The Thin Gruel of Rising M&A Volume

Alessandro Pasetti, of Dow Jones Investment Banker, reports:
The banking industry remains in a regulatory flux and there is thin gruel for rainmakers contained within Dealogic’s preliminary end-of-year data out today. A sharp rebound in credit is necessary to spur M&A on a large scale. That still feels a long way off, and may never reach the pre-credit crunch heights.
The key Dealogic numbers are:
–Announced global M&A activity this year was nearly a fifth higher in dollar terms than last year, with emerging markets snatching a record-breaking third of the world-wide total and surpassing Europe for the first time.
–Cross-border transactions account for an increased proportion of the rally.
–North America, with $979.7 billion of deals, is ahead of all. Japan’s deal volume is down 36% year-on-year to $90 billion, the only country bucking the trend of an M&A pick-up across the globe.
–Energy led the industry ranking for the first time on record, having recorded its highest yearly volume ever. The figure is skewed by the $42.6 billion acquisition of Brazilian oil & gas assets by Petrobras, the largest deal of the year.
–Emerging-market volume reached $876.9 billion in 2010, up 56% from $561.2 billion in 2009. It accounted for 32% of global M&A, the highest share on record. The so-called BRIC nations (Brazil, Russia, India and China) accounted for 52% of emerging-market volume.
–Financial-sponsor buyouts totaled $183.8 billion in 2010, up 74% from $105.5 billion in 2009. Secondary buyouts reached $56.7 billion in 2010, the highest since 2007.
–Cross-border volume reached $969.2 billion via 9,573 deals, up 62% from $598.6 billion via 8,328 deals in 2009. Emerging markets accounted for 35% of total cross-border volume, at $336.3 billion.
Fortunes over the next year or two ride on whether banks will get the loan engine firing on all cylinders for clients across the rating spectrum. Of course, lending conditions by financial institutions have eased recently, but it certainly doesn’t feel as if a credit splurge is around the corner.
As growth stalls in western economies, M&A will struggle to record a significant rebound next year, with activity likely to be driven by defensive moves. Defensive, opportunistic, strategic. It doesn’t much matter to a banker what results in fees, though arguably a vigorous deal-making world needs all three to be kicking around.
Slivers of light are appearing. Blackstone Group gets in gear to launch a $15 billion buyout fund, Apax is following suit, so private equity may provide the necessary fillip on the back of opportunities among distressed assets.
Then there are the emerging markets.
The BRICs are providing bankers with trends and M&A activity likely to keep them busy in the medium term. Growth potential remains strong in the group but there are political risks bubbling up and surging competition for mandates. This suggests only the few with scale will emerge victorious–and the Chinese banks, with longer-term aspirations to be as powerful as Goldman Sachs Group, will complicate that.
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Corporate Deal Makers Cautiously Return

December 20, 2010, 10:54 am — Updated: 12:51 pm -->
By EVELYN M. RUSLI, NYT DealBook:
As the dark clouds of economic uncertainty lift, the environment for corporate deal-making is looking brighter.
With record cash on their balance sheets, United States companies are once again willing to invest in growth, according to McKinsey & Company’s quarterly report on economic conditions. The report, set to be released on Monday afternoon, found that a majority of executives are not postponing acquisitions or capital investment. And many are looking abroad, eager to capitalize on the fast-growing emerging economies and the rising influence of China, India and Brazil.
William Huyett, a director at McKinsey, said companies were cautiously optimistic, a positive sign for deal-making activity in 2011.
“First and foremost, there is confidence that the real markets are starting to grow again, unemployment is starting to drop and capital markets are starting to stabilize,” Mr. Huyett said. “Boards of directors are less skittish in pursuing transactions. We’re far from out of the woods, but the period of absolute uncertainty has passed.”
That said, McKinsey’s findings represent a more tempered view among executives compared with other recent reports. Thomson Reuters and Freeman Consulting Services recently predicted a 36 percent rise in global deal activity to $3 trillion in 2011. PricewaterhouseCoopers announced this month that “key conditions are in place for a resurgence in deal-making in 2011.”
McKinsey interviewed 2,076 executives in early December from a broad swath of industries. According to the results, 54 percent said they were not delaying or failing to pursue strategic deals, versus 25 percent who said they were holding back. And about 22 percent were undecided. The results, noted Mr. Huyett, were “remarkably consistent” across all sectors.
The availability of credit has also improved. Some 44 percent said their company had received financing in the last six months. Among those who said they were postponing deals, only 16 percent cited credit issues for their decision — an improvement from 30 percent in September.
Most executives said they were looking to the emerging markets for growth, particularly India, China and Brazil. More than 75 percent expect the three countries’ influence to grow over the next five years, while the clout of developed economies, like the United States, the European Union and Japan, will stagnate or recede. Unsurprisingly, the vast majority of companies that do play in emerging markets — some 72 percent — expect a greater share of revenue or profit from these regions in the coming years.
Mr. Huyett said he expected companies to take a more moderate approach to deal-making, especially amid the current volatility.
“It’s better to take a measured course and pursue M.&A. systematically, instead of a reflexive jump in the pool that companies may regret,” he said.

