Rich Jeanneret, Ernst & Young: Up Tick in Deal Making in 2012

December 8, 2011

Strong fundamentals, led by an increased focus on growth, should generate an uptick in deal flow in 2012, according to Ernst & Young LLP’s Transaction Advisory Services. These fundamentals, which include robust cash positions, strengthening balance sheets and improved credit markets, combined with a mounting pressure for growth in a low organic growth environment, will result in a sizable uptick in transactions over the next 12 months.

While the number of transactions in the United States was flat in 2011, these factors, along with an increasing interest in healthcare, power & utilities and technology have brought a strong focus on acquisitions back into the corporate boardroom.1 The US continued to see a recovery in deal value, which increased 18% during the year to $894 billion.

“Despite the slowdown in transactions over the past few years, fundamentals have risen to their strongest point since the financial crisis began,” says Rich Jeanneret, Americas Vice-Chair, Transaction Advisory Services at Ernst & Young LLP. “Corporates are starting to put fundamentals over continued economic uncertainty and are acting on these dynamics to execute deals.”

Dealmaking fundamentals
Fortune 1000 Companies continue to hold a tremendous amount of cash on their balance sheets and have over $2 trillion in cash.3 Access to credit has also steadily improved since 2009. According to an Ernst & Young survey, global companies believe credit markets are strong enough to support growth plans and 68% of larger cap respondents say credit availability is stable to very positive.4

In addition to available capital and easing credit markets, buyer-seller expectation gaps are narrowing and valuations are stabilizing. Fifty-five percent of US companies expect asset prices to remain at current levels over the next six months and 36% of US companies say they will pull the trigger on an acquisition in the next year, according to the Ernst & Young survey.

“With improving valuations, available capital and easing credit markets we are starting to see M&A and market volatility subsist simultaneously,” says Steve Krouskos, Ernst & Young’s Global and Americas Markets Leader for Transaction Advisory Services. “With an infusion of confidence in 2012 we can expect to see more deals in the pipeline. Those companies who learned from the crisis and managed their capital agenda will have an advantage to seize opportunities for growth. While geo-political and macroeconomic uncertainties have restrained deal activity there is desire in the board room for dealmaking.”

Private equity’s split personality in 2011
Private equity (PE) increased momentum through the first part of 2011 evidenced by bigger deals and larger exits, including two record breaking IPOs. However, halfway through 2011 activity slowed down impacted by the sovereign debt crisis, deficit reduction impasse and a growing concern about a slowing economy. As a result, both buy-side and sell-side PE activity suffered in the second half relative to 2010. For the year, PE activity decreased 19% in value to $138.1 billion, while the number of deals remained flat, declining only 1%, at 914 deals.6 Fund-raising declined 7% year-over-year to $207.6 billion in committed capital.7

“At the beginning of 2011, PE was exhibiting increased activity on both the buy and sell side representing a continued recovery from the lows of 2009. As the year progressed, the volatile economy and political environment took its toll on PE activity as financing markets were less receptive and the market for IPO's dried up,” says Jeffrey Bunder, Ernst & Young’s Global Private Equity Leader. “Deals are taking longer to complete and for PE firms financing continues to be more difficult to obtain, impacting the volume of transactions. As we look forward, there is some optimism that January will exhibit a "restart", characterized by improved financing conditions and more stable equity markets. More certainty in the economic outlook should fuel an increase in PE volume and bolster both acquisitions and exits. We do expect to see continued PE activity in healthcare, energy and technology in 2012, sectors that have remained active through choppy market conditions.”

Focus on divestitures
With the slow economy, companies are more carefully managing their capital agenda and looking to divestitures and spin-offs as a tool to raise capital for growth and build shareholder value. In the US the number of divestitures increased 3% to 2,453 and experienced a 12% increase in deal value.8 According to the October Ernst & Young survey, divestiture activity is likely to increase with 30% of US companies expecting to execute a divestiture in the next 12 months. 9

“In 2011 we saw a number of notable spin-offs announced as companies attempted to build shareholder value by separating non-core businesses,” says Jeanneret. “We expect continued spin-off, divestiture and carve out activity as companies seek to rationalize their portfolios in order to improve efficiency and valuation multiples. Companies are also divesting assets and spinoffs to free up cash in the future to execute deals. Businesses that are currently struggling to grow recognize the need to do transformative transactions.”

Key sectors
With the total number of US deals remaining flat, power & utilities and healthcare stood out and saw double digit growth year over year in deal volume. Along with technology, activity in these sectors is expected to increase in 2012. The financial services sector is also undergoing a drastic industry revolution and is an area that will see ongoing change in the long-term.

Power & utilities
The strongest sector in US M&A activity this year was power & utilities, which experienced a 20% increase in the number of deals to 148 deals total (the most since 2007) and a 34% increase in value to $51.0 billion.10 This resurgence in M&A activity is the result of planned capital spending and investment in new infrastructure and technology as well as new opportunities with shale gas.

“In the last year we saw a big uptick in power & utilities M&A as the industry prepares for tremendous capital expenditures and huge infrastructure upgrades to continue the provision of energy in the US and seek new opportunities to raise capital for growth, “says Joseph Fontana, Ernst & Young’s Global Utilities Leader, Transaction Advisory Services. “Activity will likely continue to surge in 2012 with interest from PE and corporates as new shale gas plays, environmental regulation, and alternative energy are expected drive industry consolidation.”

