The decade started promisingly enough. The $164bn merger unveiled in January 2000 between rising internet giant AOL and media behemoth Time Warner was thought to be a good indicator that mergermania was on the horizon and that companies that might not be too similar in shape and outlook could get together and be profitable. But despite then AOL’s chief executive Steve Case declaring the deal as an historic moment, just ten years later the “deal of the century” is being unwound. Not only that, the Time Warner-AOL merger – valued at $360bn – is derided as one of the worst thought out deals ever made.
The scale of the disastrous union becomes apparent when one considers their former values. At the time of the official split last December, AOL had a market value of less than $2.5bn. When the two companies announced their merger, AOL was worth almost $200bn, and Time Warner some $160bn, now whittled down to around $36bn. This means that over a decade, the company has lost over $320bn of its initial value. As Daniel Stillit, mergers and acquisitions analyst at UBS, says: “The decade opened at the high point of a merger wave. It’s ending at the low point”.
Indeed, 2009 was a low-point in the recent history of dealmaking. M&A totalled $1.968trn in 2009, down 32 percent from full-year 2008 and down 53 percent from the record high in 2007, according to data from Thomson Reuters. The worst performing sectors were consumer staples and consumer products and services.
The US, which suffered a six-year low, still squeaked ahead of Europe for the first time in three years. US-targeted M&A volume totalled $783.4bn – down 24 percent on 2008 levels, with the largest US-targeted deal being Pfizer Inc’s $64.8bn acquisition of Wyeth in the healthcare and pharmaceuticals sector.
A global lacking
The dive in deal activity was not limited to the US and Europe. The Middle East has seen M&A activity in its investment banking market slip by 40 percent in the last year and by a hefty 67.5 oercent from its 2007 high. Latin America saw a drop of nearly a third in its deal volume last year, and India’s deal volume fell by over half on the previous year. Of the larger economies, only China managed to match its deal volume from 2008.
Through the first eleven months of 2009, there were 6,772 deals worth a total of $614bn, compared with 8,890 transactions worth a total of $1trn during the same period last year. Of that, government-backed mergers and acquisitions accounted for $354bn, or 15 percent of the total global volume, and M&A activity generated by bankruptcy or distressed situations reached a record $320bn. The biggest government-backed transaction was the UK’s $41.8bn share placement in the Royal Bank of Scotland.
According to Thomson Reuters, the credit freeze has impacted transactions across the board, including private equity and middle market transactions. The number of private equity acquirers in year-to-date November 2009 was down by 32.7 percent to 1,171, while value dropped by 21 percent to $146bn from $184bn over the same period in 2008. In the middle market, deal volume declined by 45 percent to 261 from 480 in 2008.
While the gloomy figures speak for themselves, there may be some salvation on the horizon as corporate financiers predict a resurgence in deal activity in 2010. M&A intelligence service The Mergermarket Group says that the last quarter of 2009 was the best quarter in value terms since the third quarter of 2008. It also points out that despite frozen debt markets and reluctance by corporations to make deals, 2009 saw more “mega deals” than 2008, with seven deals valued at more than $40bn compared to three in 2008. “Though there is still uncertainty in the markets, there are signs that the momentum will carry into 2010,” Mergermarket says. “A resurgence in financial sponsor activity, corporates sitting on record levels of cash, and a thawing credit market could signal a good year for M&A deal-makers.”
Conscious confidence
Senior bankers believe that a return in confidence among chief executives, along with an increased lending appetite at the banks, should boost corporate takeovers this year. Anthony Parsons, head of the UK mergers and acquisitions team at Deutsche Bank, says: “I think we saw the lowest ebb of this M&A cycle in 2009 and conditions are right for a pick-up in activity in 2010.” Zac Brech, head of UK M&A at Credit Suisse, adds: “We are optimistic for 2010, though it is more likely to be a year of recovery rather than anything approaching a peak.”
Already there appear to be some major targets in investors’ sights. The energy, finance, technology and healthcare industries are expected to be the hottest areas in a dealmaking market (energy and healthcare were the only two industries that showed gains in deal volume last year, according to Thomson Reuters). Analysts believe that moves by oil giant Exxon Mobil to buy XTO Energy for $30bn in stock may be a harbinger of activity to come in 2010 as companies flex their stronger share prices and release pent-up deal demand. The XTO takeover is hot on the heels of other corporate mega-deals, such as the $26bn cash-and-stock deal for Burlington Northern Santa Fe by Warren Buffett’s Berkshire Hathaway, and Comcast Corp’s $30bn planned purchase of NBC Universal.
