A major rebound in confidence in the global economy among large corporates is not yet translating into expected capital investment and M&A activity, according to Ernst & Young’s eighth bi-annual Capital confidence barometer, based on a survey this month of 1,600 senior executives in 50 countries.
The surge in confidence, fueled by positive expectations around economic growth, corporate earnings and credit availability, sees 87% of companies now viewing the global economy as either stable or improving. Fifty-one percent now believe the global economy is improving outright – more than double the 22% recorded in October 2012.
This increased confidence has fostered a strong consensus among global corporates that M&A volumes will increase – 72% expect global deal volumes to rise over the next 12 months. However, even with a renewed focus on growth (52% cite growth as a priority), only 29% of major companies expect to make acquisitions in the next 12 months, with organic growth measures (45%) the major strategic preference for executives.'
“Though this positive sentiment would normally translate into significant capital investment and M&A activity, the current situation can best be described as a “confidence paradox” — with planned activity contradicting expectations," says Pip McCrostie, Ernst & Young’s Global Vice-Chair, Transaction Advisory Services.
McCrostie notes that in the past few years, global M&A volumes have de-coupled from historical indicators of deal activity.
"There are signs of improvement but caution remains. While almost three quarters of corporates expect deal activity in the market to increase over the next year, far fewer have an intention to buy. This could actually create a first mover advantage opportunity for those willing to take action and secure assets ahead of the competition,” adds McCrostie.
The modest improvement in the number of companies planning acquisitions (from 25% in October) is largely driven by an increasing number, and higher quality, of acquisition opportunities. Thirty-nine percent of companies say there are quality acquisition opportunities available compared with 30% six months ago; 50% feel more confident about the number of opportunities available, versus only 37% six months ago.
A world of difference
There are clear differences in sentiment towards M&A across countries – in Brazil 45% of executives expect to acquire, while in Russia only 12% have similar expectations – illustrating a mixed mood within a complex macroeconomic climate, even within emerging markets. Elsewhere, in developed markets, 27% of UK executives plan to acquire assets compared to 29% in the US.
Interest in acquiring assets in emerging markets continues with China retaining the top slot as an investment destination. India and Brazil are second and third respectively, while the US remains in the top five. However, while emerging markets remain critical to growth agendas, 60% of companies now say they are reconsidering their strategies in emerging markets where growth has slowed, and will apply greater rigor to investment decisions and processes.
Sectors most likely to see acquisitions are: technology, automotive, life sciences, consumer products and oil and gas. The least acquisitive are power and utilities, mining, financial services and diversified industrial products.
Consistent with sentiment over the past six months, deals across the board are likely to remain smaller in size as caution remains despite record amounts of available cash and improving credit conditions. In total, 88% of companies planning acquisitions expect deals to be under US$500m.
Divesting for value
Mirroring exactly the number of would-be buyers, 29% of companies are planning a divestment within the next 12 months or have one in progress. The reasons for a sale – and the types of divestment – are increasingly complex and not necessarily driven by the traditional motivation of raising capital – focusing on core assets and enhancing shareholder value rank more highly as selling rationale.
McCrostie continues: “Despite growing optimism, companies are largely focused on lower-risk value creation strategies — much more cautious approaches than one would expect given increased confidence and credit availability. Divesting is increasingly a part of that mix – a strategic tool to create value that many see as less risky than an acquisition. These approaches have become the “new normal” in the post—financial crisis world. Companies want sustained evidence of an upturn before making major investments.”
Window of opportunity for first-movers
The valuation gap – often a barrier to deals – has narrowed in the past six months with most respondents (82%) saying the gap is 20% or less, compared with 68% in October 2012.
However, expectations for increased valuations are now at their highest level in the history of the Capital confidence barometer Barometer. Forty-four percent of companies expect price/valuations to rise in the next year, up from 31% in October 2012. Just 7% of companies expect valuations to decline, compared with 27% six months ago, suggesting the market has stabilised.
“We may now be nearing equilibrium between what buyers will pay and what sellers will accept,” says McCrostie. “This equilibrium is vital, signaling the deal markets are at an inflection point and ready to rebound. The pendulum is primed to swing the other way – toward higher prices for buyers, and more profitable exits for sellers."
When does risk aversion become a risk?
McCrostie concludes: “Given the surge in confidence and strong deal fundamentals, it is somewhat surprising that we haven’t seen a stronger appetite to acquire. Executives are continuing to wait for a sustained recovery before engaging in M&A. However, we may be nearing the point where this sustained caution itself becomes risky.
Economic confidence, credit conditions and valuations — along with a recent rise in shareholder activism — all signal an opportunity to act, according to McCrostie.
"While prudence, discipline and governance, are necessities in this environment, now may be the time for boards
to pursue a more accelerated growth agenda. History shows that first movers in any economic cycle can create differential value and position themselves for sustained market leadership. Now might be the right time to invest and grow forward.”