Ernst & Young LLP Says 2013 Deal Activity Will Remain Near 10-Year Low
New York, 5 December 2012 – US deal flow is likely to remain tempered in 2013 with activity remaining at or near a 10-year low. Ernst & Young LLP’s Transaction Advisory Services says macroeconomic ambiguity combined with a continued corporate focus on lower risk, organic growth opportunities and smaller, strategic deals will define deal-making in 2013.
”In the short-term corporates are hesitant to do deals; nevertheless there is huge pressure for companies to grow in the sluggish economy and M&A opportunity exists for those companies willing to be bold in today’s market,” says Richard Jeanneret, Americas Vice-Chair, Transaction Advisory Services for the global EY organization. “Companies continue to focus on optimizing their portfolios for value creation, leaving M&A on the backburner – but those companies who do not begin positioning for growth now may miss the mark in the future.”
Fewer US companies report plans to execute an acquisition in the next year as appetite for M&A fell to 23% from 34% six months earlier, according to Ernst & Young LLP’s US Capital Confidence Barometer.1 Of those companies that are planning an acquisition, 81% say they will consider deals worth US$500 million or less, suggesting that deals next year will be smaller and focused on filling strategic gaps and extending existing businesses.2 Private equity (PE) firms have a slightly more positive outlook, citing improving fundraising and confidence in credit availability.
“As corporates continue to be risk averse, PE firms are the ones to watch and are a potential bright spot in 2013 as the down economy provides a good time to invest,” adds Jeanneret. “We also see indications that global investors are focused on a flight to safety and are thinking more about the US for capital deployment, as it remains one of the world’s strongest economies, even after several years of slow growth.”
2012: The wait-and-see year
M&A activity declined in the US and around the world in 2012. The number of deals in the US dropped 10% in 2012 to 6,357 deals from 7,077 in 2011, making it the slowest year for M&A since 2002.3 Overall deal value slid 26% to $625.7 billion from $846.9 billion.4
At the end of 2011, conditions looked promising, and experts pointed to an M&A revival for 2012. However, persistent economic uncertainty, Eurozone turmoil, slower growth in emerging markets, a looming fiscal cliff with a prolonged lack of clarity in the US around tax reform and healthcare legislation depressed the global economy, and companies around the world turned their focus inward. There is slim chance of a short-term turnaround in the global economic slump and the ongoing slow growth in the US. According to the US Capital Confidence Barometer, 76% of US companies think the global economy shows no signs of improvement.5
“The outcome of the US election removes some uncertainty in the regulatory environment, but the fiscal cliff will have to be solved and there will need to be a sign that a declining Eurozone will not lead to a global financial crisis and consumer confidence will need to improve before CEOs feel more comfortable with the deal market,” says Jeanneret.
Lack of opportunity was not the cause of the M&A slump in 2012. Cash is plentiful and credit is relatively available to companies with strong balance sheets, and in most sectors asset valuations were reasonable. The main reason for the lack of activity was corporate conservatism as the c-suite and boardrooms shied away from inorganic opportunities and large transformational investments, favoring an internal and strategic look at how to return value to shareholders and grow organically.
Private equity: Stable amidst corporate decline
Despite the challenges of the global economic backdrop and less-than-robust corporate M&A activity, PE maintained its trajectory from the previous year. In 2012, the number of PE acquisitions remained consistent at 810 deals, dropping just 1% from 2011.6 US PE deal value increased slightly, up 3% to $97.3 billion.7 PE saw a considerable improvement in exits, both through M&A and IPOs – they increased 13% to 365 in 2012 – an encouraging sign given their aging portfolio.8 PE exit value improved even more, climbing 21% in 2012 to $108.6 billion, up from $85.7 billion in 2011.9
Even with improving exit opportunities, PE firms are sitting on more than $360 billion in “dry powder” to deploy; however there is a shortage of quality assets and a noticeable gap between buyer and seller price expectations, which have constrained activity.10 As a result, buyout firms have struggled to attain a consistent level of activity.