There is also plenty of talk about other major firms making bid offers. International Power, which has a market value of £4.7bn, is believed to be in the sights of GDF Suez and dealmakers think it is only a matter of time before the French energy giant makes its move. The media business Aegis, worth £1.4bn, looks vulnerable to a bid in the absence of a chief executive and analysts believe France’s Havas could pounce. The oil majors are sizing up Tullow Oil, the £10.5bn explorer, due to its impressive success in West Africa where it has had some big finds.
Airline experts predict that Aer Lingus will be on the end of a third takeover attempt from Ryanair as losses worsen. Consolidation is also expected to continue in aerospace, with the well-regarded Meggitt a top target. Also identified by bankers as potential takeover targets are Standard Chartered, the bank that specialises in emerging markets; Smith & Nephew, the medical devices group; Informa, the media group; Peugeot, the French carmaker; and Misys, the software group.
“I think we’ll continue to see the M&A market driven by the big three sectors: financial institutions, natural resources and consumer,” says Parsons at Deutsche. However, Jeffrey Kaplan, global head of mergers, acquisitions, financial sponsors and corporate finance at Bank of America Merrill Lynch, warns that people should not become over confident. “You need a sustainable economic recovery,” says Kaplan. “You cannot expect the M&A market to flourish without favourable economic conditions. The best deals often are done at the beginning of a recovery. Post-bubbles create opportunities to get great values but are not always the best times for sustained M&A activity.”
Rough but robust predictions
While there may be some disagreement about the speed of the recovery in the M&A market, most experts agree that 2010 will see an upturn in deal activity. According to PwC’s Transaction Services practice, strategic buyers with strong balance sheets and robust cash reserves will be well-positioned for strategic M&A opportunities. As these strategic buyers take advantage of their ability to manoeuvre in the face of a challenging deal environment, PwC predicts they will pursue deals with a focus on synergies, including enhancing productivity, providing cost-savings and adding revenue volume to their businesses.
“Those who have built their balance sheets for a rainy day might come out of last year’s storm to find the rainbow, and at the end of it, nicely-valued acquisition targets that provide opportunities for revenue growth and enhanced productivity,” says Bob Filek, a partner at the firm. “As a result, M&A activity in 2010 will be driven by strategic buyers who have access to capital and the strategic vision to capitalise on some of the best values we have seen in recent times.”
“Companies have taken aggressive actions on costs; the low hanging fruit is gone, and to drive further efficiency they will look to combine with similar players to drive scale and enhance productivity. The ‘merger of productivity’ will be a driving force in 2010 as companies look to drive revenue growth and enhance margins,” he adds.
Despite the credit crunch and the reluctance of banks and other lenders to dole out cash as generously and with as few questions as before, PwC believes that there is still plenty of money available to fund deals. “There is still in excess of $1trn of capital committed to alternative investment funds sitting on the sidelines, waiting for the appropriate opportunities,” says Greg Peterson, partner with PwC’s Transaction Services team. “The diversified private equity players have been bulking up their debt, hedge and distressed funds to take advantage of opportunities in distressed markets, reflecting their ability to evolve and successfully navigate choppy waters,” he says.
According to rival Big Four accounting firm Ernst & Young, private equity is sitting on $400bn in dry powder, or cash, while Fortune 1000 companies have more than US$1.8trn of cash on hand, an increase of $271bn over last year. As debt markets become more open, with banks willing to lend money for deals with higher leverage, private equity firms and corporations will begin to compete again on deals.
The divestitures market will also be a factor in fuelling deals, as more companies decide to rid themselves of holdings they don’t consider to be part of their core business. A recent PwC Transaction Services survey, Doing Divestitures in Difficult Times, concluded divestiture activity was poised for a higher level of activity in the next twelve months, especially among corporate buyers. Of the survey respondents, 69 percent anticipate similar or increased divestiture activity in the coming year. The percentage of M&A activity contributed by divestiture transactions has begun to increase in recent months, suggesting this is already taking place as 2010 quickly approaches.
Furthermore, bankers believe that extra cash on balance sheets, buoyed stock prices and rising corporate boardroom confidence points to an increase in hostile deal activity over the next year. Kraft Foods initial £10.5bn hostile offer (increased to £11.5bn and accepted) for UK confectioner Cadbury is typical of the move toward hostile deals, according to data from Thomson Reuters. Hostile bids represented only 0.9 percent of the M&A market last year, but that was still the highest rate of the past five years, the data showed.
While it is unlikely that deal volume will get to the pre-crunch levels this year, there are indications that momentum is picking up, even though the number of deals being concluded might be lower than hoped. Yet the number of megadeals concluded in the last quarter of 2009 shows signs that companies can get the cash if they want to, and the size of the deals already being done at the start of 2010, such as Kraft’s purchase of Cadbury, shows promise.
