NEW YORK, June 23 /PRNewswire/ -- Despite earlier improvements in credit and equity markets and corporate balance sheets, U.S. merger and acquisition (M&A) activity remained sluggish in the first half of 2010. Unforeseen economic events in the last two months triggered a global ripple effect reviving sentiments of uncertainty -- setting the stage for a challenging M&A environment for large cap transactions in the second half, according to the Transaction Services practice at PricewaterhouseCoopers, LLP (PwC). However, PwC contends that the middle market may be a different story.
"Going into the second half, record dry powder in the private equity space and unprecedented cash levels on the balance sheets of corporate America will combine with the desire of family held businesses and private equity backed management teams to sell prior to looming tax increases," says Bob Filek, partner with PricewaterhouseCoopers' Transaction Services.
U.S. M&A activity was down three percent compared with the same period in 2009. The number of closed deals in the first half of 2010 represents the lowest deal volume this decade, according to PwC. For the first five months of 2010, there were 2,969 closed deals representing $317 billion, compared with 3,065 deals valued at $323 billion in the same period of 2009.
While deal value and volume are down, willing lenders and open credits markets are available for transactions, according to PwC. "Banks and institutions are providing capital to execute deals," says Greg Peterson, partner with PricewaterhouseCoopers' Transaction Services. "They are lending more conservatively, but credit is available from a variety of sources and in a variety of types -- including traditional leveraged loans."
Corporate buyers continue to employ strategic deal making, pursing attractively valued companies and seeking out 'mergers of productivity' as a means to capture benefits of scale and cost savings, maintains Filek. "Companies are taking advantage of depressed valuations -- looking for deals to grow and diversify at discounted prices. Even with the uncertainty in Europe, a hesitant consumer and volatile markets, it's still an attractive time to buy."
The median deal size in the first half was $107 million, indicating that smaller, middle market deals have become the new 'normal.' "While there is still ambition to complete mega deals, the 'hit rate' will be low. The sweet spot for deals will be one to five billion dollars and below, with a mega deal or two sprinkled in," says PwC's Peterson.
PwC expects divestitures, carve-outs and spin-offs to continue to contribute to deal activity as companies separate certain assets and operations no longer seen as core to the business. The likely candidates to acquire these assets are private equity players who have strong relationships with large corporations that may be interested in selling certain assets. Business units within the industrial products and technology sectors are among the industries where PwC expects to see increased divestiture activity.
"Private equity players will also remain active in the distressed area, using their debt, hedge and distressed funds to find deals in untraditional ways," continues Peterson. "While there are concerns about stricter regulation for certain alternative investment classes, private equity is a resilient and innovative business run by sophisticated investors who will still get deals done, regardless of what transpires in Washington."
The current private equity overhang at nearly $850 billion (three and a half times the overhang in 2000) represents 54% of all capital commitments made between 2004 and 2009. Over 85% of the $850 billion is in funds larger than $1 billion, including 48% in funds larger than $5 billion, according to Cambridge Associates.
Declining values of the Euro and Pound are also providing a strong backdrop for cross-border deals, particularly in Europe. "Typically, during U.S. downturns, European companies take advantage of a poor U.S. economy, but this time, foreign buyers have to deal with issues at home, including a challenging financing market, reduced demand and declining currency values," according to PwC's Filek. "As a result, we expect the inverse to occur. U.S. corporates are going to see good opportunities to acquire high quality franchises and brands in Europe."
Sectors ripe for consolidation include:
- Aerospace & Defense – Activity in the security, surveillance and homeland security sectors are expected to continue as suppliers seek to diversify their offerings and seek growth areas away from traditional defense budgets. Look for organizational conflict of interest concerns to drive some activity, with A&D companies evaluating options to exit such activities through a sales process.
- Automotive -- With crashing 2009 assembly volumes in the rear-view mirror, companies with strong balance sheets and access to capital are poised to re-enter the deal market. Over the next three to five years, M&A will be driven by new technologies, regulations and consumer requirements. Tier one suppliers will work to realign their product portfolios to take advantage of the restructured industry. Developed markets will focus on fuel economy, hybrid and electric vehicles and infotainment and communications in vehicles, while developing markets will focus on delivering low cost vehicles and acquiring technologies.