Fundraising has been fairly active in 2012, as evidenced by the closing of the largest buyout-focused fund since the crisis. US PE firms raised $172.8 billion in committed capital in 2012, an increase of 38% over last year; though the number of funds raised was consistent with last year.11 This indicates a return to larger-sized funds in the $10 billion to $12 billion range – well below pre-crisis levels, but a significant increase from prior years. Although funds are taking longer to raise, PE firms are generally obtaining commitments. According to an EY survey, 75% of PE firms expect the fundraising environment to improve or remain stable over the coming year.
“The slow-growth global economy and dwindling appetite for corporate M&A have created a challenging and competitive marketplace, but deal financing is readily available and PE is an opportunistic investor in this type of environment,” says Jeffrey Bunder, Global Private Equity Leader for the global EY organization. “PE firms that can source opportunities and can support valuations with post-deal growth and value improvement plans should be able to generate traditional PE return levels.”
In 2013, EY expects PE activity to remain consistent with 2012 levels, with some likely rebalancing of capital allocation across the globe. Misgivings about economic growth prospects and inflated pricing in traditional emerging markets like China and India are likely to drive PE towards developed markets like the US. Continued divestiture activity as a consequence of corporates focusing on core operations may yield large carve-outs that are prime targets for PE.
Flight to quality: Increased interest in US market
To hedge against global economic unsteadiness, more global investors say they plan to look to the US for growth in 2013. In the last year, the number of inbound deals declined in the US by 17% year-over-year, in line with the slow global M&A market overall; however, the deal value for inbound M&A increased by 26% to $137.2 billion, indicating that foreign investors are turning to the US for bigger growth opportunities.12 According to EY’s Global Capital Confidence Barometer, the US is the number two investment destination for the next 12 months, just behind China, up from fourth place a year earlier.13 Non-US investors may be refocusing on the US for the future as it remains one of the world’s strongest economies, with limited but still positive growth, and the dollar is relatively cheap.
“Increased interest in the US for 2013 could signal that a global recovery, when it does arrive, might be led by the US,” says Steve Krouskos, Global Markets Leader, Transaction Advisory Services for the global EY organization. “With global and US deal expectations still low for 2013, there are plenty of opportunities for deal-making in the US in sectors undergoing drastic industry change such as healthcare and financial services.”
Quest for growth: A move toward alternative structures
Macroeconomic pressures have reduced the appetite for traditional M&A, but there is no slowdown in companies’ desire to grow. With fewer willing buyers in the marketplace, many companies are turning to organic growth and alternative deal structures – including joint ventures (JVs), collaborations and alliances – in order to reduce risk and continue to grow the top line. Companies across industries are displaying increased interest in building out their global presence, and joint ventures with local companies provide a means for them to participate in unfamiliar markets.
Lingering uncertainty in 2013 may intensify companies’ interest in JVs as companies seek to deploy some capital albeit in alternative, less risky deal structures. The oil and gas, healthcare and technology sectors are most likely to engage in JVs or alliances.
Cleaning house: Running out of options
In the sluggish economy, companies remain focused on portfolio optimization, looking to asset sales such as carve-outs and spin-offs as tools to raise capital for growth and build shareholder value. The last 18 months saw a wave of divestiture activity as companies more carefully managed their portfolios. However, this trend is expected to subside but divestitures remain an important tool for ongoing portfolio management.
“CEOs have been scouring their companies in the last few years, but they are running out of levers to pull and organic growth options,” says Jeanneret. “This focus on the core and portfolio optimization is a sign that companies are prepared to grow, which may signal that deals are coming as companies need to transform through M&A in order to grow.”
Brazil: A lone bright spot
Perhaps the one sign of life in the global M&A market – and for US cross-border dealmakers – is in Brazil. While overall Brazilian M&A activity was flat with the number of deals dropping just 1% to 521 deals in 2012, global inbound deals to Brazil increased 16% year-over-year to 197 deals from 170 in 2011.14 Inbound deal value skyrocketed 146% to $16.7 billion from $6.8 billion.15 US M&A inbound activity to Brazil also improved significantly, from 43 deals in 2011 to 61 deals in 2012, up 42%.16 While the size of US inbound acquisitions to Brazil remains relatively small with deal value in 2012 only totaling $4.8 billion, increased interest in the country is a sign that opportunity still exists, even in a slow transaction environment, for those looking to new markets.17
While Brazil’s economy exhibited lower growth in 2012 – below that of the US – the long-term growth story is supported by the country’s upcoming Olympic Games and World Cup, as well as the increasing purchasing power of the middle class and government-supported growth measures. China remains a very important commercial partner of Brazil, but the US has become Brazil’s number two partner, as US companies look to grow their presence through transactions across the consumer products, infrastructure and agribusiness sectors. Private equity has also landed in Brazil, with many PE firms setting up local offices, a trend that will continue into next year as the fragmented market leaves plenty of room for consolidation. However, buyers in the region will be challenged by a higher gap between potential acquisitions and the prices sought by sellers.
