17 October 2005
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Despite the War in Iraq continuing to rage, two catastrophic hurricanes wreaking havoc on the southern US and skyrocketing oil prices, the M&A markets in the US and Europe continue to march along at a rapid clip. In the US, M&A volume for the second quarter of 2005 (Q2) was $313bn (£177.33bn), up 19 per cent from Q2 2004. This was the highest quarterly deal volume in the US since 2000. Similarly, the year-to-date US deal volume through early October totalled $919bn (£520.67bn), up dramatically from the $654bn (£370.53bn) in US deal volume for the comparable period in 2004. Extrapolating these figures for the entire year results in an estimated US deal volume for 2005 of $1.2tr (£680bn), compared with $915bn (£518.4bn) in 2004, $599bn (£339.37bn) in 2003 and $459bn (£260.05bn) in 2002.
The reasons for this continued strength in the US M&A market are varied. For one, many US companies built considerable cash reserves during the recent economic downturn. Earlier this year, non-financial companies in the Standard & Poor's 500 had approximately $600bn (£339.94bn) in cash on their balance sheets. Now that the economy has improved, US companies are looking to spend this cash. Using it for acquisitions is a means of generating increased revenues quickly. Increased revenues are a key factor to growing profits, which for the last several years have been sustained largely through cost-cutting initiatives.
Moreover, potential buyers that do not have cash on hand can easily borrow it to pursue acquisitions. A combination of relatively low interest rates and relatively high leverage ratios means that acquisition financing is available for the vast majority of deals, even very large deals. In fact, two of the largest leveraged buyouts in US history have occurred in 2005 - the $11.3bn (£6.4bn) acquisition of SunGard Data Systems and the $8.8bn (£4.99bn) purchase of Toys "R" Us. Not only is this proliferation of cash resulting in more deals being done in the US, but it has, not surprisingly, resulted in an increase in the amount of cash, as opposed to stock, being used in acquisitions. In the first half of 2005, stock amounted to only 38 per cent of the total consideration paid in US deals, down from 68 per cent in 1998, when the US stock market boom resulted in many US acquirers using stock as a relatively cheap currency.
Another reason behind the strength in the US M&A market is the explosion of private equity firms that are participating in the deals. The dramatic increase in both the number of private equity firms and the amount of equity committed to these firms (which one estimate places at around $100bn (£56.66bn)), as well as the favourable borrowing environment discussed above, has resulted in private equity firms being involved to some capacity in a high percentage of deals being done in the US. According to one estimate, financial buyers will account for $125bn (£70.82bn) of the US deal volume in 2005, up from $73bn (£41.36bn) in 2004 and $25bn (£14.16bn) in 2003. This would amount to almost 10 per cent of the total US deal volume for 2005. Even if a private equity firm is not the ultimate buyer in a particular deal, the presence of the private equity firm in the bidding generates competition and drives up the values paid by strategic buyers.
A final factor driving the US stock market boom is perhaps the simplest: despite the many negative influences on the world economy and a lacklustre (albeit relatively stable) US stock market, confidence in the US economy, particularly among US chief executive officers (CEOs), remains high. High confidence, hordes of available cash and a proliferation of private equity firms willing and able to make deals and drive up valuations all combine to keep the US M&A markets marching ahead.
The story is much the same in Europe, with the upturn in M&A really starting to rear its head in Q3, some months behind the equivalent US upturn. Figures to the end of Q3 confirm that M&A is on the upsurge, with deals to the end of that period totalling that which Europe saw for the whole of 2004. Volumes as a whole sit at their highest level for five years, with the UK the most active in both volume and value, followed by Germany and Italy.
In broad terms, the same factors are driving this market as the ones in the US - in particular, as in the US, European corporates have spent the last few years cutting costs and plotting their reasoned return to acquisitions mode, and private equity funds and hedge funds are doing more - and, importantly, larger - deals. Corporates generally also now have lower levels of borrowing than has been the case in recent times. These factors are showing results in M&A across the board, but most obviously in the energy, power, financial services and technology, media and telecoms sectors.
Of particular interest is the cross-border nature of many of the transactions - examples within Europe include the recent announcement by Deutsche Post of its takeover of Exel and the bid for BPB by Saint-Gobain. In Q2, cross-border deals within Europe amounted to Ã¢Â‚Â¬187bn (£128.61bn). Europe is also proving an attractive market for those outside Europe looking to make acquisitions. Thomson Financial at the end of Q2 indicated this to be true to the tune of Ã¢Â‚Â¬24bn (£16.51bn).
So where does it go from here? There is no doubt that there has been a lot of activity in relation to possible deals behind the scenes: identifying targets, due diligence, boardroom discussions and investor consultation. Buyers are, however, exercising an element of judicious caution, especially in relation to the big-ticket deals. CEOs want to get absolutely the right deal at absolutely the right price. This is borne out by the fact that, as in the US, in the UK cash has been used for the vast majority of deals this year - corporates are not yet willing to put up their shares as funding.
But nothing is for sure. As we have seen in the not-too-distant past, the European market could swing dramatically downwards in a very short timescale. But the strength of investor confidence and a desire for consolidation in a number of core markets suggest that there is scope for further growth.
William Kucera is a corporate partner in Mayer Brown Rowe & Maw's Chicago office and Paul Maher is head of the firm's corporate group in London.