Dealmakers would be forgiven for thinking they’re experiencing déjà vu.
Another year began with a promising first quarter. But as the weather got warmer, the environment for mergers and acquisitions chilled.
Worries about European sovereign debt, fiscal over-reach by governments around the world and turbulent global markets now threaten bankers with a quiet summer.
“For those of us driven by transaction announcements, it has been a tough business for four years,” notes one gloomy adviser.
Global dealmaking slumped 17.5 per cent in the second quarter of the year compared with the first, led by the US which dropped 36 per cent.
Activity rose 27.7 per cent over the first half compared with the same period of 2010, a healthy upwards trend, but advisers concede that companies are again taking their time over strategic decisions.
Steven Baronoff, head of global M&A at Bank of America Merrill Lynch, argues that companies are not abandoning transactions or shelving them for multiple quarters.
“We’d describe it as more of a slowdown in the past few weeks, rather than a halt,” he says. “There is just more uncertainty in the world in terms of fiscal difficulties, deficits, housing and consumer confidence.”
Bankers argue that the fundamental factors underlying dealmaking persist – reasonable valuations, cheap funding rates and strong corporate balance sheets.
“It is a matter of timing, but not really a question of direction,” says Paul Parker, global head of M&A at Barclays Capital. “If there is a slowdown in the economy but there is still growth, then you’ll see M&A and behind that is a number of structural factors that will keep the market going.”
Companies requiring financing are facing a less hospitable reception. Investors this month withdrew a record amount from US high yield bond funds, as worries about Greece mounted and US politicians bickered about the government’s debt ceiling.
This month prices for loans trading in the secondary market dipped to their lowest level so far in 2011. The pipeline of new issues has withered as companies pulled back on plans to test the market with opportunistic deals.
“The financing markets have gotten a little tougher, both in terms of leverage and rates,” says Eduardo Mestre, vice-chairman of Evercore Partners. “Some deals that are dependent on markets will founder because of funding.”
Before the recent jitters, Europe was enjoying a pick-up in M&A after a protracted period of depressed activity.
European deals worth $383.4bn have been announced so far this year, up more than 54 per cent on the first half of 2010.
That represents a rebalancing of activity, say bankers, after the US dominated large-scale dealmaking in the first three months of the year.
However, the UK’s share of deal activity has shrunk, down to 14.8 per cent of the European market, the lowest levels since Mergermarket records began. Traditionally the largest and among the most open market for deals in Europe, banks argue that confidence in the UK’s economic recovery remains fragile.
Instead, sizeable continental deals boosted volumes, including Johnson & Johnson’s $21bn deal to buy Synthes of Switzerland and the acquisition of Nycomed, another Swiss pharmaceutical company, by Japan’s Takeda for $13.7bn.
Advisers argue that large, strategic deals can prompt a rethink by rivals.
“Many companies who may have considered the status quo as a good option are looking at a changed landscape in their industry,” says Mr Parker at Barclays Capital. “They are having to think about their competitive response.”
Industry bankers report a flurry of conversations after US power company Duke Energy agreed a $26bn merger with Progress Energy in January, while AT&T’s $39bn deal with T-Mobile USA has prompted soul-searching among telecoms rivals.
Moreover, some would-be buyers may be encouraged by the markets’ reception to deals. Avis Budget shares, for example, jumped 7.6 per cent this month when the car rental company announced a $1bn deal to buy its European counterpart, Avis Europe.
“The market reaction to announced deals in many cases is positive, which is a new phenomenon,” says Hernan Cristerna, head of European M&A at JPMorgan. “We would normally expect acquirers’ stock to underperform after a deal is announced and the contrary shows investor support of M&A.”
The markets seem to be receptive to growth through acquisition, argue bankers, as the economic environment makes it tougher for companies to promise credibly top-line growth on an organic basis.
“For those who felt this was going to be a sharp snapback then perhaps the standalone plan looks pretty good,” points out Mr Baronoff. “But for those who feel it will continue to be a difficult economic environment and growth will be challenged, then given the current cost of financing it makes sense to think about transactions.”
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