Yet strong balance sheets mean that capacity remains for "intelligent" deals to be struck
||Europe and U.S. bear the brunt of falling deal activity but Asia Pacific remains strong|
||Consumer services to be worst hit sector; basic materials to remain resilient |
31 January 2008
After calling the top of the M&A market six months ago, the latest version of KPMG's Global M&A Predictor provides further evidence that M&A activity has now reached a plateau and could even be in decline in some areas.
The Predictor suggests that 2008 deal levels may just about hold steady compared to 2007 but deal values are expected to fall away. However, with corporate balance sheets generally looking strong, the capacity for "intelligent" deals to be struck does still remain.
The latest Predictor - a forward looking index of 1,000 leading companies' net debt to EBITDA ratios and Price Earnings ratios - shows that global forward PE ratios have now dropped from 17.1x to 17.0x; helping to confirm the plateau period which KPMG expects to characterize M&A activity in 2008.
The previous Predictor - in the summer of 2007 - had shown PE ratios rising from 16.8x to 17.1x; a sufficiently sluggish increase for KPMG to confidently call the top of the market ahead of the U.S. sub-prime crisis.
Stephen Barrett, International Chairman of Corporate Finance at KPMG and partner in the U.K. firm, commented: "There was no satisfaction in accurately forecasting the top of the market six months ago. However, if there is some consolation to be taken, it is in the fact that - also as predicted - any slowdown will be a fairly gentle, gradual one. There are definite winners and losers though; look closely and you see that the forward PE ratios are down 0.7 and 0.5 in Europe and the U.S. respectively. It is mainly the Asia Pacific region - where forward ratios moved forward strongly from 17.0 to 19.0 - which is bolstering the overall numbers. This leaves us with a real mixed outlook. Where there is appetite and confidence, there are constraints such as a lack of funds or suitable targets. Where there is cash, there is nervousness, caution and a slight loss of appetite"
"Overall though, deals will still be struck. Working from corporate balance sheets which look marginally healthier than they did six months ago, companies will be able to put together intelligent deals if they can rally investors and the market into creating bold and imaginative, value-enhancing transactions. Indeed, falling valuations and strong balance sheets could mean that 2008 becomes the year for acquisitive companies to consider consolidation and diversification deals."
A brief glance at the historical data bears out what KPMG's Predictor suggested six months ago. According to Dealogic data, the five months up to the end of November 2007 saw 15,654 deals globally at a value of US$1,787.9 billion. Comparing this to the 17,535 deals recorded in the first half of 2007 - at a value of US$2,718 billion - suggests that while the complete second half figures may eventually compare favorably on deal volumes, deal values look set to be well down on the first half. In fact, it is only the presence of a large number of low value Asia Pacific deals, which seem to be keeping the second half numbers within touching distance of the first half.
This significant fall in total deal values is despite generally strong corporate balance sheets being in place. In the six month period from the end of May 2007 to the end of November 2007, global corporate indebtedness actually recovered across all markets, with net debt to EBITDA ratio's improving from 0.91 times to 0.81 times. According to KPMG, this helps to illustrate the significant capacity that exists to comfortably raise new debt so long as a purchaser can meet the challenge of boosting corporate confidence and investor appetites, convincing potential backers that their intelligent deal is the one to back.
Forecast M&A activity by world region
The Predictor indicates a clear split in appetite for deals, with the mature regions of Europe and North America showing a declining valuation trend (PE's down from 16.2x to 15.5x and 17.9x to 17.4x respectively), while the emerging regions such as Africa/Middle East and Asia Pacific (PE's up from 13.7x to 15.5x and 17.0x to 19.0x respectively) have recorded increased valuations. This suggests that increased M&A activity will be seen in the emerging markets over the next six months, compared to decreased levels of activity in the mature regions. Balance sheets globally remain strong with a Net Debt/EBITDA ratio of 0.81 times, with Africa/Middle East and Asia Pacific the strongest indicating that together with increased appetite for deals, these regions also possess the greatest financial capacity for deals. Europe, the U.S. and Latin America have seen no material change in their balance sheet capacities.
Commenting on M&A prospects in Europe, Stephen Barrett said: "The second half of 2007 witnessed a significant decline in the average value of deals, compared to H1 which saw record deal values due to several mega deals being completed in the mining, consumer and utility sectors. We expect ongoing market turmoil to continue to limit the capacity to drive deals. Furthermore, our Predictor shows a fall in valuations for the region, dampening down prospects for the period ahead. Our analysis suggests that while the outlook for deal flow in Telecoms and Utilities looks positive, the Consumer Goods & Services, Technology and Industrial sectors all exhibit weakening underlying fundamentals for M&A growth. However, the trend for mega deals in the Europe region could again skew average deal values but, overall, business can continue to expect to see declining deal volumes."
