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Smaller M&A deals pay far superior premium

Ultra-low interest rates are encouraging a rebound in mergers and acquisitions (M&A), with premiums on deals for small and medium-sized companies far outstripping larger transactions, according to Allianz Global Investors.

Companies, buoyed wider-spread optimism of an improving economy, are looking to put cash to work externally while business valuations are still attractive.
Improved sentiment means more corporates are likely to embrace M&A and capital expenditure compared to the organic growth and deleveraging that prevailed after the crisis.
Between 2001 and 2013, US buyers were willing to pay an average M&A premium of 25 per cent for small caps and just over 26 per cent for mid-caps, according to Standard & Poor’s indices analysed by AllianzGI Global Capital Markets & Thematic Research.
The premium for large-cap M&A, in contrast, was just 10 per cent.
The premiums were calculated using the average share price during the last 20 days prior to acquisition.  
Andrew Neville, lead portfolio manager of the AllianzGI Global Small Cap Equity Fund, says: “Competition to buy smaller companies is intense. While many large companies will often compete to bid for smaller firms, only a handful of firms have the scale to mount bids for their larger peers. Larger companies also tend to be well covered by research and their share prices closer to true value as a result. In the small cap world things are very different – research is scarcer, leaving companies trading more frequently below their fair value. 

“Costs, both that can be taken out and in terms of financing deals, also make large cap M&A more expensive. When a larger company buys a smaller firm, it uses its clout to negotiate better supplier deals and removes duplication. To buy a small cap, a larger company can often simply use existing cash resources or access cheap debt, which is much cheaper than the cost of raising equity to acquire a bigger peer.
“M&A is pro-cyclical with the economy. As the economy improves then we get more M&A, peaking at the top of the economic cycle. What we are seeing in Europe is that as growth returns company management are becoming more confident and so willing to acquire other companies to improve their own growth prospects.”
Stefan Scheurer, capital market analyst at AllianzGI and author of the research paper, says: “The global M&A market has been invigorated in recent weeks, suggesting deal-making could become an additional driving force for equities-market performance over the coming year. Transaction volume, though not yet close to previous cycle peaks in 2000 and 2007-8, stands at USD680 billion so far this year, the highest level, year to date, since 2007 and up 56 percent on the same period a year ago.
“Greater emphasis on M&A comes because companies have delevered since the crisis and the years of loose monetary policy have made financing cheap and abundant. Capital gearing – the ratio of net debt to earnings before interest, tax, depreciation and amortisation (EBITDA) – stands at just 1.5x, some 10 per cent below the 20-year average.”
Non-financial, corporate free cash flow to national GDP has risen to four per cent for US companies, not far from the all-time high of 4.4 per cent. For the G4 group comprising the US, the UK, Europe and Japan, the figure had risen to three per cent of combined GDP by late last year, up from two per cent in the middle of 2009.

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