Mergers & acquisitions were down about 50% in 2012 from their 2007 highs, well below 2011 levels. The inhibiting factors that created a meaningful slowdown over the past few years are subsiding, however.
Last April, we projected a recovery in deal activity for the balance of the year, based on:
- Low interest rates and easing credit availability for good borrowers
- Cash-rich and often under-leveraged corporate balance sheets
- Attractive stock market valuations
- The manifold strategic earnings level and balance-sheet synergies of an acquisition for many companies looking to increase incremental growth
- The likelihood of acquisitions becoming immediately accretive, given low financing rates and attractive purchase prices
- The opportunity for acquirers to partake in a still-early economic recovery resulting in a longer period for realizing the benefits of a sound acquisition.
While these factors should have provided a catalyst for deal activity, they were overwhelmed by confidence-sapping macro negatives, ranging from fears of a European meltdown, a slowing Chinese economy, and numerous concerns about the U.S. economy, the U.S. elections, the looming fiscal cliff, and pending health care costs that would begin to kick in as of 2013.
The question, as we enter 2013, is what might be different? We believe that much of the lurking uncertainty of 2012 has been or will be clarified, contextualized and overcome. The U.S. election has been decided. In spite of the usual rancor and threats, we believe that a deal will soon emerge from Washington that will avoid the fiscal cliff. Ultimately, while the level of 2013 taxes and health care costs might not be ideal for accelerating the U.S. recovery, there will be certainty, which will enable corporations to plan accordingly.
Globally, China's economy seems poised to reaccelerate. While Europe is expected to continue to struggle, the worst-case scenarios appear increasingly remote, and in many respects, Europe could be finding a bottom.
Our point is not that the environment will be optimally conducive for corporate expansion or growth, but that greater clarity and certainty will enable companies to price in these realities while taking advantage of the still-available positives that outlined above.
Furthermore, the relatively slow global recovery makes smart strategic acquisitions a timely tool for accelerating earnings growth. Importantly, the market has rewarded recent acquirers, suggesting a positive predisposition to such deals, many of which have been immediately accretive. With such acceptance, additional deals are likely, quiet possibly creating a self-fulfilling growth cycle for deal activity.
The strength of the stock market in 2012 should also spur activity. Anticipating continued economic recovery, companies might be reasonably projecting another decent year for stocks in 2013, a conviction that could lead to a conclusion that time is no longer on the buyer's side.
The other potential driver of M&A activity should be private equity. Confidence concerns, as well as the need to address operating concerns in previous deals, have significantly slowed PE activity in the past couple of years.
As with strategic corporate buyers, PE will greatly benefit from greater clarity and certainty. Many PE firms have cash to invest. What they have lacked is the confidence to put that money to work for fear that it will be misplaced. That fear should abate significantly, and with it there is a reasonable likelihood the PE sector becomes more active in 2013.
If we are right about a pickup in deals, we expect continued and increasing activity in industrials, energy, health care, media and technology companies among U.S., multinational and overseas entities.
For investors seeking to profit from potential acquisitions, we suggest focusing on companies to own as ongoing independent investments, and to consider the potential for a buyout as icing on the cake. Since the criteria that guide value-oriented investors also motivate both strategic and financial buyers, using a valuation-driven approach is very useful.
A few stocks that offer intrinsic merit and could attract a takeover bid include Devon Energy (DVN), Harris (HRS), Southwestern Energy (SWN), and Zimmer (ZMH). Two less meritorious names as independent investments that could nevertheless attract outside interest are Monster Worldwide (MWW) and Staples (SPLS).