Why M.&A. May Rebound

BY HEIDI N. MOORE, NYT DealBook, December 10, 2010:

After a long drought, companies and private equity firms may be ready to make deals again, oddly enough because of cash, debt and taxes.

Here are the main reasons why:

Cash
A consensus is emerging from several prominent dealmaking experts that mergers are coming back, largely because companies can now afford them. U.S. companies have a near-record $1.93 trillion of cash on hand, according to Federal Reserve data.

Debt
Low interest rates have spurred corporate borrowing and refinancing at unprecedented levels. Private equity firms, which are enthusiastic users of junk bonds, have driven junk volumes to an all-time record this year, according to new data from Thomson Financial.

Big borrowing is likely to continue. Analysts at investment bank Keefe Bruyette & Woods predicted that the Fed will keep interest rates low throughout 2011. That would keep the debt markets open for a long enough time for private equity, in particular, to refinance their companies’ crushing debt loads.

Taxes
The potential of new stimulus in the form of tax cuts that will benefit companies and rich individuals. Congress is currently hammering those out.

But despite the increasingly ideal conditions, deal makers may have to prepare themselves for potential disappointment. For one, American corporations may still prove themselves unwilling to spend on acquisitions as long as the economy’s growth still looks tenuous.

That kind of caution has prevailed so far. Despite record cash levels, companies have bunkered down, presumably traumatized by the financial crisis and reluctant to deploy their cash for activities like hiring. It’s a big reason why the national unemployment rate has hovered about 10 percent for over 18 months even as corporate cash balances hit their highest levels in 50 years.But despite the increasingly ideal conditions, deal makers may have to prepare themselves for potential disappointment. For one, American corporations may still prove themselves unwilling to spend on acquisitions as long as the economy’s growth still looks tenuous.

Hope, however, springs eternal. PricewaterhouseCoopers, for instance, struck an optimistic note for 2011 in a report on Thursday, indicating that incipient merger activity this year is a leading indicator of … more mergers. PwC believes that companies are out of recovery mode and ready to make acquisitions again to grow.

PwC also said that private equity is returning to the fray. A veteran dealmaker, Kohlberg Kravis Roberts & Co. founder Henry Kravis, strongly agreed this week. Kravis showed some optimistic swagger in a speech at a Goldman Sachs financial services conference this week, in which he lauded private equity’s ability to pay more for companies as a sign that private equity is ready to drive deals again after a two-year hiatus.

The observations from Kravis and PwC’s report echo the same outlook from veteran investment banker Kenneth D. Moelis at a conference last week. Moelis believesthat M&A will recover, but slowly.

“These bubbles don’t get reblown quickly,” he said last week.

There is still a question, however, of whether companies will actually go out there and start buying.

One merger arbitrager said that companies are dying to make acquisitions again, but there is very little interest from shareholders in doing so.

And if and when investors become vocal about how companies deploy their excess money, the shareholders would have to support deals and strongly oppose low-return uses of the cash, like raising dividends or staging big stock buybacks.

But there is another option: companies might do acquisitions, but just spend very modestly. Small deals would allow companies to make acquisitions without digging to deeply into their treasure chests.

And, even if all this is enough to increase confidence to pull the trigger— and prices are right— cautionary tales loom large. There are still significant problems being worked out from the past dealmaking boom.

There are different views on whether those past merger and debt issues will be damning enough to put the brakes on new deals.

On the optimistic side is Tim Hartnett, who leads the U.S. private equity practice for PwC. He said this week that an anticipated high volume of distressed private equity deals never materialized because companies cut costs, cleaned up their balance sheets and “that Doomsday scenario never happened.”

Meanwhile, research from Moody’s Investors Service indicates the weak volume isn’t necessarily a reflection of responsible management. A Moody’s report this week suggested that some private equity firms may have saved their portfolio companies from bankruptcy through high-wire financial engineering: buying up their portfolio companies’ distressed debt and then paying creditors with other kinds of securities.

