M&A Deal Flows Checked By Economic Slowdown, Says EY

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New York, 2 July 2012 – The tepid global economy has greatly slowed the pace of US M&A activity, as deal flow dropped by 15% to 3,159 deals in the first half of 2012 from 3,729 in 20111. Deal value also tumbled by 43% from the prior year 2.

While the US economy has exhibited signs of improvement, supplemented by an increase in consumer confidence, M&A continues to be affected by volatility in the credit and stock markets and uncertainty in the global economy, particularly in the Eurozone, exacerbated by slowing GDP growth in the emerging markets and minimal to nonexistent growth in the developed world.

With M&A activity waning, boardrooms are focused on optimizing capital through organic growth and returning value to shareholders with M&A alternatives. According to EY’s US Capital Confidence Barometer, 55% of companies cite growth as their primary focus, up from 42% six months ago3.

The drop in deal activity and increased desire for growth has created a renewed focus on portfolio optimization, which could lead to corporate divestitures by management teams and boards in their bid to return value to shareholders and drive top and bottom line growth. The EY survey also reported that 34% of US companies were likely to sell assets in the forward-looking 12 months, a 70% increase from April 20114.

“In recent conversations with top corporate deal makers, there is a prevailing thought that incremental value will be created through strategic portfolio management,” said Rich Jeanneret, Americas Vice-Chair, Transaction Advisory Services for the EY organization. “Never before has it been more important for companies to evaluate which portfolio businesses are critical to implementing their corporate strategy over the next three to five years.”

Over the past decade, corporate strategy relied heavily on M&A for growth. However, EY has found more executives are coming to realize that effective portfolio management and corresponding divestitures can be essential to growth. Divesting with a focus on raising capital for investment in core businesses, emerging markets and extension of existing products and services builds value. As executives increasingly understand the strategic benefits that proactive portfolio management can provide – particularly when corporate growth is difficult to achieve and efficient capital allocation is a priority – companies are executing well-timed divestitures, accompanied by stronger balance sheets and increased readiness for strategic acquisitions.

In the uncertain growth environment, expect to see the robust divestiture activity to continue through portfolio rationalization, star-bursting, tax-free spins and carve-outs.

“Companies that are focused on effective portfolio management will be well positioned for growth when clarity returns to the economy,” Jeanneret added.

Private equity revs its engines

While the overall private equity deal environment is stabilizing, activity levels remain well below expectations considering the amount of "dry powder" and availability of deal financing. In the first half of 2012, US deal volume was down 6% (buy side and sell side combined) and US PE deal value was flat5. Completed deals have taken longer to close and are being sold in very competitive processes, resulting in relatively high valuations.

Although fundraising remains challenging, there has been an increase in activity and funds continue to close. Approximately US$368.5 billion6 in uncalled capital still remains available to PE funds, and credit markets have been receptive to new deal financing for the past six months. The financing markets have stabilized, with attractive terms available for buyout borrowings.

With nearly one-third of global companies considering an asset sale in the next year7, PE firms have already started to demonstrate an eagerness to acquire carved-out businesses as platform or add-on deals. PE firms are also focused on exits of more mature portfolio companies, positioning their portfolio companies for sale or IPO in an effort reduce the record numbers of investees residing in PE portfolios.

“As corporates streamline their balance sheets and sell off non-core businesses, carve-outs are a consequence and PE funds appear to be preferred buyers representing attractive near term buyout opportunities,” said Jeff Bunder, Global Private Equity Leader for the EY organization. “PE firms are poised to do deals – dry powder backed by an increasingly favorable borrowing environment is providing the impetus to complete acquisitions.”

In the next six months, PE activity is expected to continue at a moderate pace, likely consistent with prior years. This continuation will hinge on the stability of the global geopolitical situation, particularly as the next chapter of the Eurozone unfolds. An even greater improvement in corporate confidence and re-emergence of corporate M&A activity may be required in order to see a significant surge in PE deal activity.

Despite improving deal conditions, vague economy clouds corporate M&A

Uncertainty surrounding the looming European debt crisis, slowing growth in emerging markets and the slow US economic recovery are dragging down confidence in the global economy. Although deal opportunities from six months ago still exist, corporates are reluctant to execute a deal without being able to predict economic trends. While the near-term outlook in Europe is weighing heavily on corporate confidence overall, confidence in the US employment outlook is improving, and 90% of companies plan to maintain or increase their current workforce in the forward-looking 12 months, according to the EY US Capital Confidence Barometer survey8.

Cash and credit are also becoming easier to obtain with nearly $2.037 trillion in cash on corporate balance sheets and improving lending conditions for M&A9. Forty-eight percent of companies in the US expect to use debt as their primary source of deal funding, compared with 33% six months ago10.

