The year 2009 began with a sharp decline in M&A activity, a hangover from the end of 2008 as the world concentrated on the fallout from the collapse of Lehman Brothers and on rescuing the global financial system.
Global M&A was at its lowest level since 2004 across the year, though the fourth quarter did see a 24 per cent increase over the third quarter, meaning that the year ended more satisfactorily than it started.
The headline statistics do not tell the whole story, however. The characteristics of the market were very different to the boom years of the middle of the last decade. Depending on what statistics you use, globally financial sponsor (or private equity) backed transactions were down around 60 per cent against 2008 despite the uptick in the last quarter. There were few bright spots, but around the turn of the year Warburg Pincus’ acquisition of Survitec from Montagu and KKR’s acquisition of Pets at Home were indicators that the UK market might start to follow the slight improvement seen in the US market.
Today, financing remains scarce and the fundraising environment for private equity in 2010 looks tricky, except possibly for those few high-performing funds that can demonstrate they have weathered the downturn and achieved profitable exits. A number of private equity houses were hoping to tap the IPO market to refinance investments and hopefully return capital to their investors but, at the time of writing, the environment for this looks pretty challenging. Even without new fundraising, the industry is said to be sitting on €400 billion of equity commitments globally and, if the debt markets do splutter more convincingly to life over the spring, private equity could be back in the game competing with trade buyers for strategic assets.
Nonetheless, the pressure is on the private industry to come up with a convincing model that works with lower leverage. Investors are questioning the standard private equity fund model which many see as unaligned and inflexible compared with, say, hedge funds. There are also the problems of dealing with legacy portfolio restructuring and motivating both sponsor and portfolio company management teams at a time when their carry or equity participations appear unlikely to pay out.
Much of the M&A that took place in 2009 was strategic, with transactions in the pharmaceutical sector such as Merck’s acquisition of Shering Plough and Pfizer’s acquisition of Wyeth being good examples. In the UK, the most high-profile such deal was Kraft’s acquisition of Cadbury, which is just the kind of situation that private equity might well have expected to compete for in a market where debt was more obtainable. Indeed, other trade buyers might also have emerged had debt been more freely available. It is also interesting that the transaction caused some, including Cadbury chairman Roger Carr, to call for a change to takeover regulation in the UK. Short-term shareholders played a vital role in the transaction, and during the offer period 26 per cent of Cadbury’s shares were sold by long-term shareholders, mainly to hedge funds. Carr called for changes to redress the balance in favour of longer-term shareholders (including changes to disclosure requirements) and raising the mandatory minimum acceptance level for takeover bids above the present 50 per cent requirement.
There was also activity in the natural resources markets. That trend is expected to continue into 2010, with smaller independent oil companies bracing themselves for the wave of consolidation to continue. A good example of the type of deal we can expect to see in the oil services sector was announced in late February 2010: Schlumberger’s US$12.4 billion all-share acquisition of Smith International. Here, the strategic buyer did not need debt finance and was able to buy at a lower valuation than would have been possible at the top of the M&A cycle. There is no doubt that, in certain sectors, pressure is growing on corporates to make strategic divestitures and acquisitions.
In financial services, banks such as Deutsche, Santander, HSBC and Barclays are said to be on the lookout for wealth-management businesses. There will be continuing activity in other areas of the financial services sector. A combination of a tightening global regulatory environment (for example, the AIFM directive in Europe and President Obama’s proposals for the Volcker Rule regulation in the US) and the unwinding of government intervention will put pressure on major financial institutions to divest and restructure. The Prudential/AIG transaction announced in early March is a case in point.
Generally, restructuring gathered momentum in 2009, but it can be expected to peak over the next four to five years as the debt taken on during the boom years becomes due for repayment. Global restructuring M&A reached the highest annual volume on record in 2009, with a major highlight being the automotive sector bailout in the US.
Emerging-market deal volumes dropped substantially in 2009 but less so than in the developed world. Chinese companies in particular took advantage of market conditions to make 154 international acquisitions in 2009 for a total of US$31.3 billion, according to Deal Logic. The vast majority of these were in the natural resources sector.
Overall, few expect 2010 to be a boom year. There remains in many sectors a valuation gap between buyers and sellers in general. It seems likely that mid-market M&A may recover more rapidly than larger transactions. It is also probable that we will continue to see large regional variations. The Euro zone looks set to continue to struggle with its huge deficits and attendant pressure in the currency markets. The UK is grappling with an election in the spring and the possibility of a coalition government lacking the political will or ability to reduce the huge public-sector debt with sufficient speed and vigour. Relatively speaking, emerging (especially BRIC) economies look more likely to have a stronger year in M&A.