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Why M&A Faces Strong 2012 Headwinds

The market loves big deals, which offer a signal of confidence to investors. The problem for activity in early 2012 is that companies require confidence more than ever before pulling the trigger on transactions.

Negotiating Pay
CNBC.com
Negotiating Pay

But certainty will be hard to come by, a trend that will cause mergers and acquisitions activity to stall in the early part of 2012. With the overhang of a European debt crisis, U.S. fiscal woes, and slowing growth in Asia, dealmakers whom I surveyed expect next year’s M&A landscape — both here and abroad — to start slowly but turn a corner in the second half.

That’s because companies refusing to put their high cash levels to use will face heightened pressure from investors to do so.

“Shareholders may agitate for a return of capital, a separation of assets — or may sell their shares altogether in favor of more dynamic strategies,” said Jim Woolery, JP Morgan’s co-head of North America mergers and acquisitions.

U.S. corporate cash levels reached a record of nearly $1 trillion in the third quarter; Howard Silverblatt of Standard & Poor’s estimates the fourth quarter will be the first in nearly four years where total cash on corporate balance sheets decreased.

But companies weren’t putting that money toward acquisitions, choosing instead to buy back stock, issue dividends and plow money into capital expenditures. Cash will turn toward acquisitions only when confidence is restored.

Global M&A volume tapered off 22 percent from July onward, data from Dealogic show, with the fourth quarter’s $537 billion in deal volume the lowest since the third quarter of 2009.

The inherent fear of shareholder backlash is what will keep corporate activity humming, even as Europe’s debt crisis handicaps the market.

What to Look For

The lion’s share of deals in the next six months will likely carry certain attributes. First, transaction size will target a sweet spot of $1 billion to $5 billion — a range that communicates willingness to grow but won’t cause distractions from overall strategy.

Second, transactions in the technology and energy sectors will be rampant. One big reason: Ability to raise the money to seal the deal, since companies opted in recent years not to stack their balance sheets with debt.

“Most of the large energy companies have maintained ample access to capital at highly attractive rates,” said Gary Posternack, head of Americas M&A at Barclays Capital. “So financing should not be a constraint.”

The energy sector claimed the year’s largest deal — Kinder Morgan’s purchase of El Paso for $37.9 billion, announced in October — even as other sectors had their hands tied.

Because both energy and technology are largely insulated from macroeconomic uncertainty, potential sellers have seen their valuation stay more intact, a detail that makes negotiating deals easier. Executives of financials and materials companies — where stocks have slid more than 10 percent this year alone — may expect a higher price than buyers are willing to pay.

Yet another point to prove: When the market starts rising, so will dealmaking. And so, as it happens, will confidence.

Follow Kayla on Twitter: @kaylatausche

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