The largest companies around the world, in almost all sectors, are anticipated to return to profit growth and are driving down debt, which is creating substantial capacity for M&A activity, according to KPMG's bi-annual 'Global M&A Predictor'. However, while profit predictions and cash positions are positive, price to earnings ratios, which indicate corporate appetite to do deals, have fallen 3 percent. Indeed the calculation used in the Predictor to test appetite shows that the UK is the only major M&A mar
David Simpson, Global Head of M&A at KPMG, commented: “The largest companies around the world, viewed through an M&A lens, are confusing places to be. On the one hand profit expectations are up 7 percent compared with 6 months ago. On the other hand, the lack of longer term stability can be seen in the lag of market capitalisations behind profit expectations - profit expectations might be up 7 percent but market capitalisations are only up 4 percent. Companies are also driving down their net debt, compared to earnings, but this is not translating into confident acquisitive activity.”
Simpson added, “Confidence or appetite to do deals looks incredibly negative in some countries. In the major M&A geographies, Japan has the most negative outlook with the largest companies’ pricing compared to earnings down 13 percent. This may partly explain why Japanese acquirers are focusing on foreign acquisitions rather than domestic ones. One ray of hope is the UK, which is the only major market to have moved into positive territory, albeit at a low level (pricing compared to earnings is up 1 percent). Given the gloomy global backdrop, a grain of positivity is meaningful even if it simply suggests that we are neither in the Eurozone nor too dependent on slowing emerging markets."
The global outlook for large corporate M&A activity broken down by sector shows that energy has the least appetite of the sectors with price compared to earnings down 10 percent, with consumer discretionary closely behind with price to earnings down 9 percent. By contrast, healthcare has the strongest M&A appetite of the sectors with the price to earnings ratio up 4 percent. Simpson went on to say: “Profit expectations for consumer discretionary businesses are extremely positive with a 20 percent increase but it’s perhaps no real surprise that pervasive uncertainty is dulling corporate appetite to put hard earned cash on the table for deals. While small and mid cap exploration and production continues to demonstrate opportunistic deal activity, the appetite for energy majors to contemplate large cross-border corporate M&A is being limited by strained balance sheets, uncertain economic and policy environments and a depressed commodity price outlook.”
“The only sector globally, which has both increasing capacity and appetite to do deals is healthcare. The largest healthcare companies have seen the largest increase in price compared to earnings of 4 percent (compared with energy at -10 percent). The increase in appetite is most pronounced in the Asia Pacific and North American regions. Our own client activity shows that the M&A market is proving resilient in the healthcare sector, with continued growth in demand for healthcare products and services around the world helping to support pricing, despite a backdrop of tighter government funding gradually pushing more of the cost of care on to the consumer in some regions. In pharmaceuticals, the patent cliff continues to be a factor for the drug majors in undertaking inorganic growth to ensure their future pipelines,” said Simpson.
Shawn McCarthy, Partner, Transactions & Restructuring, KPMG in Russia and CIS says: “The M&A Predictor is an interesting indicator of anticipated M&A activity globally; however its relevance as a broader indicator of Russian M&A activity can be a bit misleading. Historically, the performance of the 23 public Russian companies included in the Predictor index has illustrated positive developments including growth in profit, company valuations, and since the outset of the 2009 financial crisis, a continued focus on reducing overall debt and deleveraging operations. When combined with our proxy for measuring market appetite – the growth or decline of P/E Multiples – the index measures the relative interest from the largest Russian corporate to execute M&A transactions.
As of our recent iteration of the M&A Predictor study, Russian companies are projecting flat growth in net profits (2%), modest growth in operating profit (4%), and a significant reduction in net debt (-15%) in next 12 months – all indicators which illustrate an increased capacity to do deals from a financial perspective. Still, negative market sentiment and concerns over the stability of the Euro and Eurozone economies, and to a lesser extent, demand concerns in China, continue to impact investor confidence and valuations within emerging markets. The Market Capitalization of Russian companies in our index has declined 28% from a year ago today, as P/E (price-to-earnings) multiples and valuations have come down significantly in the last 12 months and are currently forecast to decline another 6% in the coming year. In part, this is due to investor sentiment that in turbulent, uncertain markets – emerging market equities, including those in Russia, are riskier, and thus are discounted as investors move to sell emerging markets and buy equities in more stable, developed markets. Though valuations in Russian public companies have declined, the index is largely comprised of natural resource, metals, and energy companies – sectors that have been directly impacted by lower commodity prices and weakening demand, particularly in China – and this has weighs significantly on the overall performance of the index. In spite of the decline in public company valuations, it is worth noting that we have not seen a relative decline in pricing on M&A deals, especially for transparent companies that show an established history of profitable growth.
Without a doubt, economic uncertainty in the Europe continues to impact investor confidence and weighs on M&A expansion plans, especially regarding investments in emerging markets that are perceived as being “riskier” investments. The decline in M&A activity extends into all global markets, and the Russian market was no exception: the number of transactions in the first half of 2012 declined from the same period a year ago (95 announced transactions in H1’12 versus 118 deals in H1’11; Source: MergerMarket). Though investors have generally become more selective in assessing acquisition targets, Russian M&A activity continues to be driven by the long-term strategic considerations on the part of both international and domestic trade buyers (strategic investors) looking to benefit in the growth of the Russian economy. Although economic instability in Europe would increase the conservatism of potential acquirers and impact liquidity within Russian financial markets, we expect that the Russian M&A market will be more resilient given the longer-term strategic interests of international trade buyers and an active domestic M&A market in Russia and the “near-abroad” CIS Market”.
© 2017 KPMG Audit LLC, the Mongolian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.