When two is stronger

IFR Top 250 Borrowers 2008
9 min read

The pace of consolidation in certain industry sectors – energy and metals and mining, to name a couple – and the velocity of capital flowing between emerging economies and their more advanced peers have been the key drivers of global merger and acquisition (M&A) activity this year.

These are also the main reasons why the current trough in M&A activity is likely to be brief compared to those seen in previous downturns.

“The factor to watch this time around is less about the volume of M&A activity and whether it is up or down, and more about the velocity of capital coming from emerging economies – where companies are in a position to use both equity and liquidity – and how it’s going to be put to use,” said David Livingstone, head of Europe, Middle East and Africa M&A at Credit Suisse in London. “The fundamentals of M&A are also supported by the need for continued consolidation in some industries.”

To be sure, companies in countries such as India, Russia and Brazil, have been the protagonists of several important M&A deals this year. Transactions such as Indian conglomerate Tata Sons’ US$2bn acquisition of Britain’s luxury car brands Jaguar and Rover, and Russian steelmakers Evraz and TPG’s joint bid for the US$4bn buyout of Canada’s IPSCO made their mark in the M&A arena.

Experts report both the Indian and Brazilian pipelines hold a significant number of new, cross-border M&A deals. The Middle East with its sovereign wealth funds and Africa have also made – and will continue to make – an important push forward in the M&A business worldwide. This will draw the leading banks further into these regions.

A lot of money has been flowing into Russia, Brazil and other countries, mainly on the back of the boom in commodity pricing. As a result, numerous companies in those countries now have cash to spend on buying up competitors – both within their domestic markets and without.

“This doesn’t, of course, mean that companies in other parts of the world won’t be making acquisitions, but those in places like Brazil, Russia and the near East certainly have an edge right now,” said Christopher Kandel, co-head of law firm White & Case’s bank finance practice in London.

There is certainly a push by corporates in Asia, Latin America and elsewhere to not only buy other companies in those regions, but to also snap up Western European or American companies if they can. At the same time, there are probably more Western European companies – and, to a certain extent, sponsors as well – expanding into emerging or recently emerged economies as they look to gain exposure to their growth and diversify their revenue streams.

“The rationale behind this is quite simple: Growth for corporates and sponsors that can't get meaningful leverage,” said Wilhelm Schulz, co-head of M&A for Europe at Citigroup in London (Citi, in fact, led the Tata/Rover deal). "They’re substituting leverage for growth in order to drive returns, because going into emerging markets assures Ebitda growth at a time when that part of the world is growing.”

But despite this rationale and the corporate buyout activity it has engendered, there is still no denying that M&A, like any other financial market sector, has taken a serious hit this year. Year-to-date completed global M&A deals stands at around US$ 1.1trn, according to Thomson Reuters data, compared to US$ 3.9trn of completed deals for the whole of 2007.

Financial sponsor-driven M&A – by far the greatest driver of M&A activity in 2007 – has taken the greatest hit this year. Year-to-date deal value volume stands at US$150bn – significantly down from the US$900bn recorded for 2007.

“Large-scale LBOs were the order of the day last year but they’re simply not there anymore,” said Citi's Schulz. “On a general basis, banks have been much more reluctant to take on syndications, and sponsors now want to have their bank group in place upfront, which is putting constraints on actionable deal size in LBO situations.”

Indeed, financial sponsors are finding it extremely difficult to put together LBO financings of more than a billion euros in debt, agreed Kandel. This has impeded the completion of large deals, but at the same time, he said, several sponsors have been able to fairly easily raise debt for deals that they previously would not have had much interest in doing.

“It’s been interesting to see that financial sponsors, who in the old regime would have been looking only at multi-billion dollar transactions, are now competing for deals that one would have thought too small for them,” Kandel said.

Yet the “right kind” of private equity deal – one that is priced correctly, has low leverage and comes with a good equity component as well as a credit story – can still entice bank lenders, even if it is large. Nordic Capital’s mammoth US$4bn buyout of ConvaTec, the wound care division of Bristol-Myers-Squibb, for example, generated significant bank interest despite its substantial size.

“It’s a challenge to put together a really large buyout these days, but some are getting done,” said Oliver Brahmst, a New York-based partner in White & Case’s M&A practice.

Corporates have been leading the M&A game this year. In most cases they have had an easier time than sponsors raising credit – if they need it – for deals. But even cash-rich corporates have been constrained by one other factor that continues to hold back the pace of M&A activity overall: valuation uncertainty.

Nearly a year after the debacle engendered by the subprime crisis and the ensuing havoc it wreaked upon the credit markets, big differences remain in the values that buyers and sellers ascribe to many businesses. In many cases the failure to come to an agreement is constraining M&A activity globally. M&A bankers complain that not far behind the hardest issue these days – getting a deal financed – comes the issue of reaching agreement over valuations.

Despite the discrepancies in buyer/seller business valuations and constraints on the availability of credit – particularly in some industries – M&A is still alive and kicking. Deals may be smaller, but the number of deals that are being done still remains strong. “Our conversations with both corporate and sponsor clients are constant,” said Livingstone.

While the consolidation thrust in such sectors as metals and mining and utilities (particularly in Europe) continues to play an important role in spurring new M&A deals, industries such as food and beverage and healthcare have also been generating deals. Media and telecom M&A is also seeing new activity. It should not be long before financial institutions – many of which have been significantly affected by falling asset valuations – will also be looking to merge, once asset values are more certain.

Experts believe the current M&A cycle is different from past cycles: most companies do not have overlevered balance sheets. At the end of last year consulting firm KPMG said in its Global M&A Predictor that corporate balance sheets remain strong globally, with a net debt/Ebitda ratio of 0.81 times. Africa, the Middle East and the Asia-Pacific region are the strongest parts of the world, KPMG said, indicating that together with increased appetite for deals, these regions also possess the greatest financial capacity for deals.

Europe, the US and Latin America have seen no material change in their balance sheet capacities, the firm added, but throughout the globe, the strength of corporate balance sheets means that the capacity for “intelligent” deals to be struck remains.

“We're also not dealing with broken business models like we were in the 2000-2001 period, when the internet bubble burst,” Schulz said. “This makes a big difference compared to other down cycles.”