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M&A deal flows checked by economic slowdown, says Ernst & Young

The tepid global economy has greatly slowed the pace of US M&A activity, as deal flow dropped by 15 per cent to 3,159 deals in the first half of 2012 from 3,729 in 2011.

Deal value also tumbled by 43 per cent from the prior year.

While the US economy has exhibited signs of improvement, supplemented by an increase in consumer confidence, M&A continues to be affected by volatility in the credit and stock markets and uncertainty in the global economy, particularly in the Eurozone, exacerbated by slowing GDP growth in the emerging markets and minimal to nonexistent growth in the developed world. 

With M&A activity waning, boardrooms are focused on optimising capital through organic growth and returning value to shareholders with M&A alternatives. According to Ernst & Young’s US Capital Confidence Barometer, 55 per cent of companies cite growth as their primary focus, up from 42 per cent six months ago.

The drop in deal activity and increased desire for growth has created a renewed focus on portfolio optimization, which could lead to corporate divestitures by management teams and boards in their bid to return value to shareholders and drive top and bottom line growth. The Ernst & Young survey also reported that 34 per cent of US companies were likely to sell assets in the forward-looking 12 months, a 70 per cent increase from April 201.

"In recent conversations with top corporate deal makers, there is a prevailing thought that incremental value will be created through strategic portfolio management," said Rich Jeanneret, Americas vice-chair, transaction advisory services for the Ernst & Young organisation. "Never before has it been more important for companies to evaluate which portfolio businesses are critical to implementing their corporate strategy over the next three to five years."

Over the past decade, corporate strategy relied heavily on M&A for growth. However, Ernst & Young has found more executives are coming to realize that effective portfolio management and corresponding divestitures can be essential to growth. Divesting with a focus on raising capital for investment in core businesses, emerging markets and extension of existing products and services builds value. As executives increasingly understand the strategic benefits that proactive portfolio management can provide – particularly when corporate growth is difficult to achieve and efficient capital allocation is a priority – companies are executing well-timed divestitures, accompanied by stronger balance sheets and increased readiness for strategic acquisitions.

In the uncertain growth environment, expect to see the robust divestiture activity to continue through portfolio rationalization, star-bursting, tax-free spins and carve-outs.

While the overall private equity deal environment is stabilizing, activity levels remain well below expectations considering the amount of "dry powder" and availability of deal financing. In the first half of 2012, US deal volume was down six per cent (buy side and sell side combined) and US PE deal value was flat. Completed deals have taken longer to close and are being sold in very competitive processes, resulting in relatively high valuations.

Although fundraising remains challenging, there has been an increase in activity and funds continue to close. Approximately USD368.5bn in uncalled capital still remains available to PE funds, and credit markets have been receptive to new deal financing for the past six months. The financing markets have stabilised, with attractive terms available for buyout borrowings.

With nearly one-third of global companies considering an asset sale in the next year, PE firms have already started to demonstrate an eagerness to acquire carved-out businesses as platform or add-on deals. PE firms are also focused on exits of more mature portfolio companies, positioning their portfolio companies for sale or IPO in an effort reduce the record numbers of investees residing in PE portfolios.

"As corporates streamline their balance sheets and sell off non-core businesses, carve-outs are a consequence and PE funds appear to be preferred buyers representing attractive near term buyout opportunities," says Jeff Bunder, global private equity leader for the Ernst & Young organisation. "PE firms are poised to do deals – dry powder backed by an increasingly favourable borrowing environment is providing the impetus to complete acquisitions."

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