Commenting on M&A prospects in the Americas region, Peter Hatges, Chairman of KPMG's Corporate Finance practice in the Americas region, said: "2007 was another strong year, with deal volumes and values similar to the previous record year in 2006 for the Americas, as evidenced by Dealogic's recent data. However, our Predictor's declining forward-looking North American valuation trend indicates that the region is beginning to lose appetite for deals, perhaps driven by the issues in U.S. sub-prime lending. In terms of balance sheet capacity, our analysis shows that North America remains strong, with an improvement in Net debt to EBITDA ratios - but clearly the credit crunch could limit the ability to leverage this. Despite the potential for high value deals in the resources and basic materials sector, deal appetite is likely to be somewhat suppressed, particularly in Consumer services and Telecoms. The focus for businesses with significant sales in the U.S. will be on productivity in 2008, particularly as currency advantages reduce profitability."
Commenting on M&A Prospects in the Asia Pacific region, Julian Vella, KPMG's Corporate Finance Chair for the Asia Pacific region said: "Outside of the region's mature markets, many of Asia Pacific's national economies are buoyant, enjoying a minimum of five percent GDP growth. We can therefore expect the largely untapped potential of regional and sector consolidation to continue to drive healthy corporate deal-flow, particularly in financial and consumer services, and in industrials where we expect several medium sized as well as some mega-deals to be done."
"Debt issuance is generally not a constraint for medium sized deals in the region which, to date, has been somewhat protected from the impact of the U.S. credit crunch. However, Asia Pacific is by no means immune: companies seeking to roll-over significant debt to fuel further M&A activity may be hampered by the more stringent terms likely to be imposed by lenders, perhaps even forcing the sale of non-core assets to generate equity and avoid restrictive covenants. To lessen the ripple effect of a worsening global credit crunch, corporates in the region should urgently review any maturing debt facilities to ensure they remain nimble and the collective appetite for M&A stays healthy."
Forecast M&A Activity by Global Sector
KPMG's forward PE valuation analysis of global sectors highlights Basic Materials (13.7x to 15.1x), Telecoms (15.9x to 16.9x) and Industrials (17.4x to 17.6x) as exhibiting the most positive forward looking valuation trends, suggesting that this is where the M&A activity is likely to be over the next six months. The weakest are Consumer Services (down from 19.6x to 18.1x) and Healthcare (down from 17.9x to 16.8x).
In terms of balance sheet capacity, Utilities and Industrials have the least capacity, while Technology and Healthcare continue to show net cash, reflecting traditional balance sheet structures. However, Industrials have shown a significant improvement with Net Debt/EBITDA strengthening from 2.07 times to 1.71 times.
Within this, Asia Pacific Oil & Gas and Utilities have shown the strongest valuation development of all region/sectors, with Africa/Middle East Basic Materials and Consumer Services also very strong. The weakest region/sector development is identified as Latin America Utilities and Industrials, and Africa/Middle East Technology and Consumer Goods, with North America Telecoms also weak.
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Notes to editors:
KPMG's Global M&A Predictor tracks 12 month forward Price to Earnings multiples (PE) and estimated net debt to earnings before interest, tax, depreciation and amortization (EBITDA) ratios to track and establish the direction of M&A activity.
KPMG's Global 1,000 comprises 1,000 of the largest companies in the world by market capitalization, with a representative weighting of countries and sectors, to help ensure appropriate inclusion. A panel of KPMG firms' professionals sits every half-year and reviews the constituents of the index to seek to ensure that it remains reflective of global changes in regional and sector weightings.
The data is sourced from JCFQuant, the corporate earnings estimates data provider. KPMG firms' professionals calculate 12 months forward PE ratios (expressed as a multiple) for each qualifying company of the 1,000, and aggregates these into regions and sectors to aid comparison. This valuation tool is used due to its transparency, the ready availability of data and widespread acceptance in the investment community. Our PE's test for "paper capacity" i.e. the relative ability of companies, sectors and regions to originate deals using shares only.
Net debt to EBITDA is calculated using estimates from JCFQuant, again by each company in our 1,000, and is a respected ratio that indicates capital structure and financial gearing. This ratio tests for "debt capacity" - that is, the relative ability of companies, sectors and regions to originate deals using debt only.
By comparing both sets of forward looking ratios, with sectors and regions weighted by market capitalization, KPMG's Global M&A Predictor attempts to identify changes over time that could imply trends in appetite for deals and indeed capacity for deals. It also attempts to compare and contrast sector regions to highlight possible areas of deal flow. (Note: Net debt/EBITDA ratio calculations are not relevant for financial services and property sectors. These sectors have therefore been excluded from this analysis.)
Dealogic is a leading supplier of relationship management, transaction execution and information systems for the investment banking industry. With offices throughout the world, Dealogic offers coverage of global capital markets and corporate finance activity.