“Bolstered by a bullish local sentiment, Brazilian companies are looking towards M&A for strategic growth – for example, to increase their market share or expand into a new product or region,” says Sergio Barcelos Dutra de Almeida, Partner, Transaction Advisory Services, EY. “In 2013, we will see Brazilian companies pursue smaller deals, both domestically and abroad, in order to fill these strategic gaps.”
China: All eyes on what’s next
Like the rest of the world, China saw a drop in M&A in 2012, with deals falling 12% to 2,029 from 2,310 in 2011.18 Deal value increased by 5% to $114.2 billion in 2012 from $108.5 billion in 2011.19 Inbound investment into China from the US also declined 54% to just 24 deals from 52 in 2011.20
Despite China’s slower M&A market, the world is looking closely at the world’s second-largest economy as it undergoes major generational change. In November, the Communist Party of China completed its 18th National Congress – only the second orderly change of leadership in the country in the past 60 years. China also remains the top investment destination for US companies. Whether companies are considering M&A or partnering opportunities, the country is top-of-mind for all looking to grow in 2013.
However, continued global economic worries slowed growth in China in 2012, and many Chinese companies report a direct impact from the ongoing Eurozone crisis amid worries of effects on their profitability and capital agenda. In 2013, rather than pursue M&A, Chinese companies are expected to prioritize paying down debt and focusing on organic growth. Specifically, Chinese companies are eyeing technology to help them exploit new markets and products.
“Despite the lower M&A volumes in 2012, China is still the number one investment destination globally, and companies around the world are looking to the country as a growth opportunity,” says Bob Partridge, Greater China Leader, Transaction Advisory Services for the global EY organization. “In 2013, Chinese companies will look to the US, Europe and, in particular, emerging markets that have strong consumption and export potential for M&A opportunities.”
Key sectors: Investing for the long term
With the total number of deals decreasing globally and in the US, industries across the board saw a decline in activity and deal value. Financial services, healthcare and life sciences, energy and consumer products are the sectors most likely to see activity in the long term, but a significant increase in activity is unlikely to materialize in 2013.
In 2012, M&A activity was down in financial services due to ongoing deal-making complexity, regulatory uncertainty and the continued redefinition of the industry. The number of US deals dropped 10% to 497 deals in 2012 from 552 deals during the same period in 2011.21 On a positive note, deal value crept up by 8% to $35.4 billion in 2012.22
The financial services industry continues to face significant structural change. This coupled with macroeconomic pressure, including ongoing Eurozone uncertainty, has led to a subdued deal-making environment and a bleak short-term outlook for financial services M&A. However, the medium and longer-term horizon is increasingly more positive.
Financial services CEOs and boardrooms remain focused on capital management and preparation for regulatory capital changes across the sectors that make up the industry. Additionally, ongoing US rulemaking and implementation of the Dodd-Frank legislation, coupled with other global regulatory reform, will continue to consume executive attention.
Banks remain focused on growing earnings and face challenges in a low interest rate, low-growth environment. With increasing regulatory and capital requirements, small and mid-sized institutions will need to achieve scale in order to be profitable, which is expected to spur some M&A consolidation activity in 2013. Scale will also be a catalyst for mid-size asset management businesses, which may become attractive merger candidates. Larger institutions continue to attract scrutiny regarding their lines of business, scope and size, which will prompt them to continue to actively examine long-term global business strategies. This, in turn, may contribute to upticks in both acquisition and divestiture activity.
“The financial services sector continues to undergo enormous industry transformation, creating caution around M&A – however, strategic transaction plays remain important as institutions define their future,” says Nadine Mirchandani, Leader of the Financial Services Office, Transaction Advisory Services, Ernst & Young LLP. “Changing demographics and global wealth creation shifts are reshaping the industry footprint among large global financial services companies and more focused institutions. Additionally, as consumers of retail financial products generationally evolve, product and service innovation will become more important to capture wealth management, insurance and asset management markets, as well as banking market share, as demands for mobile money and electronic banking options increase."
