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Why a Wave of European Deals Could Be Next

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2013's surge in merger and acquisition-related activity is heading for Europe, according to strategists who say the continent has the same essential ingredients in place for a revival in deals as the United States.

(Read More: M&A 'Almost Necessary' Now: Yahoo's Santoli)

"M&A [mergers and acquisitions] lags a rising market," wrote Citi analysts in a report last week. "The ongoing rally in the equity market is likely to feed into corporate confidence and M&A activity should follow, if history is a good guide."

Bank of America Merrill Lynch agreed, albeit cautiously, with Citi's bullish outlook.

"Extrapolating from the M&A deals thus far in 2013… European M&A is clearly rising, albeit not surging, and still well below 2007 levels," wrote Bank of America Merrill Lynch credit strategists in a note last Thursday.

According to Reuters, worldwide M&A activity has reached $278.9 billion year-to-date, an 18 percent increase on the same period last year. And for the first two weeks of February alone, global M&A figures stood at $147.9 billion, a 15 percent increase on the whole of January.

Last week saw a flurry of mega deals out of the U.S. Berkshire Hathaway bought ketchup maker Heinz, bankrupt American Airlines parent AMR merged with US Airways to form the world's largest airline company, and cable giant Comcast took full control of NBC Universal from General Electric (NBC Universal is the parent company of CNBC).

U.S. M&A has more than doubled compared to this period a year ago, and so far accounts for 57 percent of deals made this year.

However, the Citi analysts highlighted the large amount of cash European companies are holding on their balance sheets, suggesting they have scope to make acquisitions.

They forecast European companies, excluding the U.K., will hold a total of 750 billion euros ($1 trillion) in cash by the end of this year, while U.K. companies will hold 150 billion pounds ($230 billion). In comparison, U.S. companies are expected to hold $1.3 trillion.

Citi said the U.K., rather than continental Europe, was more likely to see a large rise in deals.

"Historically, the U.K. has been happy hunting ground for investors looking to find exposure to corporate action. Unlike various continental European countries, we believe most U.K. companies could potentially be for sale, given the laissez-faire attitude of U.K. regulators and politicians to acquisitions," analysts wrote.

Citi highlighted multiple U.K. companies which it said could become M&A targets, due to their combination of strong balance sheets and attractive free cash flow relative to investment grade bond yields. These included Easyjet, a low-cost airline, retailers like Next, Burberry and WH Smith, and Britain's biggest newspaper group, Trinity Mirror.

"Buybacks are probably more suitable for bigger caps, while history tells us that M&A targets are more likely to be found in smaller caps," the analysts said. They defined small caps as companies with market capitalization of less than 2 billion euros ($2.7 billion) and large caps as those with market cap greater than 10 billion euros ($13 billion).

Candidates on Citi's big cap list included Franco-German EADS and the U.K.'s BAE Systems. The aerospace giants scrapped a $45 billion merger last year when national governments proved unable to reconcile competing interests.

Meanwhile, Bank of America analysts noted that credit spreads for European telecommunication companies – and for Spain's Telefonica – in particular – had widened considerably on speculation about M&A activity and downgrade concerns.

While investor focus in the mining sector remains on Glencore and Xstrata's long-awaited merger, Lee Downham, Ernst & Young head of mining and metals transactions for the U.K. and Ireland said other European and Asian deals could be on the cards.

"We saw an increase of Chinese and other state-owned entities acquiring in 2012, and we expect that to be an increasing trend, along with more diverse private investors into the sector," Downham told CNBC on Monday.

"The big diversifiers that we all know and love, like BHP Billiton, Rio Tinto and Anglo American, will do deals, but they are capital constrained. They will look to recycle capital, look to divest, as well as acquire. But increasingly, the valuations are looking attractive to the private sector, not least because there aren't returns elsewhere."

Karen Guch, a Baker & McKenzie partner specializing in M&A transactions, also predicted an increase in both European and Asian activity.

"There is a greater prospect of large M&A deals in Europe and also Asia this year, although not on the scale we have seen in the U.S. recently," she said.

"Corporates are more likely to be in the heart of that activity, either on their own or with private equity funds, or we may see a number of funds club together if large attractive assets come to the market."

However, Guch warned that the limited depth of the European high yield debt market compared to the U.S. could prove a constraint.

"The debt markets in Europe are still relatively patchy and high yield offerings are still less common/easy than in the U.S., so private equity players could still be constrained from doing very large M&A deals because of that. One solution to this is for them to club together – the vogue at the moment is for them to team up with corporates, but there has to be a clear story for both sides to make this work," she said.

Investors who want exposure to increased M&A activity should consider investing in the companies that arrange the deals, rather than the participating companies themselves, said Downham.

"I think they have got a much easier route to market because they do not have the same shareholder issues around being risk adverse that the large corporates have," he said.

However, other market participants remain skeptical a substantial surge in M&A is pending.

"A deal is great for a few companies, and could be extended to anticipate further take-outs for a larger swath of individual companies, but the reality is we still have to contend with major macro issues," Gina Martin Adams, institutional equity strategist with Wells Fargo Securities, said on Thursday after the $23 billion buyout of Heinz was announced.

"Can we go as far to say this deal today is going to spark a massive wave of M&A? Not really. We can get a bit of optimism, but Europe takes it away."

- By CNBC's Katy Barnato

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