M&A deal flow looks brighter

Frank Holmes, partner in Gambit Corporate Finance, gives his analysis of corporate transaction activity this year and next

Globally, merger and acquisition activity in the first three-quarters of 2010 was 20% ahead by value, as compared to last year.

The emerging markets, in particular India and China, contributed the most at around one-third of this M&A volume, whilst the US came in second and Europe was relegated to third place for the first time on record. The financial services sector witnessed the most deal activity followed by oil and gas, telecoms, healthcare and in fifth place, energy and utilities.

The value of cross-border mergers and acquisitions of UK-based companies has exceeded domestic led deals and has been driven by bidders from the US, Western Europe, Asia and the Far East.

In the last six months, we have been engaged by Welsh companies confronting potential purchasers from India, Australia, US, Hong Kong, France and Germany. We see this being due to confidence in their own markets, availability of capital, advantageous exchange rates and a stable legal system.

On the buy-out front, 2010 activity in number and value across the UK has been stronger, which is not difficult, given the virtual collapse in 2009.

Many of the buy-outs of significant size have been “pass the parcel” deals termed secondary buy-outs, involving private equity groups buying from each other. This is a function of improved valuations and the appetite to invest to survive.

In the UK, the M&A market’s bidders, whether corporate or private equity, have remained unsettled – as if playing “musical chairs” – by the severe economic slowdown, the new coalition government era, and difficulties in accessing debt finance for regulatory and commercial reasons whilst trying to fathom the potential impact of the Comprehensive Spending Review (CSR).

Earlier this year, we published a 10 Year Survey highlighting disclosed indigenous Welsh company exits between 1999 and 2009. The trends in more than 400 disclosed deals of less than £100m in value followed a similar profile to the UK statistics for the same period.

Deal activity value peaked in 2007 with five local companies being admitted to AIM, approximately 40% of those listed today. Then 2008 and 2009 saw a global financial meltdown, including the collapse of Lehmann’s, the bail-out of AIG and an unprecedented banking crisis on top of a deepening recession.

The M&A wave petered out to a mere ripple in 2009 as trade and private equity withdrew to manage their businesses, and conserve cash whilst the management buy-out market dried up in the absence of bank finance. Private equity firms focused on portfolio management with some investments creaking or imploding under over-geared balance sheets, compounded by declining trading performances.

Deals undertaken in Wales with disclosed values in the first 10 months of 2010 have a cumulative value just shy of £200m ascribed to 32 transactions out of 83 reported. This lack of disclosure may be a shift towards privacy but is more likely an indication of smaller value transactions in the SME market.

The largest deal in the period, and the only one exceeding £100m, was the £110m refinancing of Iceland Foods by Barclays.

Opportunistic bolt-on acquisitions and development capital fundraising transactions account for a further £50m in almost equal portions. Delistings rather than stock market flotations have occurred and are likely to be more prevalent in the remainder of 2010 and early 2011, further reducing Wales’ quoted portfolio to 10 or fewer participants.

These statistics must have some bearing on the lack of support for a stock exchange in Wales.

So what is the outlook?

The 2010 budget and CSR have put severe pressure on government departments to cut spending and the UK’s growth is still projected to be subdued this year and next.

The UK Government’s commitment to push ahead with infrastructure spend on road and rail, school refurbishment and new nuclear power stations will be positive boosts to UK companies.

Large support services outsourcers will benefit from bundling contracts as a compromise to downward pricing whilst consultants will need to prove they generate value for money and public sector focused recruiters will suffer.

There are reasons to be pessimistic about consumer spending, capital investment and net exports and the companies exposed to these drivers.

A difficult borrowing environment persists and curtails the ability for an already shaken private equity sector to regain the highs experienced three years ago. The average percentage of debt in buy-out deals has dropped from 51% in 2006 to 27% in 2010.

Wales has its own issues, some of which have been identified in WAG’s Economic Renewal Programme, not least low employment rates, skill shortages and an ageing population.

The jury is out on WAG’s sector-based strategy for supporting private enterprise and specifically companies operating in ICT, energy and environment, health, advanced material and manufacturing, financial services and creative industries, as its preferred sectors.

On the grounds of growth and employment potential this is a credible selection.

However, it should not be at the expense of indigenous companies operating in the food and drink, leisure and business services industries, which include some very successful companies. The six HSBC Wales Regional finalists included two such companies, Penderyn Welsh Whisky and Cambrian Pet Foods, as runners-up.

The proprietor age issue is a UK-wide phenomenon accentuated by the baby boomer generation pending retirement. Wales could take the lead with WAG sponsoring succession planning by enabling mentoring through this critical phase of the corporate life cycle thereby preserving economic value. Cessation of trade and closure, such as the recent Maskreys announcement, is not a productive option.

Access to capital remains a major concern, despite indigenous providers Finance Wales and more recently Westbridge Capital (which raised £10m this year), exasperated by investor readiness that often lets corporates down in beauty parades to investors within or beyond the Principality.

We see Wales’ environmental, clean-tech and renewable sector forging ahead with some anticipated multi-million pound disposals and fundraisings. Green investment will be high on the agenda in the long term, despite the green investment bank receiving less funding than hoped.

The optimists amongst us look forward to marginally improved business activity next year on the back of a slight increase in confidence now that the CSR is less of a mystery, economic growth is not as low as anticipated, and albeit at a different pace, life must go on.

We are seeing growing appetite locally for bolt-on acquisitions and private equity capital for growth opportunities in business services, clean-tech, med-tech, food and specialist manufacturing. Vendor age will bring a reality check to valuations and creative deal structures will help make up for the expectations.

Wales’ private sector, which is blessed with numerous smart SMEs, must continue to focus on innovation whether in proprietary technology or applications, and create demand-led opportunities in less competitive arenas with a global reach.

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