M&A is on the rise. Why?

Certainly an improved economic outlook, better performing equity markets and banks’ increasing propensity to lend have contributed significantly to the recent M&A market recovery. However, the more important question asks…is the recovery merely a temporary respite, or will it continue?

We believe the recent recovery is not just a temporary phenomenon, but rather a longer term trend that will continue through 2010 and into 2011, largely due to the following six factors. 
 

1. Companies Need to Put Their Cash to Work

To weather the recent recession and survive what was an uncertain outlook, companies shifted their focus to conservative cash management policies in order to strengthen their balance sheets. Through cost cutting and reduced cash outlays, companies stockpiled cash and/or used cash to pay down debt.

• Cash balances of the 421 non-financial firms in the S&P 500 increased 31% to $964 billion in 4Q ’09 when compared to 4Q ‘08
• As conditions have improved and the outlook has become more clear, companies are putting their cash to work in three main ways:
  • Acquisitions – after its cash balance increased almost 500%, Walgreens acquired Duane Reade for $1.1 billion in cash
  • Share buybacks – after its cash balance increased more than 80%, Pepsi announced a plan to buy back $15 billion of stock (global share buybacks through 1Q ‘10 represented nearly half of total ‘09 buybacks)
  • Dividends – after its cash balance more than doubled, Starbucks recently announced its first dividend (in addition to a share buyback program)

 

2. Private Equity Groups Hold Record Amounts of Capital

In ‘07 and ‘08, Private Equity Groups raised record amounts of capital: $301 billion and $264 billion, respectively. However, the recent economic upheaval and tight credit markets kept most financial buyers from deploying their capital.

• The amount of committed (and undeployed) capital, commonly referred to as the “PE overhang”, swelled nearly 70% to more than $400 billion by the end of ‘09, far exceeding the $292 billion record set prior to the downturn
• The recent declines in deal activity have strengthened the resolve of many PE firms to invest their committed capital before they face demands from investors to reduce management fees and/or extinguish commitments
  • Nearly 30% of the PE firms that have announced an acquisition in ‘10 did not complete an acquisition in ‘09
• 304 PE investments were completed in the U.S. in 1Q ’10 with a combined value of more than $14 billion, representing the best quarter in over a year in terms of deal volume (the middle market accounted for 80% of these deals)
  • The exit market also has experienced an increase in activity, with 65 completed exits in 1Q ‘10, more than double that of 1Q ‘09 

 

3. Credit Markets Thawing and Interest Rates Attractive

Credit markets have eased, albeit slightly, as banks begin to regain comfort in extending loans to strong credits. 

• 4Q ‘09 saw an increase in lending activity, with volume topping $25 billion, an increase of more than 37% from the same period in ‘08
  • Average debt multiples of LBO loans increased 1x EBITDA to 4.3x in 1Q ‘10 when compared to the ‘09 average of 3.3x
• On a historical basis, interest rates remain at record lows since the Federal Reserve lowered the Federal Funds Rate target to nearly zero in December ‘08. Additionally, both the Fed and the European Central Bank have indicated rates will remain low for an “extended period.”
  • In ‘10, deals of various sizes have been financed by debt as weaker credits once again are able to attain financing and stronger credits now benefit from better financing terms and conditions
  • Examples of deals announced in ‘10 financed partly or completely by debt are API Technologies Corp.’s $29 million acquisition of Kuchera Industries, Inc. and Kuchera Defense Systems, Inc.; Thoma Bravo’s announced $142 million acquisition of Plato Learning, Inc. (NasdaqGM:TUTR); Madison Dearborn Partners’ announced $915 million acquisition of BWAY Holding Company (NYSE:BWY); and Phillips-Van Heusen Corp.’s announced $3.2 billion acquisition of Tommy Hilfiger Corporation
      

4. Growth Opportunities Lie Abroad

Opportunities to diversify abroad are gaining momentum. While much of this is driven by improving global economic conditions, companies also are finding attractive opportunities to deploy capital outside the U.S. 

