Confidence Paradox: Executives Set for Bolder Dealmaking Future, but Action will Take Time, According to Ernst & Young

-- Optimism for M&A in the US as deal volumes expected to improve; deals will remain smaller and opportunistic

-- Valuation gap narrows-45% expect valuations to rise in the next 12 months

-- Growth top priority for US companies-61% focused on growth, up from 46% six months ago

-- US corporate confidence surges-47% of companies plan to create jobs; retain workforce

Apr 22, 2013, 09:00 ET from Ernst & Young

NEW YORK, April 22, 2013 /PRNewswire/ -- As confidence in the global economy returns and credit availability improves; deal volumes are likely to see modest improvement as companies' focus on growth rebounds, according to Ernst & Young's latest Global Capital Confidence Barometer, based on a survey last month of almost 1,600 senior executives in 50 countries around the world.  

There is a strong consensus globally that mergers and acquisitions (M&A) volume will increase as confidence in the overall economy starts to climb with 61% of US companies expecting US deal volume to improve and 76% of US companies expecting global deal volume to improve over the next twelve months. Yet only 29% of US companies expect to pursue acquisitions in the next twelve months, only a modest improvement from six months ago at just 23%, suggesting that companies are more focused on organic growth. In the US, the sectors most likely to see M&A activity are financial services, mining and metals, automotive, technology and life sciences.

"Executives are experiencing a confidence paradox. There are clear signs of a dealmaking inflection point and companies are ready to transact; however, it may take time before we see plans turn into actions," said Richard M. Jeanneret, Americas Vice Chair, Transaction Advisory Services for the Ernst & Young organization. "Respondents say asset valuations are poised to rise, and while they do not have near-term plans for transformational M&A, executives are positioning their strategies for a growth pickup and companies are setting the stage for a bolder future."

Forty-four percent of US respondents feel more confident about the number of M&A opportunities available, up from 40% six months ago; 34% of companies say there are quality acquisition opportunities available, roughly flat with 36% six months ago.

Valuation gap narrows and cash primary source for deal funding

While there are clear signs of improvement, it is unlikely that the economy and dealmaking will rapidly recover to the levels of 2005-2008. However, there may be an opportunity for those companies that act now and execute deals as buyer-seller expectation gaps narrow.

Valuations are gaining momentum and are at their highest level in two years. Forty-five percent of companies expect price/valuations to rise in the next year up from 33% six months ago. Just 5% of companies expect valuations to decline, compared with 21% in October 2012.

"The perceived gap in asset valuations has been a factor in the slowdown in dealmaking over the past few years; however, the market is stabilizing suggesting a turning point in dealmaking and a potential rebound in M&A," said Jeanneret.

Fifty-six percent of companies said they will use cash as the primary source to fund deals over the next year. Respondents also say credit availability is up, selected by 58% over 28% from last year.

Boardrooms focused on low-risk growth and smaller deals

Consistent with sentiment over the past six months, companies are reluctant to execute large, transformational acquisitions and deals are likely to remain smaller in size, despite record amounts of available cash, and a significant increase in credit availability. Fifty-eight percent of US companies expect to do deals between $51 million and $500 million in the next 12 months.

Sixty-one percent of US respondents cited growth as their companies' focus over the next 12 months, a major rebound from October 2012 (46%). Organic growth remains the top preference of companies with excess cash, selected by 36% of respondents. Organic growth will be balanced and companies will focus more rigorously on execution of core products/existing markets as well as bolder organic growth strategies.

"Companies are requiring longer lasting evidence of an economic upturn and are gravitating toward low risk growth and value creation, but they are gradually trending toward an investing agenda.  Companies are assuming less risk than expected, given strong fundamentals for M&A, but with valuations improving we may see a shift toward transformational growth in the long-term," said Jeanneret.

Divestments continue as core strategy
The appetite to pursue divestments remains and divestment intentions have normalized as more companies have shifted from stabilization to a growth agenda. Eighteen percent of US companies are likely to divest in the next year, consistent with the findings from our recent Global corporate divestment study.

The top reasons to divest are focusing on core assets, raising capital and enhancing shareholder value. Slightly more companies, 22% compared with 18% six months ago, plan to pursue divestments to fund inorganic growth (M&A) plans, suggesting that the rationale for divestments is evolving as companies now recognize the opportunity to use divestments a tool for growth.

Emerging markets still top of mind

The top investment destinations continue to evolve and extend from emerging markets to developed markets including: China, India, Brazil, the US and Canada. This is a shift from six months ago when the US was in the number two position behind China and Germany rounding out the top five markets instead of this year's new entrant, Canada.

Companies remain optimistic about opportunities in emerging markets, but are exercising more caution with their plans. Seventy-two percent of respondents remain optimistic about opportunities, however only 31% have not changed their approach to investing in emerging markets and 41% say they will "apply further rigor," when assessing deals. Regulatory risk and political risk are cited as the top barriers for doing deals in emerging markets.

Economic confidence improves

Ninety percent of US respondents view the global economy as stable or improving up from six months ago (72%) and compared to 87% globally. Global economic sentiment has improved significantly, although the US – often an economic bellwether – is less optimistic. Only 44% of US respondents view the global economy as improving, below several other major economies including Japan (65%), France (64%) and Germany (63%). US companies do see improvement on growth. Seventy-two percent of US respondents are positive on economic growth, up dramatically from 34% six months ago and 51% a year ago. In addition, more than half of US respondents are positive on employment growth (62%), credit availability (58%) and corporate earnings (57%), which have all nearly doubled in the last six months.

There are still challenges ahead; 49% of US companies cite debt ceiling challenges as the greatest economic risk to business compared with 27% who cite stagnation in the Eurozone over the next year and 24% who cite slowing growth in emerging markets. US Companies do view today's regulatory environment as pro-growth, suggesting that the economy may continue to improve.

"Macroeconomic pressures globally and in the US, including uncertainty around fiscal and tax policy as well as sequestration remain on the radar, but overall, companies are more confident about the future. Improving economic confidence will drive more companies to create jobs and retain workforces as our barometer found that 47% of US companies plan to create jobs up from 32% six months ago signaling that companies are focused on growth," said Jeanneret.

Entering capital commitment economy

Over the past five years, companies have shifted from focusing on deleveraging to cost optimization, driving a lot of cost out of the business and creating cash flow, which stabilized earnings but pared companies down to bare bones. Having achieved this and as companies shift toward an investment agenda, it is imperative that companies position themselves now, in this muted market, to create value and grow for the future.

"We are at an inflection point and entering a capital commitment economy, meaning for companies to grow, they need to make commitments to invest, transform and grow. Though we've seen some big transformational deals pop already this year, M&A activity will be modest as companies opt for lower risk strategies. The global economy remains weak, but for companies willing to make bold moves – especially due to unrelenting pressure to grow – there are opportunities out there," concluded Jeanneret.

About the survey

The Ernst & Young Capital confidence barometer is a survey of over 1500 senior executives from large companies around the world and across industry sectors. The objective of the Barometer is to gauge corporate confidence in the economic outlook, to understand boardroom priorities in the next 12 months, and to identify the emerging capital practices that will distinguish those companies that will build competitive advantage as the global economy continues to evolve. This is the eighth bi-annual Barometer in the series, which began in November 2009.

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SOURCE Ernst & Young