“Without clarity from Europe in the short term, companies are unsure of their ability to complete deals in the current economy,” said Steve Krouskos, EY’s Global and Americas Markets Leader for Transaction Advisory Services. “Slowing growth in China and Brazil are not easing confidence issues in the M&A arena, but companies are still looking to the emerging economies to reach new markets and seek growth through partnering and the right acquisition.”

Brazil saw modest improvement in M&A activity, with 317 deals announced in the first six months of 2012, up 4% over the prior period. Deal value saw a relatively modest decline of 5% to $28 billion11. In China, there was a 19% dip in deal number from the corresponding 2011 period, and value dropped 12% to $56.1 billion12. India also saw an 18% decline in deals to 322 in 2012; however, deal value was up 14% to $9.7 billion13. Despite slow growth and the rocky M&A environment, boardrooms have not taken their eye off Brazil, China and India, which remain the top three US investment destinations14.

Key sectors

Oil and gas
The US oil and gas industry was one of the few sectors in the first half of 2012 to see an increase in deal value, up to $55.8 billion, a 37% increase compared with the same period last year. However, the number of deals slid 26% to 160 in 201215.

“With varying forecasts for oil demand, uncertainty is guiding the M&A tempo in the oil and gas sector, and while we are seeing a few large transactions driving up total value, deal activity in the near-term is likely to remain at current levels,” said Ron Montalbano, US Oil & Gas Sector Leader, Ernst & Young Capital Advisors, LLC.

Healthcare & Life Sciences
Healthcare reform has instigated strong M&A activity in the healthcare and life science sectors, as healthcare companies seek deals to increase scale and diversify operations by converging sectors, and life sciences companies adapt to the new landscape and patent expirations on pharmaceuticals. These industries, too, are not immune from uncertainty, with theirs stemming from the future of healthcare reform and the outlook for economic stability in Europe.

The number of US life sciences deals remained flat, with 79 announced transactions in 2012; however, value dropped to $18.3 billion from $21.5 billion for the first six months of 201216. The number of healthcare deals dropped 30% to 219 for the first half of 201217. “We saw quite a bit of activity after healthcare reform was passed, especially as companies moved to a greater focus on increasing scale and augmenting evidence-based care platforms,” says Gregory Park, US Healthcare Leader, Ernst & Young Capital Advisors, LLC. “With some clarity around the supreme court ruling on reform, and despite other uncertainties, we are more optimistic about the outlook for healthcare M&A and expect to see continued activity.”

“The life sciences sector has its eye abroad, and companies are looking to the emerging markets to replenish expiring patent pipelines and drive growth,” said Ben Perkins, US Life Sciences Sector Leader, Ernst & Young Capital Advisors, LLC. “In addition, pharma companies are very focused on portfolio optimization and are evaluating what businesses are core and shedding assets that will not lead to growth.”

Technology transactions continue to make headlines, with a handful of household-name deals, but on the whole tech companies are exhibiting some conservatism. The number of deals in the first half of 2012 was down slightly by 3% to 663, compared with 686 deals in the first half of 201118. Deal value was also down 42% to $32.2 billion19.

“Cloud computing, ‘big data’ analytics, mobility and social media are the major trends still driving activity in the tech sector—and this trend will continue,” said Jeff Liu, US Technology Leader, Ernst & Young Capital Advisors, LLC. “With more debt and equity deals in the last few months, traditional tech giants and newer, well-capitalized social media players are the primary buyers looking to add key businesses and expand into markets. Deals are happening faster, and there is a fair amount of PE interest in the sector.”

Financial services
As macroeconomic factors continue to challenge dealmaking and the sovereign debt crisis continues to be a problem for banks, M&A in the financial services sector declined 13% to 256 deals in 201220. Financial services deal value dropped 77% to just $8.5 billion21.

“Even with the challenging dealmaking climate, there is a regulatory driven agenda that is impacting M&A in the sector which may result in divestitures and a corresponding opportunity for financial services companies looking to conduct deals. This may be seen particularly in the asset management area, as availability of transaction opportunities, a focus on growth and scale and expansion into countries with growing wealth accumulation including Brazil, India and China and newer emerging markets may motivate activity,” said Nadine Mirchandani, EY’s Global Asset Management Sector Leader, Transaction Advisory Services. “Until there is a resolution to or stability relating to the sovereign debt crisis, which will be slow in coming, and further clarity around US and global financial reform, the outlook for financial services is uncertain.”

Summarizing the overall outlook for deal activity, Jeanneret concludes, “Until clarity in the economy settles in, boardroom conservatism will persist and M&A activity is likely to remain at current levels for the foreseeable future,”

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This press release is being issued by Ernst & Young LLP, a client-serving member firm of Ernst & Young Global Limited operating in the US. Ernst & Young Capital Advisors, LLC is a broker-dealer affiliate of Ernst & Young LLP and a member of FINRA.www.finra.org.