Monday, February 18, 2013

2013 - Year of the Deal or Year of the Snake?

A rash of deal activity, especially larger deals, has occurred this month with the Dell, Heinz and Comcast announcements. This increase, which actually started in 4Q12, if sustained, could see 2013 deal flow reach a post crisis level not seen since the credit crisis. Care is needed in M&A predictions, however, as a rebound has been projected for the past several years. This time, the rebound seems likely to last for the following reasons:

1.     Reduced, albeit still significant, macro political and economic uncertainty.

2.     Significant pent-up demand given years of depressed activity.

3.     Pent-up need for consolidating M&A in several industries including tech, consumer products and banking to offset growth and margin pressures.

4.     Improved financing conditions. Bankers and investors, in general, are searching for yield in a low return environment given their improved financial condition following massive credit crisis losses. The focus has shifted to return on capital instead of return of capital. Consequently, the return of cheap and plentiful financial capacity to fund the $23B Heinz LBO at an aggressive 6X funded debt to EBITDA level.

5.     The stock market has finally recouped its crisis related losses after 5 years. M&A and the stock market are both reflections of investor confidence.

6.     Corporate balance sheets and earnings remain robust. Hence, deal and debt capacity are strong and permits larger deals.

7.     Investor reaction to recent announcements has been unusually positive. Buyer shareholders are suspicious of M&A announcement given the propensity to over pay. Thus, buyer stock prices frequently decline. Current deals, occurring earlier in the cycle, appear to have lower price risk and better strategic rationale than deals in general. Therefore, buyer’s share prices have actually increased following the deal announcements. This will not go unnoticed by other potential buyers. Of course, the potential for an over-priced HP-Autonomy deal is never more than a click away.

8.     Momentum feeds on itself. A combination of confident buyers combined with liquidity provided by yield seeking investors will support a herding effect which can last for a considerable period.

The most likely result is an upturn in the M&A cycle which builds over the next few years. The speed and magnitude of the rebound are unknown. As in previous cycles, the best (i.e. reasonably priced) deals are made earlier in the process. It appears 2013 may actually be the real deal. This is good news indeed for revenue starved advisors, banks and investors at least in the short run.

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