Equity markets started the week positively, having welcomed better figures from China that weren’t quite good enough to preclude official stimulus – a favoured combination. However, investors are still twitchy ahead of this week’s two main events– the ECB meeting on Thursday and US non-farm payroll data on Friday. After the announced fall in inflation in May to 0.5%, we’re odds-on for some ECB action. It’s really just a case of “to QE or not to QE” – probably not, yet. It is much tougher to get a handle on the US economy as it comes out of a weather-induced lull. Recent data continues to be mildly positive, but not good enough to shake off growth concerns. Meanwhile, the M&A and IPO markets continue to garner attention. Press reports have focused on those that didn’t make it; but failure isn’t the trend.
M&A in 2014 – rolling with the punches
The biggest deal of last month was the one that got away. Pfizer’s rough wooing of AstraZeneca is on hold now for at least six months, unless AstraZeneca’s board reconsider, in which case it’s three. Of course, there have been other false starts, such as the aborted merger of Omnicom Group and Publicis Groupe and Metso’s rejection of Weir. However, reports suggest that despite knockbacks, Weir’s deal ardour remains undented, whilst M&A remains high on many companies’ agendas. EY analysis of Dealogic data shows global M&A value hit US$283bn in May, down from the record levels seen in April, but up 47% against May 2013 and 27% higher than the average monthly total during the last two years. In total, May saw 43 deals over US1bn, with oil and gas leading the way and diversified industrials featuring heavily across EMEA.
As highlighted in EY’s latest Capital Confidence Barometer for April-October 2014 and in recent high-profile deals, the trend is still for big transformational M&A – the type that opens up new markets and brings new talent. AT&T’s decision to acquire DIRECTV for US$67bn, diversifies its revenues away from pure wireless and gives AT&T a foothold in Latin America. According to the Financial Times, Apple’s purchase of Beats Electronics for US$3bn is larger than the combined value of Apple’s previous ten largest M&A deals – where purchase prices have been disclosed.
Reasons for more of the same….
There are good reasons to believe that deal volumes will continue to pickup during 2014. Activity has been rising across the year, driven in good part by sluggish organic growth and a lack of alternative uses for cash. Returns are low across all asset classes, whilst rising stock markets make buy-backs less attractive.The impetus for US companies to spend ‘trapped’ cash abroad also remains strong. Pfizer’s bid for AstraZeneca highlighted “inversions” where US companies lower their tax bill by utilising “trapped” cash in an overseas acquisition and relocating their topco. According to Standard & Poor’s, more than a dozen U.S. companies have completed this type of deal since 2011 and a further US$1tn of cash is ‘trapped’ overseas.
Another impetus for M&A may well be cooler IPO markets. Again, failure is the not trend here so much as increasing selectivity. Total European IPO share issuance in the year to date is $25.3bn from 85 deals, more than triple the same period of 2013, with nearly a third raised in London. Despite the focus on some high-profile withdrawals and disappointments, many companies are still floating – which is more than we could say a year ago. However, with so many prospectuses hitting the desk, investors are applying more discretion than six months back, when there were slimmer pickings. Companies looking to IPO now need to standout from the crowd, especially in congested sectors, like retail. They also need to be offering real upside for the buyer and a longer-term rationale for floating beyond a sponsor’s exit. Falling IPO valuations may well check private equity’s enthusiasm and encourage alternatives – as in Apax’s decision to sell, rather than list Travelex. After all, PE normally favours the cheaper and cleaner M&A route to exit.
..with some words of caution
So it’s good news, but still a mite too soon to absolutely call the end of the M&A downturn. Threats still lurk and confidence is relatively fragile. Weak employment and inflation data underlined the delicacy of the Eurozone recovery. Deflation, or even a period of very low inflation, would add to the problems of sluggish growth by raising real levels of debt and by delaying spending and investment decisions. We’ll explore this topic further in our upcoming EY Eurozone Forecast and accompanying 20-minute webcast on Thursday, 19 June. The ECB should respond on 5 June with a combination of measures, including an interest rate cut, possibly supported by a negative deposit rate and more liquidity support targeted at SMEs. They will almost certainly stop short of QE for now. However, pulling an economy from a high unemployment, low inflation, and low growth trough is incredibly tough.
Other pressures may stymie M&A across Europe, not least increasing national introspection – as highlighted by recent election results and popular reaction to high-profile M&A deals on both sides of the English Channel. France tends to be the cause celebres when it comes to government-led M&A protectionism, but popular feeling is pushing in this direction elsewhere. Of course, this isn’t a trend limited to the EU. The Russian government’s recent move to amend takeover rules for public companies might ostensibly be aimed eliminating loopholes in the existing regulatory framework; however, it also makes the process more stringent, complex and daunting.
Funding might not seem like an immediate issue, given the high levels of primary demand. However, investment banks have recently highlighted rapidly falling levels of activity in the secondary market, which is causing them to shrink their fixed income trading desks and reduce their role as secondary “market makers”. Healthy capital markets need to be deep and liquid, with options to sell as well as buy. Strong demand for primary issues means investors aren’t currently looking down; but when they do they might notice how difficult it will be to sell bonds they don’t want to hold to maturity.
The role of shareholder activism
What role will shareholders play? It’s unlikely they’ll be quiet. Shareholder activists are having an impact in 9/10 boardrooms we surveyed in our Capital Confidence Barometer. The general perception of activists is that they focus on cost reduction, freeing up cash or unlocking value through divestment; however our research and experience shows shareholders increasingly influencing M&A. There’s obvious evidence of this in the proposed Valeant – Allergan deal and a vocal media presence in the Pfizer – AstraZeneca bid.
It’s another compelling reason why all executives should have activism on their agenda, whether pressure is currently being applied or not. Being proactive and prepared is critical. Experience shows the advantages of conducting an audit of potential issues to understand and embrace activist concerns, rather than to encourage acrimony by pushing them away.