Deals and IPOs

Why Climate for M&A Could Get Even Better in 2012


If the U.S. economy is to grow in 2012, it may have to do so on the backs of mergers and acquisitions activity, which is expected to be healthy again after a strong 2011.

Negotiating Pay

Though much of this year's M&A movement came in the earlier part of the year, the U.S. still registered a healthy $841 billion in deals. That's a 24 percent gain from 2010 and the highest since pre-financial crisis levels in 2007, according to Dealogic.

With valuations low, corporate cash balances high and tax changes likely to spur deal momentum, economists' M&A outlook for the coming year is largely positive.

The European debt crisiscould weigh in the early part of the year — as it did in the second half of 2011 — but corporations are expected to get hungry for takeovers as the year progresses.

"In the beginning of the first quarter corporations are going to want to assess what's happening overseas," said Peter Cardillo, chief market economist at Rockwell Global Capital in New York. "After that we will see companies step up to the plate and we could probably top this year's level. The reason for that is corporations are still very cheap."

Increased M&A likely will be the cause more than the effect of U.S. economic growth, which consensus pegs at between 2 and 2.5 percent for the year ahead, Cardillo said.

"It may not accelerate quickly on the domestic front, but on the international front it will," he said. "You're going to see a lot of multinational corporations beginning to look for cheap bargains in euro-land."

Corporate America has chosen to sit on the much of the more than $1.5 trillion on balance sheets, but M&A activity was still plentiful.

US domestic M&A — where the targets and buyers were based in America — accounted for 31 percent of all global activity, the highest level since 2006, according to Dealogic. U.S.-targeted M&A, where one party was outside the country, totaled $996.5 billion, the best since 2008 and a 12 increase over 2010. Volume actually fell, though, from 9,965 total deals to 9,873.

In terms of sectors, health care led the way with $141.2 billion, followed by utilities and energy and technology.

Health care also is expected to be strong in 2012, but some new areas could benefit as well.

Among them are the small-cap space in general but small- and mid-cap banks, biotechnology, consumer packaged goods and environmental services in particular are expected to do well.

"Reviews of a large sample of earnings calls and transcripts from various (third-quarter) earnings announcements indicate that M&A is a priority for many corporates," Deutsche Bank strategists said in their 2012 outlook. "M&A currently represents, we believe, the best opportunity for growth in a slow organic growth macroeconomic environment in the industrialized economies."

Deutsche Bank formulated an index that measures M&A affordability by comparing implied price-to-earnings multiples of single-A rated debt against widely followed market indices such as the Standard & Poor's 500 and the Euro Stoxx 50.

It found value to be "near its all-time highest level" particularly for companies that have a lot of cash at their disposal.

"One of the drivers of this trend is historically low valuation multiples, and valuations that are in many cases at discounts to the sum-of-the-parts valuation," the firm said. "Investors appear to be placing greater value on pure play focus, and spinoff transactions have generally been well received by the market."

Expected changes to corporate tax laws also are likely to foster a positive M&A climate as large corporations start shedding underperforming subsidiaries. Deutsche said this may drive smaller deals, particularly those in emerging markets, rather than blockbuster corporate takeovers.

Investors May Demand Deals

Yet another factor that could influence deals is the slow-growth economy itself. With companies unable to achieve "organic" growth — or that driven by sales and traditional activities — they'll look to expand their reach through absorbing competitors.

If nothing else, investors may begin to demand that companies start putting their cash to work.

"Value-enhancing cash deployment could benefit U.S. equities with excess capital, stable earnings and conservative coverage ratios," strategists at Bank of America Merrill Lynch said in a note to clients. "With a significant compression in valuations, M&A could be advantageous to both acquirers and acquirees."

Financial companies, which did not participate in the 2011 M&A boon, could face a harder trek as investors continue to worry over their exposure to the European crisis.

Yet the crisis itself could benefit one group in the financial industry.

Keefe, Bruyette & Woods has upgraded its view on regional banks to overweight on the belief that they finally will see some deal activity because they will be shielded from whatever fallout emanates from across the Atlantic.

KBW sees a sector trading at book value and ready to grow; it changed its rating on the group from marketweight.

Financials Forecast for 2012

"M&A has yet to show signs of life and the current rate, regulatory and macroeconomic environment make it very hard for banks to achieve meaningful profitability improvement in the near term," the firm said in its 2012 look-ahead. "We believe this has to change and the small- to mid-cap banks  have the greatest opportunities to adjust through M&A-driven expense reductions and capital deployment."

Small caps in general could benefit after seeing $13 billion flow out of the sector this year and M&A activity "subdued," JPMorgan Chase told clients in a note that also pointed out a record number of companies in the space participating in share buybacks in the third quarter.

"With improving visibility and declining volatility, we see: 1) M&A activity being more robust in 2012 with cash-rich U.S. corporates and underinvested (private equity) firms; 2) flows reversing or stabilizing; 3) U.S. stocks likely to be seen as relative 'safe havens,' especially with minimal international exposure by small caps; and 4) stock repurchase activity increasing with rising cash balances and high (return on equity)," the firm said.

"We had a pretty good year and that's a good indicator that's going to continue," Cardillo, the Rockwell Global economist, said. "Economic activity is starting to show signs of picking up and that is probably going to continue."

Tune into Closing Bell today at 3:15 for a deeper discussion of this issue.

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