Thursday, November 23, 2006

M&A heating up or heading up?

The latest figures from transaction management firm Dealogic show that the value of deals this year has already set a new record, at $3.37trillion (£1.77trillion), surpassing the previous high set during the dotcom buyout bonanza of 2000.

This year has not just been notable for the volume of M&A, it has also been remarkable for the size of the deals taking place.

The year got off to a big start with the $39.5bn takeover of French steel firm Arcelor by rival Mittal Steel in January.

In February the deals got even bigger, with Spanish utility Endesa receiving a bid from German energy group E.ON that has subsequently risen to $66bn.

And then in March, US telecoms giant AT&T agreed to acquire smaller rival BellSouth in a deal worth $83.4bn.

M&A fever

The relentless run of deals has continued throughout 2006, culminating earlier this week with $75bn worth of deals in one 24-hour period.

According to the experts, there are a number of key factors driving the surge in M&A activity seen in the last couple of years - a boom in demand for commodities and raw materials, modest company valuations and the availability of cheap money.

The economies of developing nations like China and India are growing fast, creating huge demand for the commodities needed to build new factories, roads, power stations and ports and produce manufactured goods for their booming export trade and domestic markets.

This has sent commodity and energy prices rising and boosted profits for oil and gas companies, miners and steel makers.

graph of M&A deals in 2006

It has also led to consolidation in these sectors as companies look to increase their production capacities and cost efficiency via the quickest route - by buying up rivals.

Deals that have fallen into this category this year include Mittal Steel's $39.5bn purchase of French rival Arcelor, copper mine owner Freeport-McMoran's $26bn swoop for rival Phelps Dodge and Suez's $43.1bn tie-up with French counterpart Gaz de France.

Meanwhile, strong economic growth around the world in recent years has boosted corporate earnings across most industry sectors have left company valuations at a reasonably-priced level.

"Balance sheets are as healthy as we have seen in a long time," says Lars Kreckel, an equity strategist with investment bank ABN Amro.

"This gives them the capacity to fund a takeover, and now they have the confidence as well."

Private equity

According to John Cole, a partner at consultants Ernst & Young, heavy M&A activity is one of the hallmarks of a stable, mature economy.

  1. AT&T (US, telecoms) buys BellSouth (US, telecoms) - $83.4bn
  2. E.ON (German, energy) buys Endesa (Spanish, energy) - $66.1bn
  3. Suez (France, utility) buys Gaz de France (French, energy) - $43.1bn
  4. Mittal Steel (Dutch, steel) buys Arcelor (French, steel) - $39.5bn
  5. Banca Intesa (Italy, finance) buys Sanpaolo IMI (Italy, finance) - $37.7bn
Source: Dealogic

"There comes a point when even a well-run company cannot grow much further organically, it can't eat any more market share," he says.

But the main impetus for M&A growth this year has not been companies buying other companies, it has been private equity investors buying companies.

According to Dealogic, private equity firms have done $563.2bn worth of deals this year, 17% of all M&A activity, up from a 12% share of activity in 2005.

With their recent successful track record of buying under-valued companies and selling them at a profit, private equity giants like Kohlberg Kravis Roberts, Permira, Blackstone and Carlyle have been able to raise huge funds from eager investors wanting to share in the profits.

Investment bank Credit Suisse reckons that private equity houses will raise up to $200bn in the US and Europe.

But the money they get from investors is dwarfed by the huge sums they will be able to borrow against it.

Credit Suisse estimates this will swell their takeover budget to between $500bn and $600bn.

Cheap debt

Cheap money is at the heart of the M&A bonanza.

Building site in China
Surging economies in China and India are lifting global earnings

Although interest rates are on the way up in many countries, they are still historically low.

Hence private equity companies can borrow huge amounts of money, confident that they can accommodate these debts with the earnings growth they can achieve from their takeover targets.

"Private equity companies are very good at making use of low borrowing costs," says Mr Kreckel.

"All the pieces are still in place for strong M&A activity looking forward."

Prospects for 2007

If anything, Mr Kreckel expects the deals to get bigger as the even greater sums available to invest bring larger companies into play as potential targets.

"It can make sense to buy one big company instead of 25 smaller ones, and they often offer more value," he says.

Copper mined and processed by Phelps Dodge
Rising commodity prices have boosted mining company profits

Although the current M&A cycle is three years old, it shows no sign of stopping.

Recent notes issued by ABN Amro, Credit Suisse and Morgan Stanley all point to another bumper year next year.

Economic growth looks set to remain relatively strong and stable, and interest rates should stay at historically low levels.

And although M&A activity has surged to levels seen just before the dotcom crash and economic slump in 2001, more companies are funding their takeovers with cash rather than financing the deal with their own shares.

Experts also point to the historically low levels of companies defaulting on their debts.

Things could change - interest rates could rise sharply, company earnings could slump and a number of high-profile private equity deals could turn sour and spook the markets - but at the moment, M&A activity is set to continue apace during 2007.

taken from bbc world website:
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