Comment: Stalling M&A activity points to faltering recovery
Anxiety over double-dip recession remains
As we have pondered in this column before, there are many indicators as to whether we are heading towards any sort of sustainable economic recovery, from employment levels to GDP growth and the housing sector. But one of the more interesting is the level of merger and acquisition activity in the market.
Although not delivering a clean view of economic growth, the willingness of retailers and food and drink manufactures to consider acquiring new businesses is a solid indicator of their levels of confidence in the consumer environment. More importantly, it is a good reflection of companies' faith in the medium and long-term health of the sector.
So it was with some interest that I read this week a recent report from the business consultancy company KPMG on the levels of M&A activity in the sector and its implications.
There were a number of interesting themes, but chief among them was that the value of acquisitions in 2010 so far have shown that, according to KPMG, "there has clearly been an economic recovery under way, although it recently seems to have stalled".
According to the report, in the food, drinks and consumer goods sector, deal values hit US$49.1bn in the first quarter of 2010, which was a significant improvement on the low point of $10.1bn in the first quarter of 2009. However, by the second quarter of the year, deal values reached only $18.9bn, with the volume of deals only reaching 669, a 12-month low.
The chief concern is that these figures suggest we may be heading towards a double dip recession. KPMG's last look at the market, in January, indicated that the M&A market "would once again be open for business".
"Confidence has ebbed during the past six months and it now seems evident that prospective corporate purchasers have yet to re-open their warchests," KPMG said.
That said, it is far from all bad news and the consultancy still believes that, whilst activity is muted, increasing earnings expectations suggest that "the future for M&A activity is being laid".
As recent acquisitions by Coca-Cola Co. and PepsiCo of its bottling networks and Kraft of Cadbury show, deals are being done and there are a number of factors at play still driving M&A activity, which will likely pick up in the year ahead.
A continuing grim economic environment will always provide rich pickings for companies with strong balance sheets, who are still able muster the war chests necessary to buy up distressed businesses. But the recession has driven M&A activity in other ways too, most notably with Coke and Pepsi a desire to take control of its supply chain, in order to better influence margins. As KPMG points out, there is also the more fundamental desire to look for cost savings at times like this or to consolidate and take capacity out the market.
This reduction in fragmentation, KPMG says, has been most at play in Eastern Europe where a combination of big state-owned brands coming onto the market and fragmented consumer goods and retail sectors are providing opportunities.
Much of the activity so far has been amongst local companies looking to build a stronger regional presence. However, KPMG's Slovakian analyst, Ken Ryan, reports that many of the better local brands "are being bought by private-equity groups who then prepare them for sale, either splitting off individual components of the business or consolidating brands into a single business".
Indeed, the role of private equity is an interesting one and the KPMG report seems to suggest an evolving emphasis for what is a key sector in stimulating global M&A. On top of the activity in Eastern Europe, similar deals are being struck in India, Argentina and China, with PE houses doing relatively small deals to consolidate a market or taking small stakes in local businesses with a view to providing expertise to help in medium and long-term development.
This idea that private equity is now positioning itself as a long-term partner in FMCG businesses is not one everyone will be familiar with. And the image of the "buy, strip and flip" merchant is one the sector still struggles to shrug off.
"But in truth they [private equity groups] always were more than the single-minded financial engineers that some held them to be," says the report. "In this market, where increases in value are hard to come by, they are bringing real business-building skills to the table."
The food and drink sector remains an attractive proposition for PE houses and expect those not already active again in the industry to return in force when conditions improve. Price though seems to remain an issue. KPMG reports that its analysts believe the market for assets still has some way to fall before an acceleration in M&A can happen.
It is an interesting point and one that suggests a divergent view of the long-term returns on investment in this current market between sellers and buyers.
"KPMG in the UK, the US and Spain all reported potential vendors staying out of the market through an unwillingness to accept the prices on offer. Some of this is due to the falls in property prices that each of these countries have experienced, but there is also a lingering feeling that the high prices seen in the mid-2000s may still be achievable in today's market," the report says.
David McCorquodale from KPMG in the UK says owners have simply not come to terms with the fact that pricing structures driven by leverage and private equity from 2000 to 2007 have gone.
In a credit starved market, the bad news is that prices will simply have to fall before real M&A growth returns. And, even then, the outlook remains patchy, with emerging markets the likely hotbed of any return to form as consumer confidence continues to lag in the more traditional Western economies.
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