Healthcare and Life Sciences
There was a flurry of healthcare M&A activity in 2011 as companies repositioned portfolios, financing markets continued to improve, and certain players anticipated regulatory changes around the US Patient Protection and Affordable Care Act. 2012 saw a continuation of M&A around these themes; however, the number of US healthcare deals declined 17% to 495 from 594 in 2011, in keeping with the overall M&A slowdown.23 Deal value, which reached an astounding $107.6 billion in 2011 due to a handful of megadeals which drove up value, fell off by 55% to $49.0 billion in 2012.24
Healthcare services companies are undergoing an increasing level of strategic reflection around organic growth and M&A activity as they position for the future under a fully deployed healthcare reform environment. In addition, healthcare companies and private equity firms are opportunistically pursuing M&A strategies in the sector, given the number of high quality and strategic assets coming to market or expected in the coming months.
“The delivery of and reimbursement for healthcare services is undergoing a tectonic shift,” says Greg Park, US Healthcare Services Sector Leader, Ernst & Young Capital Advisors, LLC, “and the increased industry emphasis on improving the patient experience, higher quality patient outcomes and reducing costs is resulting in M&A amongst healthcare facilities, providers and payers for scale and convergence. Healthcare IT will continue to be a focus of the evolving healthcare delivery market, as providers and payers increasingly rely on powerful analytics to influence behaviors, improve patient outcomes, control costs and deliver superior service.”
In life sciences, the value of US deals remained relatively flat in 2012, increasing by only 1% to $36.2 billion, while the number of deals dropped 3% to 146 deals year to date.25 After the spate of deal activity surrounding the patent cliff, life sciences are undertaking a much more calibrated and pragmatic approach to M&A.
EY expects continued transaction activity in life sciences in 2013, at similar if not lower levels compared with 2012. Companies are layering in oncology and metabolic diseases into their portfolios, and diabetes in particular is a strategic priority as the disease has gained prominence in the US healthcare landscape. Deal activity will be driven by these strategic acquisitions, by consolidation among generics, as fewer drugs come off patent, and by growth in emerging markets, mainly Brazil and China, where having a local footprint has become a necessity. Life sciences companies in Japan have also demonstrated increased interest in foreign investment.
However, barriers to deal-making remain, with valuation presenting the foremost challenge. Because of the scarcity of assets coming to market, investors have been bidding up public assets dramatically. Pharmaceutical companies are continuing to pursue assets in order to protect their franchises, but they are struggling to justify valuations.
“Life sciences companies are very comfortable from a business perspective with the acquisitions they have already made,” says Ben Perkins, US Life Sciences Sector Leader for Ernst & Young Capital Advisors, LLC. “Transactions in 2013 will be primarily driven by the rationalization of assets, and large pharma and medtech companies will selectively target assets that fill strategic gaps – and reward those companies handsomely.”
Although the Affordable Care Act has been reaffirmed, uncertainty lingers around specifics of its execution and budgetary issues that may affect the US economy. Nonetheless, US healthcare services and life sciences companies are expected to continue their strategic focus.
Oil & Gas
After two solid deal-making years in 2010 and 2011, the US oil and gas sector experienced slower activity levels in 2012 in terms of M&A, but the sector did experience quite a bit of non-traditional transaction activity. Although 2012 deal volumes were still up from 2010 levels, US deals in the sector declined 23% from 2011, to 315 deals total.26 2012 also saw a significant drop in deal value to $77.1 billion, down 55% from $169.8 billion in 2011, due to a few megadeals which drove up overall value in the prior year.27
Overall, 2012 was a fairly consistent year for the oil and gas sector given the overall economy. Upstream sector activity remained relatively strong, driven by companies divesting noncore assets and continued investment in the US shale regions. Shale regions are garnering increasing interest levels from both domestic and international investors due to improving fundamentals. The midstream sector experienced encouraging M&A activity as companies sought strategic assets to fill infrastructure gaps in support of new regions of oil and gas production. Softness in US land rig count and associated services, such as pressure pumping, resulted in slightly lower activity levels in oil services M&A.