• In the first three months of ‘10, nearly 350 transactions were announced involving a U.S.-based buyer and a non U.S.-based seller, representing a 45% increase from the 1Q ‘09. While the increase is partly driven by improved economic conditions and the increase in overall M&A, developed and emerging markets in Europe, Asia and Africa are seen by many to offer significant growth opportunities across many industries.
  • In one of the most high-profile transactions of the year, Kraft Foods, Inc. (NYSE:KFT) acquired Cadbury plc (NYSE:CBY) for $22.3 billion, in a long fought battle that ended when the deal closed in March of ‘10. According to the New York Times, “Analysts had long supported Kraft’s rationale for the merger, which would…help the American food company expand into faster-growing countries like India, South Africa and Mexico.”
  • Earlier this month, Thomas & Betts Corporation (NYSE:TNB) announced that it had completed its $115 million acquisition of PMA AG, a Switzerland-based manufacturer of technologically advanced cable protection systems, that will, according to T&B, “expand access for the T&B family to growing industrial markets outside of North America”
      

5. Remaining Competitive

Given both the difficulties encountered in generating organic growth and the opportunistic behavior of their well-capitalized counterparts, many companies have engaged in and will continue to make acquisitions so as not to be left behind. 

• Companies that can neither grow organically nor obtain financing to pursue their own acquisitions may have no choice but to find a buyer/partner in order to compete. This reality, coupled with the improvement in general market conditions and increased clarity on future results, has increased the openness of many would-be targets to acquisitions.
  • In the two largest deals of ‘09, Merck (NYSE:MRK) announced its acquisition of Schering-Plough (NYSE:SGP) for $46.0 billion in March of ‘09, after Pfizer (NYSE:PFE) announced its acquisition of Wyeth (NYSE:WYE) for $64.5 billion in January of ‘09
  • Apollo Global Management announced its offer, which was terminated earlier this month, to acquire Cedar Fair (NYSE:FUN) for approximately $2.2 billion in December of ‘09, after its rival, The Blackstone Group (NYSE:BX), announced its acquisition of Anheuser-Busch Inbev’s (ENXTBR:ABI) American theme parks for approximately $2.7 billion in October of ‘09
  • Apple Inc. (NasdaqGS:AAPL) acquired Quattro Wireless, Inc. in January of ‘10, entering the mobile advertising industry already occupied by Google Inc. (NasdaqGS:GOOG), Microsoft Corporation (NasdaqGS:MSFT), Yahoo! Inc. (NasdaqGS:YHOO) and AOL, Inc. (NYSE:AOL) 
      

6. The Need to Diversify Due to an Uncertain or Negative Industry Outlook

Many large companies that find themselves in mature industries are using M&A to combat market uncertainty, low projected growth or negative industry outlooks.

• Some healthy companies, especially those in stable (or shrinking) lines of business, are using their available cash and debt capacity to acquire new platforms and diversify their product/service offerings
  • In April of ‘10, Hillenbrand, Inc. (NYSE:HI) acquired K-Tron International, Inc. (NasdaqGS:KTII) for $435 million in a diversification strategy aimed at reducing its dependence on the low-growth death care market.⁽¹⁾ K-Tron manufactures material handling equipment and systems.
• Other companies are using “tuck-in” or “bolt-on” acquisitions to supplement their product/service offerings either as part of a defined strategy or because they may not be in a position to acquire a large target
  • 110 of the companies that comprise the S&P 500 made an acquisition in 1Q ‘10, more than in each of the past three quarters
  • In the past six months, nearly 40% of the S&P 500 have made an acquisition, while over 50% have made an acquisition in the past 12 months
  • In the past 12 months, nearly 30% of the S&P 500 have made more than one acquisition, while nearly 15% have made more than two acquisitions

 
While hindsight may be 20/20, forecasting the future certainly is not. Nonetheless, we believe the factors identified above will be key contributors to a sustained recovery. 




Sources: Capital IQ, The Economist, The New York Times, Pitchbook, Standard & Poor’s, Thomson Reuters, The Wall Street Journal

⁽¹⁾ P&M Corporate Finance served as financial advisor and provided a fairness opinion to Hillenbrand, Inc. (NYSE:HI) on its acquisition of K-Tron International, Inc. (NasdaqGS:KTII).