Surprising appetite for deals despite market turbulence

• Future M&A activity fueled by stronger balance sheets and falling debt levels
• Credit markets strong enough to support growth
• Large corporates can draw upon cash war chests 
• Increased consensus around asset values sees 30% rise in potential sellers come to the table

MOSCOW, LONDON, 13 October 2011 – Despite economic turbulence and market turmoil, 41% of leading international companies expect to make an acquisition in the next 12 months, according to Ernst & Young’s latest Capital confidence barometer, based on a survey of more than 1,000 senior executives around the world. Surprisingly, that is a slight increase on six months ago, despite the intense market turmoil during August, when the survey was conducted.

Stronger balance sheets together with a greater focus on operational fitness mean there is a continued appetite for M&A among large cap corporates. There is also a greater convergence around the price of assets, encouraging sellers to come to the table. Almost two thirds (57%) see valuations remaining at current levels for 12 months, resulting in a 30% uptick in potential sellers compared with six months ago – 26% of businesses now plan to divest in the next year.

The fifth bi-annual Capital confidence barometer, finds that almost half of respondents are focused on growth in the next 12 months, with only 7% now focusing on survival – the lowest number since the barometer was first published in 2009.

Pip McCrostie, Global Vice-Chair, Transaction Advisory Services, at Ernst & Young, says: “There is a new paradigm with M&A activity and market volatility now able to co-exist. Currently, leading companies are shrugging off continued market upheaval and focusing on growth and M&A. For them this is not 2008 all over again. They have spent the past three years reducing the financial risk on their balance sheet and taking tough efficiency measures needed to strengthen their positions, which helps them manage in volatile times.”

Stronger balance sheets encourage M&A
Three years of focusing on capital management underpins the resilient attitude of those companies who might come to the deal table. Large corporates are in much better shape than 2008. Balance sheets have been significantly strengthened. In addition, businesses have improved their capital structure by reducing interest costs and extending maturities. Overall debt has fallen, with 61% having debt-to-capital ratios of less than 25% and 78% plan to maintain or reduce their debt-to-capital ratios further in the next 12 months.

Corporate earnings outlook is relatively strong, with almost half (47%) confident they will be at least stable; a further third believe earnings potential is positive. Funding conditions have also improved, with 68% saying capital market conditions are at the very least stable.

Surprising corporate confidence in an uncertain market
Despite concerns over weakening global growth, many of the leading companies are surprisingly optimistic about their own national economy as well as the long term global economic outlook. Declining growth in the US, coupled with the country’s credit downgrade and the escalating sovereign debt crisis in the Eurozone sparked dramatic stock market activity at the time of the survey. Despite this, two-thirds (63%) of respondents feel that the global economy is at least stable. Confidence is particularly high in sectors such as power and utilities, oil and gas and metals and mining.

Pip adds: “Buoyed by confidence in local economies, many global corporates are now in a strong position to buy with de-risked balance sheets and large cash war chests. Based on the survey, we see a surprisingly favorable M&A environment with the majority of respondents positive about the number and quality of deal opportunities and the likelihood of closing them. A critical factor is the convergence of potential buyers and sellers around what they see as relatively reasonable and stable asset prices – resulting in a significant increase in those looking to sell.”

Emerging markets are prime targets for investment
The most attractive markets for investment according to the survey are China, India, Brazil, the US and Australia. Outside the recognized BRIC countries Malaysia, Mexico and Argentina are the three most popular emerging market destinations for investment. More than a third of respondents said their motivation for M&A was to gain share in a new market.

“Having an effective emerging market strategy is an absolute necessity for leading companies today,” says Pip. “A balanced business portfolio needs to have an emerging market presence as well as mature market operations.

“The Asian emerging markets are among the most attractive – with their high-growth potential offering some protection against current volatility in mature markets.”

Barriers to M&A remain, but strategic deals could be on the horizon
A large majority of respondents (85%) are concerned that mounting regulatory pressures could potentially impede growth. Regulatory risk could de-rail growth plans – particularly in the area of banking and financial reform, which could have a broad impact across sectors and geographies.

Pip concludes: “Regulation is one potential hurdle. There is also the fundamental question of the economy. While our respondents’ M&A attitudes are remarkably robust given the current environment, a slump into a double dip global recession would mean all bets are off.

“However, for the time being, our respondents have learned to manage in volatility: they have the capability – and ambition – to do strategic deals in the current climate.”

Most Russian respondents are generally optimistic overall. However, they are cautious

• The state of the Russian economy is stable or improving
• The likelihood of short term volatility is high, mostly due to global factors
• Most see asset values increasing in the next twelve months
• Russian companies are increasingly looking at divesting assets to focus on core assets and fund M&A growth plans, which may signal increased deal activity
• Cash will be the primary source of deal funding in the next twelve months in Russia, as deleveraging continues

Along with some other countries, the Russian Transaction Advisory Practice has received the explicit right to prepare a country specific Capital Confidence Barometer.

Profile of respondents:

• Panel of over 1,000 executives surveyed in July and August 2011, including 45 respondents from Russia.
• Companies from 57 countries including Australia, China, France, Germany, India, Japan, the UK, the US and Russia.
• Cross-section of respondents from over 19 industry sectors.

The snapshot of our findings gauges corporate confidence in the economic outlook and identifies boardroom trends and practices in the way companies manage their capital agenda.

On the results of the survey, Hakob Sarkissian, CIS TAS Leader, comments, “The first Russian Capital Confidence Barometer shows that most Russian respondents are generally optimistic overall. However, they are cautious. Confidence in the Russian economy has increased since April 2011 and the focus of many companies is now growth.”

The survey shows, that Russian respondents view the likelihood of short term volatility as high or very high, mostly due to global factors. However, most Russian participants believe that the state of the Russian economy is stable or improving and expect to maintain or increase their workforce. Russian respondents believe that capital market conditions are stable or positive, and some of them will take advantage of low interest rates to refinance their debt. Cash will be the primary source of deal funding in the next twelve months in Russia as deleveraging continues. Russian companies are increasingly looking at divesting assets to focus on core assets and fund M&A growth plans, which may signal increased deal activity. In particular, Russian companies are considering cross border acquisitions to gain market share, concentrating their efforts primarily in Eastern Europe and Asia Pacific.

“Despite these positive indications, mounting regulatory pressures, most importantly tax regulation, may represent a risk to growth and profitability in the future,” says Hakob Sarkissian. “Price and asset valuations are expected to increase over the next twelve months, which may have a negative impact on deal making activity. The majority of Russian companies are focusing on finding opportunities to grow their business, in sharp contrast to their global peers which are more concerned with maintaining stability.”

About the survey
The Ernst & Young Capital confidence barometer is a survey of over 1000 senior executives from large companies around the world and across industry sectors. The objective of the Barometer is to gauge corporate confidence in the economic outlook, to understand boardroom priorities in the next 12 months, and to identify the emerging capital practices that will distinguish those companies that will build competitive advantage as the global economy continues to evolve. This is the fifth half-yearly Barometer in the series, which began in November 2009.

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