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Europe’s M&A market faces headwinds as PE groups wait to pounce on favourable valuations

Storm clouds are building on Europe’s M&A horizon, as record high valuations and rising economic macro risks sow seeds of caution among corporates. 

As highlighted in a recent white paper by CMS, a full service global law firm, entitled “Storms brewing: European M&A Outlook 2019”, European M&A value over the last 12 months (Q3 2018 to Q2 2019) is down 22 per cent year-on-year to EUR652.2 billion. Only 27 per cent of respondents surveyed by CMS expect the level of M&A activity in Europe to increase over the next 12 months, compared to 65 per cent last year. 

But against these headwinds, deals will still be done as new opportunities arise, especially in sectors such as Europe’s TMT space, where aggregate deal value increased by 177 per cent last year, reaching EUR169.1 billion. 

With financing conditions expected to tighten, just over half of the survey’s respondents believe this will play into the hands of private equity groups and that companies will increasingly turn to them to finance deals. 

And with record levels of dry powder in the PE space, there is no shortage of capital to put to work. As Reuters reports, US private equity firms raised USD191 billion in the first nine months of 2019; nearly as much as in all of 2018. 

PE groups are biding their time and waiting to see if economic conditions in Europe deteriorate, potentially letting steam out of a highly valued marketplace (after the US). 

As Stefan Brunnschweiler, Partner, Global Head of the CMS Corporate/M&A Group, tells PEwire, 67 per cent of PE groups believe they will find favourable valuations.

“I think for quite a while, PE managers as well as corporates, have struggled with high valuations of target acquisitions,” says Brunnschweiler. 

“As we face a potential market downturn, we see more and more sellers trying to pull together an auction process. Fortunately, or unfortunately, depending on which side of the transaction you are on, sellers are very often factoring in the insecurity of the economy, as storm clouds build on the horizon, by either lowering the price or by imposing a larger part of the price to be paid as an earn-out; shifting the risk back to the seller based on what the future may bring. 

“So long story short, I do think PE groups see an opportunity to find targets at more reasonable prices.” 

He says that in Europe, a lot of companies are focusing on their core competence and consequently US buyers see the possibility of acquiring assets that were not previously on the market. 

“Brexit led to quite a lot of M&A activity last year but now the Brexit question is impacting the M&A market; it is quite clear that deal numbers are down and the ‘wait and see’ approach is probably the best way to describe things at present,” suggests Brunnschweiler.  

As the CMS report points out, regulatory intervention has also spooked dealmakers and led to the lapse or cancellation of deals. Deutsche Bank and Commerzbank called off their tie-up, citing execution risks. UK supermarket chains Asda and Sainsbury’s canned their EUR8.3 billion merger following the intervention of the UK’s Competition and Markets Authority (CMA), while the European Commission blocked a deal between French train manufacturer Alstom and the rail arm of German conglomerate Siemens.

“Storms are brewing: the headline of our report says it all,” remarks Brunnschweiler. “It’s a situation where firms are more cautious and while transactions are still happening, a lot of deals are not done because the right fit cannot be found and firms are walking away. What can also be said is that it is taking a lot longer to close deals, there is more focus on due diligence…the overall sentiment in Europe is more cautious.”

For large established PE groups like Blackstone and Vistra, both of whom have just finished fundraising for their latest funds (USD26 billion and USD16 billion respectively), they will be watching the megadeal space closely in Europe. Through the first half of 2019, 59 deals worth USD1 billion plus were completed, compared to 89 deals in 1H18. 

Despite the fact there is all this money available, “there is a responsibility for PE managers to be cautious and ensure they do the right deals”, says Brunnschweiler.  “I think that’s a good development, actually. I’ve seen years where there was so much money in the market and acquisitions were done because there was so much pressure on PE managers to do deals, such that they overpaid for assets and ended up paying the price. There is a lot of dry powder in the market, but nevertheless PE managers remain cautious.” 

Corporate carve-outs could present M&A opportunities for PE groups as large corporates, driven in part by shareholder activism, engage in non-core asset divestments and focus on their core competencies. It is a natural reaction to the overall economic development that some companies are choosing to restructure. 

Favourable valuations are another driver, with 67 per cent of private equity respondents citing this as a reason to transact.

When asked what deal making trends he is currently seeing, Brunnschweiler concludes:

“Warranty indemnity insurance is being used more in transactions and becoming more important. Also, transactions where earn-outs are important, or where joint ventures are built to bring businesses together. These are just some of the trends I am seeing and this is adding to the complexity of deals in the M&A market.” 

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