By Claire West

According to the latest KPMG Global M&A Predictor, UK companies are increasingly in a strong cash position, with forecast net debt compared to EBITDA (earnings before interest, tax, depreciation and amortisation) set to tumble by 30% over the next year. Net debt is forecast by analysts to go down 21%, showing extensive deleveraging, and meaning that M&A capacity is improving strongly.

However, analyst forward P/E ratios (market capitalisation compared with earnings) - which give an indication of confidence and appetite to do deals — show that the picture is less rosy as the ratios are down some 14% over the last 12 months for UK companies. Such a significant drop suggests diminished deal-making appetite.

Frank Carter, Transactions Partner at KPMG in London commented:

“The UK M&A market is at a strange impasse where companies have been paying down substantial levels of debt, compared with their earnings, and are predicted to do so substantially over the next year but reduced price to earnings ratios show that the market is unconfident. On the stock markets, where markets are improving in spite of economic nervousness, this is called ‘climbing a wall of worry’; we are seeing the same situation in the M&A market.

“One thing is certain, management teams are going to have to work hard this year to get investors on side and support their M&A ambitions. With the market cap of the UK companies in our survey up 8% in the last year, it’s a communications battle some management teams will feel confident they can win. Companies that want to escape low growth home turf will have to convince investors if they are to succeed.”

Key UK versus global findings of KPMG’s Global M&A Predictor:

· Forecast net debt to EBITDA ratios are set to fall by 18% over the next year for companies globally but are set to drop a massive 30% for UK companies;

· Global net debt is predicted to fall by 10%, compared with more than double for the UK at 21%;

· Forward P/E ratios are down 11% globally but are worse in the UK where they are down 14%;

· The largest global companies saw their market cap rise by 12% in the past year, compared with 8% for the UK;

· At an industry level, global M&A appetite is highest within the telecommunications sector where forward P/E ratios are up by two percent, thanks to the increase in markets (nine percent) outstripping expected earnings (eight percent). It is the only sector whose P/E is in positive territory, although non-cyclical consumer goods is not far behind at zero;

· On the net debt to EBITDA ratio, the technology sector has long been the superstar of the Predictor, with its ratio of-1.1x representing a net cash position. However, an improvement in the Healthcare sector ratio (down from 0.3x to 0.1x) means that it may soon be the second sector to move to a net cash position.

Commenting on M&A prospects in technology, Jonathan Stankler, technology M&A partner at KPMG, said:

“While many industry sectors are likely to be entrenched in low demand economies in the short term, technological advancement could prove to be one of the exceptions as companies at the forefront of innovation find ways to lead us into the future; be it web-enabled television replacing digital in homes; music and sporting events bypassing traditional media companies to go direct to market or social network sites becoming platforms for all web services, such as e-retailing, communication and media. As a consequence, technology companies in the mobile data space and the Cloud are well positioned to deliver strong growth going forward. In addition, a myriad of technological advancements is providing stimuli to the deal market as companies seek to share IP and access technology hungry environments.”

Frank Carter added:

“Regardless of the twists and turns in the economy, retail and consumer goods companies always keep investors on their toes! While the sector is known for being subject to the capriciousness of consumer behaviour, non-cyclical consumer goods like food have really been the solid performer in this downturn. While sectors like leisure and property continue to frighten nervous investors, food and food retailers are proving more comforting owing to an understanding that commodity price increases need to be absorbed and that this is non-discretionary spend. Retail was a relatively hot trend of 2010 and we expect it will continue to attract both corporate and private equity deal-making activity this year, particularly at each end of the value or luxury poles.”