Surprising appetite for deals despite market turbulence

Despite economic turbulence and market turmoil, 41% of leading international companies expect to make an acquisition in the next 12 months, according to Ernst & Young’s latest Capital confidence barometer, based on a survey of more than 1,000 senior executives around the world. Surprisingly, that is a slight increase on six months ago, despite the intense market turmoil during August, when the survey was conducted.

Stronger balance sheets together with a greater focus on operational fitness mean there is a continued appetite for M&A among large cap corporates.

There is also a greater convergence around the price of assets, encouraging sellers to come to the table. Almost two thirds (57%) see valuations remaining at current levels for 12 months, resulting in a 30% uptick in potential sellers compared with six months ago – 26% of businesses now plan to divest in the next year.

The fifth bi-annual Capital confidence barometer, finds that almost half of respondents are focused on growth in the next 12 months, with only 7% now focusing on survival – the lowest number since the barometer was first published in 2009.

Pip McCrostie, Global Vice-Chair, Transaction Advisory Services, at Ernst & Young, says: “There is a new paradigm with M&A activity and market volatility now able to co-exist. Currently, leading companies are shrugging off continued market upheaval and focusing on growth and M&A.

For them this is not 2008 all over again. They have spent the past three years reducing the financial risk on their balance sheet and taking tough efficiency measures needed to strengthen their positions, which helps them manage in volatile times.”

Stronger balance sheets encourage M&A

Three years of focusing on capital management underpins the resilient attitude of those companies who might come to the deal table. Large corporates are in much better shape than 2008. Balance sheets have been significantly strengthened. In addition, businesses have improved their capital structure by reducing interest costs and extending maturities.

Overall debt has fallen, with 61% having debt-to-capital ratios of less than 25% and 78% plan to maintain or reduce their debt-to-capital ratios further in the next 12 months.

Corporate earnings outlook is relatively strong, with almost half (47%) confident they will be at least stable; a further third believe earnings potential is positive.

Funding conditions have also improved, with 68% saying capital market conditions are at the very least stable.

Surprising corporate confidence in an uncertain market

Despite concerns over weakening global growth, many of the leading companies are surprisingly optimistic about their own national economy as well as the long term global economic outlook. Declining growth in the US, coupled with the country’s credit downgrade and the escalating sovereign debt crisis in the Eurozone sparked dramatic stock market activity at the time of the survey. Despite this, two-thirds (63%) of respondents feel that the global economy is at least stable. Confidence is particularly high in sectors such as power and utilities, oil and gas and metals and mining.

Pip adds: “Buoyed by confidence in local economies, many global corporates are now in a strong position to buy with de-risked balance sheets and large cash war chests.

Based on the survey, we see a surprisingly favourable M&A environment with the majority of respondents positive about the number and quality of deal opportunities and the likelihood of closing them. A critical factor is the convergence of potential buyers and sellers around what they see as relatively reasonable and stable asset prices – resulting in a significant increase in those looking to sell”

Emerging markets are prime targets for investment

The most attractive markets for investment according to the survey are China, India, Brazil, the US and Australia. Outside the recognised BRIC countries Malaysia, Mexico and Argentina are the three most popular emerging market destinations for investment. More than a third of respondents said their motivation for M&A was to gain share in a new market.

“Having an effective emerging market strategy is an absolute necessity for leading companies today,” says Pip. “A balanced business portfolio needs to have an emerging market presence as well as mature market operations.

“The Asian emerging markets are among the most attractive – with their high-growth potential offering some protection against current volatility in mature markets.”

Barriers to M&A remain, but strategic deals could be on the horizon

A large majority of respondents (85%) are concerned that mounting regulatory pressures could potentially impede growth. Regulatory risk could de-rail growth plans – particularly in the area of banking and financial reform, which could have a broad impact across sectors and geographies.

Pip concludes: “Regulation is one potential hurdle. There is also the fundamental question of the economy. While our respondents’ M&A attitudes are remarkably robust given the current environment, a slump into a double dip global recession would mean all bets are off.

“However, for the time being, our respondents have learned to manage in volatility: they have the capability – and ambition – to do strategic deals in the current climate.”