Healthcare
Another bright spot in 2011, healthcare activity in the US increased 11% to 565 deals year to date and the value of healthcare deals skyrocketed 159% to $113.8 billion.11 A handful of large deals led the resurgence as healthcare services companies and payers looked to achieve scale and, in some cases, drive sector convergence in the wake of healthcare reform legislation passed in 2009.

“The rebound in healthcare M&A was kick started by healthcare reform and stronger financing markets and continues as companies seek scale and convergence of new services and technologies,” says Gregory Park, US Group Head, Healthcare M&A and Capital & Debt Advisory, Ernst & Young Capital Advisors, LLC. “We expect to see continued momentum in healthcare activity in 2012, including further industry consolidation and strategic partnerships, as the industry evolves to position itself ahead of timelines set by healthcare regulation requirements and to address changing reimbursement.”

Technology
In 2011, deal activity in the technology sector was relatively flat in the US compared with 2010, with a slight decrease in both the number of deals and value to $79.4 billion.12 Globally, the number of tech M&A deals saw an uptick of 5% and deal value significantly increased by 18% to $152.4 billion.13

With growing demand from today’s digital consumer, companies across industries are continuing to pursue strategic deals that integrate mobile, wireless and cloud technologies into the business framework. Big strategic buyers are looking to top targets to capitalize on good valuation and the liquid market for patents.

“We are entering a transformative cycle for technology propelled by mobility, the evolution of cloud computing and the explosion of data,” said Jeff Liu, US Group Head, Technology M&A and Capital & Debt Advisory, Ernst & Young Capital Advisors, LLC. “Despite a flat 2011, 2012 will be a strong year for technology M&A as these disruptive technologies spur significant strategic deal-making activity among technology companies and PE firms looking to generate returns.”

Financial services
While the number of financial services deals in the US continues to be at an all-time low and is down 9%, the value is up nearly 157% to $62.5 billion, the highest value since the financial crisis of 2008.14

“Overall, the year started off strong in financial services and activity was fairly robust but as the year went on the pace has slowed down largely due to the sovereign debt crisis in Europe, ongoing low-growth trends in US, market volatility and regulatory reform uncertainty,” says Nadine Mirchandani, Ernst & Young’s Global Asset Management Sector Leader, Transaction Advisory Services. “While the last year has been slow, there is huge wave of change taking place in the sector and some structural fundamental dynamics will keep financial services very active going forward with expected divestiture activity as they redefine their business.”

Brazil and China
With US companies needing ways to grow in the sluggish economy, many are continuing to look to the rapidly growing markets of Brazil and China as well as other new emerging markets for future growth.

China is the number one country in the world where companies are looking to invest or execute deals in the next year.15 The country’s economy continues to grow at an impressive rate due to government stimulus and the huge and growing middle class consumer population. With plenty of financing and capital available, M&A was strong in China with $119 billion in deal value and 2,493 deals announced in 2011 so far this year, up nearly 9%.16 China itself is also looking overseas, with over $22.3 billion in outbound deal value announced so far this year, representing an 8% increase over the prior year.17 This indicates that capital flows are continuing to shift around the world.

“M&A in China is expected to moderately increase in 2012 with ongoing macroeconomic pressures both globally and domestically causing some hesitation with dealmakers in the short-term,” says Krouskos. “China continues to be a growing global economic force at home and abroad. We can expect PE and corporates to remain active particularly in manufacturing, energy and consumer products as the country requires natural resources to fuel its strong economic growth and emerging middle class.”

Brazil remains an attractive investment market, as executives continue to rank the country among the top three most likely destinations where they will make an outbound investment.18 U.S. companies have demonstrated significantly more interest in Brazil; with the number of U.S. inbound deals in 2011 up 15% over the previous year.19 The total number of deals in Brazil increased 22% to 578 deals in 2011.20

Brazil has been minimally affected by the global economic crisis; in fact, the country has benefited from the slower growth in more matured economies. Growth in Brazil was sustained by heightened infrastructure spending in preparation for hosting the 2014 World Cup and 2016 Olympics, global demand for commodities including pre-salt and oil & gas, and increased consumption resulting from a rapidly growing middle class. According to the International Monetary Fund, Brazil is expected to overtake the United Kingdom as the sixth largest global economy in terms of GDP by the end of this year and is expected to break into the top five by 2020.21

“The fundamentals that insulated the Brazilian economy from the financial crisis will sustain a high level of M&A activity in 2012 and despite the global slowdown strategic buyers and financial sponsors are continuing to pursue their acquisition strategy,” says Rogerio Villa, Transaction Advisory Services Leader, Ernst & Young Terco in Brazil. “Brazilian companies are focused on growth and 71% expect to grow in the next 12 months, which makes the country a prime location for long-term opportunities for both corporates and private equity firms.22”

Conclusion
“In the immediate term, it is hard to predict M&A activity as we see drastic market swings, but we know for certain that the eagerness for M&A is there and we expect to see dealmaking pick-up in the first quarter of 2012. In the US, companies with strong balance sheets and plenty of cash on hand are well-positioned to finance and execute strategic transactions and grow in 2012,” says Jeanneret.