According to an EY survey of oil and gas executives, appetite for M&A in 2013 is dampened, with 28% of executives citing plans to pursue an acquisition in the next 12 months, down from 48% a year ago.28 While this points toward subdued M&A activity in the sector in early 2013, on the capital front, oil and gas companies are showing tremendous interest in master limited partnerships and continued interest in joint ventures. Subsectors utilizing the master limited partnership structure continue to expand as service companies and other related sectors seek to raise capital.
“Economic and political uncertainty, both in the US and abroad, weighed on oil and gas companies, which stepped back from transformational deals in 2012,” says Ron Montalbano, US Oil & Gas Sector Leader for Ernst & Young Capital Advisors, LLC. “The oil and gas industry is a resilient and innovative sector. While global economic uncertainty will likely continue to affect M&A levels in the industry, the availability of reasonably priced capital in combination with the large number of attractive investment opportunities in the sector suggest that we will see some activity in 2013."
Consumer products activity in the US decreased 8% to 893 deals year-to-date, and deal value plummeted 40% to $52.1 billion.29 The global economy and the US fiscal cliff continue to paralyze the sector, and companies are approaching acquisitions with caution. While M&A declined in the industry overall, the beverage sector saw some significant cross-border activity, representing the majority of the past two quarters’ dollar volume.
Additionally, price fluctuation and volatility in the commodities markets have put pressure on the bottom line, and companies in the sector have needed to focus on managing costs.
“To further their capital agenda, companies are investing in their brands by increasing their advertising and marketing spend and taking costs out,” says Steven Potter, US Consumer Products Leader for Ernst & Young Capital Advisors, LLC. “Focusing on building the bottom line organically is especially critical at this juncture if companies want to be positioned to succeed when the economy recovers.”
Deals will still get done in 2013 as companies in the sector pursue smaller, sub-billion dollar transactions. The sector is also ripe for private equity deals; as multinational consumer companies continue to divest noncore assets and PE investors demonstrate new interest in the consumer products space. EY continues to believe that significant pent-up demand for M&A exists, as corporate balance sheets are strong and uncommitted private equity funds are substantial.
M&A in 2013 will likely be characterized by those companies looking for long-term opportunity. Deals will be smaller and more strategic, as companies fill product gaps and seek new market opportunities. Ongoing European instability may also present opportunities for US buyers with healthy balance sheets. If a resolution is reached around the fiscal cliff and there is more stability in the Eurozone we could see a real spark in M&A activity in 2013.
“In 2012, US companies retreated inward, waiting for clarity and a signal for global economic recovery,” says Jeanneret. “In the last five years, companies have pared down to the bare bones and become more efficient than they have ever been. Having achieved this, it is imperative that companies position themselves now, in this muted market, to create value and grow for the future.”
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1 EY US Capital Confidence Barometer, October 2012
2 EY US Capital Confidence Barometer, October 2012
3 Thomson Financial as of 11/26/2012, over the same period in 2011
4 Thomson Financial as of 11/26/2012
5 EY US Capital Confidence Barometer, October 2012
6 Dealogic as of 11/26/2012
7 Dealogic as of 11/26/2012
8 Dealogic as of 11/26/2012
9 Dealogic as of 11/26/2012
10 Dealogic as of 11/26/2012
11 Dealogic as of 11/26/2012
12 Thomson Financial as of 11/26/2012
13 EY Global Capital Confidence Barometer, October 2012
14 Thomson Financial as of 11/26/2012
15 Thomson Financial as of 11/26/2012
16 Thomson Financial as of 11/26/2012
17 Thomson Financial as of 11/26/2012
18 Thomson Financial as of 11/26/2012
19 Thomson Financial as of 11/26/2012
20 Thomson Financial as of 11/26/2012
21 Thomson Financial as of 11/26/2012
22 Thomson Financial as of 11/26/2012
23 Thomson Financial as of 11/26/2012
24 Thomson Financial as of 11/26/2012
25 Thomson Financial as of 11/26/2012
26 Thomson Financial as of 11/26/2012
27 Thomson Financial as of 11/26/2012
28 EY Oil & Gas Capital Confidence Barometer, October 2012
29 Thomson Financial as of 11/26/2012