- Entertainment, Media & Communications -- Private equity interest remains strong with new investment in and through platform companies. High-profile acquisitions over the past several years, as well as numerous middle-market acquisitions, have led private equity's interest and influence via platform investments to expand across the E&M landscape. As private equity investors continue to assess the cyclical and structural issues within certain E&M subsectors, PwC expects that interest to permeate even further via bolt-on acquisitions as well as new platform company investments. Additionally, more traditional, well-capitalized corporates in this space appear to be stabilizing and interested in potential M&A activity.
- Financial Services -- Until the impact of U.S. financial regulation is fully realized, uncertainty will be cause for continued stagnation of deals in the sector, other than some continuing interest in FDIC supported takeovers. However, opportunities exist for companies to divest non-core assets and consider capital raising alternatives such as debt or equity raises. Consolidation in the property and casualty insurance is still expected in light of continued soft premium pricing and desire to maximize scale, while life insurance consolidations will likely continue to be a less active space given returning investment portfolio valuations and focus on product redesign.
- Healthcare -- As the full impact of U.S. healthcare reform becomes better understood, look for increased industry M&A and joint venture activity. Consolidation will accelerate in the services and health insurance/managed care sectors, driven by the need to reduce costs, increase productivity and develop more integrated business models. Technology will play an even larger role; and leaders will embrace strategies and innovations that will lead to more collaboration across all health industry sectors.
- Oil & Gas -- Oil & gas commodity price differential will drive companies to increase their oil positions through acquisitions. Equipment and service companies will expand their product and geographic footprint through transactions. The offshore drilling moratorium will be an obstacle for those highly levered to Gulf of Mexico E&P projects but will likely not dampen the growing level of transactions in the sector.
- Power & Utilities -- Despite uncertainty surrounding energy policy and regulatory changes, M&A activity in the sector has been a pleasant surprise, as significant regulated and merchant company transactions have been announced in the first two quarters of 2010. PwC expects this trend to continue, with a cautious eye towards regulatory approvals of the announced transactions. IOUs continue to shed non-core assets and M&A activity remains strong in the renewable space. Expect to see continued sales of merchant power plants, particularly driven by the current and projected commodity prices.
- Retail/Consumer Products -- Watch for the strongest sectors to lead the way in accelerated activity focused on growth. Food and household products companies will look to expand portfolios and enter emerging markets as a way to boost revenue growth. Retailers faced with a lackluster U.S. consumer will be focused on business models that make sense for them in emerging markets. European specialty companies depressed by the recent downturn could be attractive to opportunistic U.S. buyers.
- Technology -- Record profits and favorable revisions in investors' expectations will drive M&A as a means of accelerating innovation cycles. The 'new R&D' will continue to drive mid-market transactions. PwC expects software incumbents to round-out offerings or acquire industry-specific applications and as major hardware players expand into end-to-end solutions. Look for semiconductor deals to come to the fore as the long-awaited cyclical rebound begins to take hold. Consumer technology and Internet majors will continue to work their way along the value chain to capture market and mindshare as mobile computing, entertainment and communications markets converge on intelligent and user-friendly devices.
According to PwC, the wild card in the second half will be just how much incentive looming tax increases give buyers to sell. "The economics could be compelling enough to drive a rush to exit by December 31, which could mean a busy holiday season for deal makers," says Filek.
*The accuracy of our previous forecasts does not guarantee future accuracy.
PricewaterhouseCoopers' Transaction Services
The PricewaterhouseCoopers Transaction Services practice provides due diligence for M&A transactions, along with advice on M&A strategy and integration, restructuring, divestitures and separation, valuations, accounting, financial reporting, and capital raising. With approximately 1,000 deal professionals in 16 cities in the United States, and a global network of over 6,000 deal professionals in 90 countries, experienced teams are deployed with deep industry and local market knowledge and technical experience tailored to each client's situation. The Transaction Services team can be involved from strategy to integration and employ an integrated business approach to uncover the realities of a deal. The field-proven, globally consistent, controlled deal process helps clients minimize their risks, progress with the right deals, and capture value both at the deal table and after the deal closes. For more information about M&A and related PricewaterhouseCoopers services, please visit www.pwc.com/ustransactionservices.
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