Ripe time for M&A, but appetite is missing

The conditions are ripe for a bonanza of mergers: Corporations are hoarding cash. The credit environment is more favourable for dealmakers. And the ranks of sellers are swelling. But that hasn’t yet convinced large corporations to pull the mergers-and-acquisitions trigger, new research shows.

Ernst & Young released its latest Global Capital Confidence Barometer on Monday. The report, based on a March survey of more than 1,500 senior executives in 57 countries, showed that the number of businesses looking to sell assets has risen from 26% to 31%.

At the same time, only 31% of global executives expect to pursue an acquisition in the next 12 months. That’s down from 41% in October 2011 – and it’s the lowest figure since the barometer began in 2009.

Meanwhile, M&A volumes globally were down 22% in the first quarter, compared with the same period last year.

Despite glimmers of economic improvement, an uptick in business confidence, particularly in the US, and lower lending constraints, companies remain cautious, as other regions, such as the euro zone, appear fragile.

“With better access to credit and large cash piles, companies have the means and the methods to do deals,” Pip McCrostie, E&Y’s global vice chair of Transaction Advisory Services, said in a statement. “But their motivation is tempered by concerns over the strength and permanence of the global economic recovery. Concerns over what they see in the short term are also clouding the longer-term view on critical M&A matters such as valuations.”

Outlook improves

Executives are largely more confident about the economy and business conditions, the report showed. Fifty-two per cent of respondents thought that the global economic situation is improving, up from 26% in October 2011. Meanwhile, only 20% were pessimistic about the economy, down from 37% six months ago.

And over the past six months, respondents have become more positive about expected corporate earnings, employment growth, credit availability and the regulatory environment.

But one indicator saw a decline in the number of respondents who held a positive view. Only 5% of respondents had a positive outlook for short-term stability, down from 14% in October 2011.

Economic and business confidence has rebounded strongly in the US and parts of Europe, including France and the UK, according to E&Y. But confidence in emerging markets such as India has either stayed flat or declined, which appears to be hampering emerging-market deals.

“The relief in the euro zone following the latest Greek debt restructuring and a more positive outlook in the US compared to late 2011 has given large corporates more confidence in the overall health of the global economy,” McCrostie said. “However, with 86% of these global companies telling us that the ongoing euro-zone crisis has affected their business, the indications are that this could be a fragile recovery in confidence that will be difficult to sustain.”

Cash could drive deals, but not yet

Economic hesitance over the past few years has been fuelled in part by tighter lending standards. As the economic picture remained unclear, lenders were less inclined to finance deals. 

And for the past few years, many companies have been cautious about making – or unable to finance –  big investments. So they have focused on generating value through organic growth, cost-cutting and divestment. As the downturn has dragged on, corporate frugality has generated big reserves of dry powder.

Cash could help companies manoeuvre in a restrained lending environment. Almost half the companies that have re-engaged in M&A or are thinking about it expect to use cash as their primary source of funding, the E&Y report says.

While there are signs of thawing in the lending arena – the proportion of those that would use debt to finance an acquisition increased to 39% from 33% six months ago – potential buyers may still choose to stay on the sidelines.

“There is still a desire to grow their stockpile of cash,” McCrostie said. “More companies are now looking inwardly – at managing their portfolios and non-core assets – rather than outwardly at potential buying opportunities.”

McCrostie added: “There could come a point when shareholders could exert pressure or governments might incentivise companies to do something with excess cash. If this happens, we could see an increase in M&A activity.”

More sellers

Divestment was especially pronounced in North America, and it was expected it to grow across Europe and Japan in the coming months as companies look to reposition themselves as a result of the euro-zone crisis.

Companies based in India, the UK, the US and Germany were among the most bullish, while their counterparts in Japan and Russia were less so. When asked where they will do deals, China, India, the US, Brazil and Indonesia were the top five target markets.

—Jack Hagel (jhagel@aicpa.org) is the editorial director of CGMA Magazine.