By Daniel Hunter
A major rebound in confidence among UK corporates in the global economy is not yet translating into capital investment and M&A activity, according to Ernst & Young’s eighth bi-annual Capital confidence barometer, based on a survey this month of 1,600 senior executives.
The surge in confidence, fuelled by positive expectations around economic growth globally, corporate earnings and credit availability, sees 93% of UK companies now viewing the global economy as either stable or improving. Fifty-eight percent now believe the global economy is improving outright — over a threefold increase on the 18% recorded in October 2012.
This increased confidence has fostered a strong consensus among UK corporates that M&A volumes will increase — 75% expect global deal volumes to rise over the next 12 months.
However, even with a renewed focus on growth (62% cite growth as a priority versus 36% in October last year), only 27% of major companies expect to make acquisitions in the next 12 months, with organic growth measures (49%) the major strategic preference for executives.
Jon Hughes, head of Ernst & Young’s transaction advisory services practice in UK & Ireland, said: “Business leaders have confidence in the global economy, they expect to see deals taking place and the fundamentals - such as improving credit conditions and realistic valuations - are there to support these deals. But unfortunately this is not translating into widespread capital investment and M&A activity - what we are seeing is a “confidence paradox” with planned activity contradicting expectations.
“In the past few years, M&A volumes have de-coupled from historical indicators of deal activity - there are signs of improvement but caution remains. While three quarters of corporates expect deal activity in the market to increase over the next year, far fewer have an intention to buy. This could actually create a first mover advantage opportunity for those willing to transact — those who are bold could secure prime assets and steal a march over the competition.”
The modest improvement in the number of UK companies planning acquisitions (from 26% in October) is largely driven by an increasing number, and higher quality, of acquisition opportunities. Thirty-seven percent of companies say there are quality acquisition opportunities available compared with 33% six months ago; 52% feel more confident about the number of opportunities available, versus only 40% six months ago.
The report reveals that the top five destinations where UK corporates are most likely to invest are India, South Africa, United Arab Emirates, Germany and France. In contrast China, India, Brazil, US and Canada feature in the top five global investment destinations.
Hughes adds: “It is surprising not to see more of the BRIC nations and other emerging markets on UK corporates’ radar, where demand and opportunities are far higher than traditional Western European markets.
“This highlights the nervousness and reluctance of some corporates to branch out - instead preferring to focus on their well trodden trade routes. While these more familiar markets shouldn’t be ignored, a reluctance to target high growth regions is going to limit growth and allow braver competitors to take an advantage in these faster growing jurisdictions. What's also clear from the global investment hot-spots is that capital is chasing demand, whether it is in developed or emerging markets.”
The sectors most likely to see acquisitions in the UK are Automotive, Technology and Consumer Products. Consistent with sentiment over the past six months, deals across the board are likely to remain smaller in size as caution remains, despite record amounts of available cash and improving credit conditions. Eighteen percent of companies planning acquisitions expect deals to be under US$50m, 70% between US$51 — 500m, 3% between US$501 — 1bn, and 9% over US$1bn.
Only 12% of companies (down from 38% in Apr 2012) are planning to divest in the next 12 months. The inability to realise price/value expectations (56%) and a disruption to the core/ongoing business (37%) are the key reasons for not pursuing divestments.
A focus on core assets (56%) and raising cash to compensate for underperformance of aggregate businesses (31%) are the main drivers for divestments, and the sale of the business unit (62%) and a spin-off of the business unit (25%) are the preferred form of divestments.
The reasons for a sale — and the types of divestment — are increasingly complex and not necessarily driven by the traditional motivation of raising capital. Focusing on core assets and enhancing shareholder value rank more highly as a selling rationale.
Hughes continues: “Despite growing optimism, companies are largely focused on lower-risk value creation strategies adopting much more cautious approaches than one would expect given increased confidence and credit availability. Divesting is increasingly a part of that mix — a strategic tool to create value that many see as less risky than an acquisition. These approaches have become the “new normal” in the post-financial crisis world. Companies want sustained evidence of an upturn before making major investments.”
The valuation gap — often a barrier to deals — has narrowed in the past six months with most respondents (82%) saying the gap is 20% or less, compared with 73% in October 2012.
However, expectations for increased valuations are now at their highest level in the history of the Capital confidence barometer. Forty-four percent of companies expect price/valuations to rise in the next year, up from 31% in October 2012. Just 6% of companies expect valuations to decline, compared with 21% six months ago, suggesting the market has stabilised.
“We may now be nearing equilibrium between what buyers will pay and what sellers will accept”, says Hughes. “This equilibrium is vital, signaling the deal markets are at an inflection point and ready to rebound. The pendulum is primed to swing the other way — toward higher prices for buyers, and more profitable exits for sellers.”
Hughes concludes: “Given the increase in confidence and strong deal fundamentals, it is surprising that we haven’t seen a stronger appetite from businesses to transact. Executives who continue to wait for a sustained recovery before engaging in M&A may be nearing the point where this caution becomes risky and ultimately detrimental to the future growth of their businesses.
“Economic confidence, credit conditions and valuations all signal that now could be the right time for corporates to make that strategic acquisition. History shows that first movers in any economic cycle can create differential value and position themselves for sustained market leadership.”
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