"Companies need to do something with their excess cash," said Bob Filek, a Transaction Services partner. "They've done a good job making their businesses more efficient, and they've got to put that cash to use somewhere. While many have increased their dividends or bought back stock, the favorite use of cash is still strategic investment, much of which is acquisition-related."
"We still have good economic numbers and robust liquidity markets that make it easy to raise debt," said Greg Peterson, Americas leader of the TS private equity practice. Those two factors alone bode well for the continuation of the wave.
What's different in this M&A market, compared with the late '90s, is private equity's increased involvement, particularly on big, complex transactions. As large funds with big overhangs of uninvested capital perfect consortium bidding, they can do deals of virtually any size. They're using all available tools and structures to get superior returns for investors, minority investments and step acquisitions as well as full buy-outs.
Private equity represented 30 percent of US deal value second quarter, a level not seen in over 10 years. In fact, during the late '90s, private equity's share rose above 20 percent only once and generally averaged between 10 and 15 percent.
The following industries are well positioned for M&A activity during the balance of 2006, according to Filek and Peterson:
-- Energy -- M&A will remain active because continued high oil and gas
prices make a lot of initiatives economically feasible for both
corporate and private equity acquirers. After three years of
unprecedented returns and the biggest stock buybacks in history,
reinvestment levels as a percent of cash flow are moving up, and major
companies -- especially the big independents -- are turning to M&A to
increase their inventory of big projects. We're seeing a lot of
activity, whether it's upstream, midstream or downstream. And it's not
just oil and gas producers, but also oil service companies and
businesses that provide critical commodities to the industry. Industry
consolidation is not the only factor driving this activity. Companies
are also doing deals to secure critical commodities, whether it's oil,
electricity, nuclear power, or even ships and other vehicles for
transporting these commodities.
-- Manufacturing -- Manufacturers are being stressed by both high
commodity prices and significant pressure to keep prices down for large
box retailer and industrial customers. They've done about all they can
to lower costs through efficiency improvements and lean manufacturing.
But at some point, they'll be under more pressure to realign capacity,
move even more production offshore, and consolidate market share. This
suggests more acquisitions. While many people are betting on
acquisitions in Asia, the most successful transactions to date have
been less complex sourcing arrangements, not control acquisitions.
-- Utilities -- Utilities continue to be a complex segment for dealmakers.
While many assumed the federal Energy Act would shorten the regulatory
approval process, it's actually created more thorough state reviews.
We still anticipate some regional plays and back-to-basics realignment
in utilities, including private equity-sponsored transactions. But
more rapid consolidation beyond what's taking place right now is
unlikely. And regulatory issues are a big factor in that.
-- Digital convergence driving technology deals -- Digital convergence --
the effort to bring together computer, phone, recording and broadcast
technologies to enable new, flexible uses of products and services
within an all-digital environment -- is leading to increased corporate
consolidation, according to 64 percent of technology executives
surveyed in a recent PricewaterhouseCoopers' study. Companies are under
pressure to gain footholds in digitally related markets, and are
willing to spend considerable sums on M&A to reach their convergence
goals. But acquirers have learned from the mistakes of the past and
are carefully assessing the commercial viability and fit of acquisition
and alliance candidates. Software developers are most likely to
benefit from this trend, followed by business information content
developers, wireless companies, entertainment companies, and electronic
device makers. Convergence was thought to be the driving force behind
some large, recent transactions in the telco/cable equipment sectors.
Convergence also colors the ongoing battle for market share between
cable companies and the RBOCs (regional Bell operating companies),
forcing telcos to decide whether to spend money on capital expenditures
or acquisitions. And consolidation among enterprise software and
hardware companies is likely to continue in response to customer
preferences for fewer vendors and solution providers.
-- Retail. For the past two years, retail M&A has largely been a
financial reengineering play with acquirers -- especially private
equity firms -- extracting value from real estate. But as that
strategy plays out, survivors will have to make their businesses work
at the store level. That argues for players with industry knowledge
becoming involved in consolidating, reinventing and restructuring the
remaining businesses. This will change the landscape of the retail
industry, especially broad line department stores.
Other factors influencing M&A activity in the second half of 2006 will include:
-- The need to simplify. As analysts and the market continue to reward
pure play companies with higher price/earnings premiums, many large
companies feel the pressure to simplify. This means focusing on
becoming or remaining the number one or two player in key businesses
and exiting other areas. The growing number of divestitures and
spin-offs of second tier brands and products reflects this trend.
-- Big private equity gets richer and smarter. As the big funds get
bigger, their contacts and sophistication give them a leg up on
creating value pretty much anywhere the opportunities are. Right now,
many private equity funds are seeking higher returns overseas,
especially in India and East Asia. But this time they're doing it far
more effectively by hiring people with deep expertise and relationships
in those countries to represent them. While there may be a paucity of
properties available right now, firms are learning to be patient and
those efforts will eventually pay off. At the same time, hedge funds
continue to put money to work in private equity deals, so the tension
arising from convergence, competition and cooperation between the two
segments will continue to be an important piece of the M&A landscape
going forward.
-- More mega-deals? Look for increasingly large deals, both by corporate
and financial buyers. 2006 will be a record year for buyout size,
while corporate acquirers are prepared to bid higher to get the assets
they feel they need to maintain growth and support their stock prices.
The only area where we don't anticipate much activity for the balance
of 2006 is sustained US acquisitions by major European companies, which
have been spending their money closer to home, particularly in Eastern
Europe.
(Photo: http://www.newscom.com/cgi-bin/prnh/20060713/NYTH110-c )
Peterson notes that the number of new private equity funds has waned in recent months. In the past, that often sent signals that the end of the cycle was drawing near. But successful funds harvested investments last year, building the track record necessary to attract new capital from quality-minded investors. So these funds are in a new investment cycle.
"With increased competition for deals and the ready availability of bank financing, private equity funds are suddenly willing to find new ways to participate in deals, including non-control deals, layering on top of another fund's investment, or taking a piece of a tranche or instrument that may not be pure common equity. Some are concerned that the money they're putting to work today will not yield a 33 percent internal rate of return, but something less." Peterson added, "A hard look at the numbers calms this fear, since the increase in purchase price multiples has largely been funded by increased debt leverage, and the ratio of equity to cash flow is actually at a historic low which should bode well for private equity returns."
Filek observed, "Right now the IPO and equity markets have the jitters, but debt is still flowing pretty freely, even though some of this represents a shift to bank financing and away from private placements. Are the equity markets right, and we're going into a bearish cycle? Or are the debt markets right, and the party's still going on? That's the million dollar question. We are still pro-deal, which would indicate the equity markets are out of kilter and the debt markets are behaving appropriately. Since rising interest rates haven't really over-corrected the broad economy, most companies are on solid footing. But that tune could change rapidly if consumers begin worrying about their jobs, long-term interest rates move above historic averages, or companies begin defaulting on loans because they cannot pass along further commodity price increases to their customers."