Private equity firms particularly favored a certain kind of debt with a risky feature called “payment in kind,” or PIK, toggles. PIK toggles are a feature that allow companies to pay back their debt with more debt. The companies that use PIK toggles are overwhelmingly backed by private equity firms. Of the 62 companies that Moody’s studied, the majority were backed by PE firms Apollo and TPG, who were active proponents of PIK toggles.

The companies that favored PIK toggles have also been defaulting at a higher rate than expected. Moody’s said that in 2009, nearly 30 percent of the companies that used PIK toggles during the boom went on to default – or nearly double the rate of ; Moody’s also found a close link between distressed exchanges, PIK toggles and default. A separate academic study last year found that 50 percent of companies that used distressed exchanges to save themselves from bankruptcy eventually went on to fail anyway.

The companies that suffered as a result of this kind of financial engineering are still stumbling through, but barely. Moody’s says companies like Clear Channel Communications, Harrah’s and other boom-time buyouts are now at high risk of defaulting on their PIK-toggled debt.

And those companies are owned by the same PE firms that are enthusiastic about a new round of deal-making.

The lesson: With problems from the past still lurking, it pays for deal makers to be cautious, even as M.&A. rebounds.

L.B.O.’s: Don’t Call It a Comeback

December 7, 2010, 10:02 am
By HEIDI N. MOORE , NYT DealBook
The buyouts last month of the big consumer names J. Crew and Del Monte were two promising signs that private equity firms were ready to come out and play again.
But don’t call it a comeback.
Sure, on the surface, there seems to be a reasonable resurrection. The volume of global leveraged buyouts have more than quadrupled this year, according to Dealogic data. Private equity firms have spent $73.6 billion on 193 deals in 2010, compared with $16 billion for 76 buyouts over the same period in 2009, noted Dealogic.
But dig deeper into the financing, and the story looks grimmer.
The private equity business runs on debt — mainly the leveraged loans and junk bonds it takes out to buy companies. As DealBook has noted, there has been a boom in such debt this year, with new records set for issuance.
That is not necessarily a good sign. Rather than funding new deals, most of the financing activity has helped private equity firms sustain their current investments, which would be in deep trouble without the help. It’s a survival play, as their portfolio companies are loaded up with debt that is quickly coming due.
The wall of refinancing that these firms face may be $100 billion more than many expected, according to Moody’s.
And private equity firms are trying to sign longer loans to avoid having to refinance again soon. The average L.B.O. loan is now 5.6 years in length compared with 5.2 years just last year.
According to Dealogic, private equity firms are signing very few fresh deals. The current volume of loans backing new buyouts is 89 percent below the record of $681.5 billion set by this time in 2007. The value of deals that private equity firms have exited is 44 percent lower than the $279.6 billion they racked up by this time in 2007.
As the industry battles its dependency on debt, private equity’s long winter may rage on for awhile.
The chill seems to have set in shortly after two blockbuster demonstrations of private equity power in 2007: the buyout of Hilton Hotels and the initial public offering of the Blackstone Group.
In 2008, private equity firms broke up — or tried to break up — richly priced deals they had signed in flusher times.
In 2009, private equity firms had plenty of cash but little access to the debt markets to deploy their strategies.
In 2010, private equity firms, with two years of weak exits and skimpy returns, had trouble fund-raising. According to Prequin, 242 funds raised $116 billion in the first half of 2010 compared with 336 funds that raised $171 billion in the second half of 2009.
In 2011, the industry’s revival may depend on whether firms can work through their debt issues while the markets are still open. To do that, private equity may have to scale back its ambitions and operate more cautiously, looking for known quantities rather than grand risks and high returns.
As the longtime investment banker Kenneth D. Moelis pointed out at a conference last week, the J. Crew and Del Monte deals were still relatively small in size for private equity deals. He predicted that such smaller buyouts would become more common, as private equity gave up its dream of the $100 billion “Big One” and focused on the more mundane job of turning around midmarket companies.
Consider one of the bigger potential deals: the Carlyle Group’s public offering. While Blackstone cashed out when times were good and valuations were high, William E. Conway Jr., a Carlyle founder, recently told Bloomberg News that the firm was going public because it was harder to get access to capital.
It’s a good insight into private equity in the aftermath of the financial crisis: the big players, once known to embrace risk and swagger, are stuck looking for sustenance for their troubled companies.
The barbarians at the gate are looking more like beggars these days.