strategy over the next 12 months?  Select up to two.

    Execution and funding top list of challenges

    CFOs list their ability to execute and integrate deals as a top challenge to their M&A strategy. This is another driver behind their stated decrease in their likelihood to close deals shown elsewhere in the survey, as many finance executives seek more innovative targets rather than relatively simple bolt-on deals. With the rise of big data and analytics, companies have more information at their disposal, but also more to review. More complex deals generally require closer due diligence scrutiny, and thus may take longer to close. Competition from other buyers and lack of acquisition opportunities are CFOs’ third and fourth leading concerns, which may also help explain the drop from six months ago in the number of deals they expect to close in the next 12 months. It also points to a potential risk of overpaying for acquisitions in a buoyant market.

    Chart 8: What are the main challenges to your M&A strategy over the next 12 months? Select two.
    EY - What are the main challenges to your M&A strategy over the next 12 months? Select two.
  • Economic outlook

    Surging confidence

    There is rising confidence in economic conditions, as four in five CFOs (81%) say the global economy is improving (see chart 9). Six months ago, only half of finance chiefs shared this sentiment. The underlying economic fundamentals are strong, as well. CFOs’ confidence in the availability of credit has been buoyed by quantitative easing policies in the EU and Japan, along with persistently low interest rates in the US and elsewhere. Their outlook for the stock market also remains positive (see chart 12).

    Chart 9: What is your perspective on the state of the global economy today?
    EY - What is your perspective on the state of the global economy today?

    Companies ramp up hiring

    Amid improving conditions, more companies are planning to grow or maintain their workforce, with nearly three-quarters (73%) of CFOs indicating they expect to keep their current staff size. On the other end of the spectrum, expectations for layoffs have dropped threefold, from 18% this time last year to 6% today. Companies are clearly prioritizing the retention of talent.

    Grass is greener for some

    At the local level, CFO attitudes seem to be characterized by a grass-is-greener mentality. While a significant number of finance executives (41%) believe the global economy and their local economy are improving, one-third (32%) of CFOs say local conditions are set to fall back.

    In some regions, political instability continues to pose a threat to businesses. Increased volatility in commodities and currencies is also a concern. In Europe, however, a weak euro, combined with declining oil prices and a more stable monetary policy, is contributing to a sense that recovery has finally taken root in the local economy.

    A brave new world

    Globalization — driven in large part by the rise of China and India — continues to greatly impact CFOs’ core business and acquisition strategies. CFOs and non-CFOs alike believe the rise of entrepreneurship will affect business strategies as well, driving the need for more supportive ecosystems (see chart 10). Finally, the potential of digital technologies — an as-of-yet unfulfilled opportunity for many companies — will continue to be critical in the year ahead.

    Chart 10: Which of the following will impact your core business and acquisition strategy most in the next 12 months?
    EY - Which of the following will impact your core business and acquisition strategy most in the next 12 months?
  • Corporate strategy

    CFOs focused on operational efficiency

    In the years since the global financial crisis, cost-cutting has become a part of the corporate DNA, both in the C-suite and the boardroom. The latest edition of the CFO Capital Confidence Barometer shows even greater attention on this area. More than half (52%) of finance executives are focused on cost reduction, and fewer CFOs are focused on growth (see chart 11). This emphasis on costs is exacerbated by short-term pressures from commodity and currency fluctuations.

    This data reflects CFOs’ ongoing and relentless focus on the bottom line, which has become the status quo particularly in North America and Europe in reaction to the uneven economic recovery. However, many CFOs seem to be willing to make spending exceptions for investments in digital solutions. With most CFOs taking a more strategic role when it comes to business growth, they realize that their companies must respond to the disruption that innovative technology is causing throughout the enterprise.

    Chart 11: Which statement best describes your organization’s focus over the next 12 months?
    EY - Which statement best describes your organization’s focus over the next 12 months?

    Outlook for earnings falls

    The Barometer shows a downward trend in CFOs’ outlook for corporate earnings, despite strong results in the US and Europe in 2014. Low inflation has made it difficult for companies to pass on costs to customers, cutting into profits.

    New technologies and increased focus on research and development may hold the key to organic growth. Finance executives and non-CFOs alike say they are focused on exploiting technology to develop new products over the next 12 months.

    Chart 12: Please indicate your level of confidence in the following at the global level
    EY - Please indicate your level of confidence in the following at the global level

M&A market remains healthy despite shrinking pipelines:

81%

believe the global economy is improving

21%

expect to hire talent

52%

are focused on cost reduction and operational efficiency

61%

believe the market for deals is stable

45%

expect to pursue an acquisition

60%

expect their deal pipeline to decrease over the next 12 months

78%

are planning innovative deals