Slower domestic growth drives new appetite for offshore M&A

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Wednesday 29th April 2015 - Subdued local growth is forcing Australasian corporates to change their M&A strategies, with 70% of those considering acquisitions looking across borders for targets, EY’s latest six-monthly Australasia Capital Confidence Barometer shows.

The Barometer also found that pressure on margins and subdued growth has forced 55% of companies to put their focus back on operational efficiency and cost reduction.

The report is based on a global survey of more than 1600 senior executives in 54 countries, including 127 in Australia and New Zealand.

Julie Hood, EY Oceania Transaction Advisory Services Leader, said the optimism of six months ago when two-thirds of respondents were planning to grow via acquisitions is in stark contrast to the latest result of 44%.

“We believe acquisitions will continue on an upward trajectory in the longer term but these results show us that the M&A game has changed,” Ms Hood said.

“Against a backdrop of local currency weakness, lower domestic growth expectations and commodity price volatility, local executives are rethinking their approach to M&A.

“We are seeing the bold beginnings of a new kind of M&A market — one marked by innovation, complexity and disruptive change,” Ms Hood said.

Ms Hood said two-thirds of Australasian companies were planning innovative M&A investment that strategically shifted the scope of their business.

“Although confidence in the quality of acquisition opportunities is higher than ever, there are fewer deals in the pipeline but they are larger in size.

“Companies are responding to slower local growth as well as disruptive forces such as digital by re-evaluating their portfolios, divesting non-performing businesses and setting their sights overseas for strategic bolt-on deals,” Ms Hood said.

Cost reduction back on the agenda

Six months ago, 54% of respondents were concentrating on actively seeking growth - that figure has now fallen to 22%. A quarter had cost reduction at the heart of their corporate strategies and this has now doubled to 55%.

Ms Hood said while cost cutting was back on the boardroom agenda, it was unlikely to include cuts to head count. More than three quarters (78%) of companies plan to create new jobs to gain the capabilities needed to grow new business and underpin digital strategies.

This is a clear increase, building on the 43% of Australasian companies who said they were planning to create jobs and hire talent six months ago. This figure contrasts with the global metric of 29% which is trending in the opposite direction, down from 52% in October 2013.

Only 2% of local respondents are looking to reduce their workforce numbers. In this new round of cost restructuring, companies are more likely to target discretionary expenditure than to cut their already lean teams.

“Australasian companies are recognising they should be recruiting now for the very different workforces they will need in the future,” Ms Hood said.

Slowing domestic economies make growth more difficult

An unprecedented 100% of Australasian executives have confidence that the global economy will remain stable or improve but the view of growth in Australasia is more subdued. Less than half (47%) of respondents believe local economic conditions will improve, while 44% say the greatest economic risk to their business over the next 6-12 months will be increased volatility in commodities, increased political instability and regulation, and slower growth in key markets.      

In the past seven months, the Australian dollar has fallen to its lowest point since the GFC, plunging from USD94¢ in early September 2014 to five-and-a-half year lows of around USD77¢ in April 2015.

“The message in this Barometer is that because of static domestic economy expectations, local companies looking to grow will need to include global M&A in their playbooks,” Ms Hood said.

Global M&A outlook

Ms Hood said the global M&A market was maintaining the positive momentum that developed during 2014. For the first time in five years, more than half of all global respondents are planning acquisitions in the next 12 months, as deal pipelines continue to expand.

Despite the positive outlook, challenges remain with greater volatility in commodity and currency markets, geographic divergence in economic conditions and monetary policies, and lingering geopolitical concerns all presenting complexity.

“Notwithstanding the challenges ahead, the consensus is that the global M&A market is on an upturn after years of crisis. Companies are learning to create opportunities and seek growth amid a more competitive economic landscape,” Ms Hood said.

Digital disruption and innovation driving new M&A

Few industries have escaped digital disruption unscathed with most in the midst of rapid transformation. This disruption will continue to be driven by nimble new entrants, dynamic advances in technology and new consumer online behaviours.

“Digital disruption and rapid technological change are creating risks as well as opportunities that need to be swiftly considered by dealmakers. New digital pressures are changing existing business models and creating new value chains around customer-centric services and agile innovation.

“Digital brings customer data trust challenges and new cybersecurity issues that must be managed as part of the dealmaking process,” Ms Hood said.

“The winners in the digital race will be the companies optimising their business models by already actively listening to their customers and offering more customised and predictive analytical services to boost convenience, and reduce time and cost.”

Local executives ranked digital the number one impact on both their core business and acquisition strategy over the next year (34%). Ranked second was globalisation at 27% with the shift of economic power to China, India and the wider Asian economy a major factor, and followed by the rise of entrepreneurship (18%).     

“Many look to digital strategies to help relieve cost pressures on multiple fronts. However, the reality is that the rise of digital channels will also increase cost pressure by lowering barriers to entry, leading to intensifying competition and commoditisation.

“To survive, many organisations will have to diversify. We expect moves into new industries and more companies to shift their focus from products to services as a way of differentiating themselves and increasing margins,” Ms Hood said.

Cross-border deals increasing

Australasian companies are changing their approach to M&A, with greater appetite for offshore bolt-ons. Australasian companies are looking offshore to achieve dramatic growth – largely in developed markets. More than half (56%) of local executives are looking at the US and Europe.

Confidence in deal numbers and ability to close is also high. We expect increasing numbers of local companies to actively pursue acquisitions in the next 12 months.

Looking at inbound investment, Australia has moved into one of the top five destinations for global investment. Given 77% of global respondents are looking at lower middle market deals, and in light of falling local exchange rates, Australia is starting to look increasingly attractive as a capital destination.

Other key findings of the Barometer include:

  • In line with global executives, 40% of Australasian respondents report that reducing costs and improving margins has moved higher up on the boardroom agenda.
  • More than 4 in 10 (44%) Australasian companies rank increased volatility in commodities and currencies as the greatest economic risk to their business in the next 6-12 months.
  • Top investment destinations for Australasian companies: UK, China, US, Germany, Canada, India & Japan
  • Top investment destinations for global companies: UK, China, US, Germany, Australia
  • Australasian executives remain confident about the M&A outlook with 84% confident about the quality of acquisition opportunities, 75% of closing acquisitions and 89% of the number of deals available.
  • Six months ago, 15% of Australasian executives reported having four or more deals in the pipeline.  Now, this has dropped to 4%. Three quarters of local respondents are currently working on just one or two deals, reflecting the careful consideration required to realise the right strategic growth.
  • More than half (53%) Australasian executives believe the valuation gap will stay the same and 46% expect it to widen over the next 12 months.
     

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