PRINT THIS PAGE Top of the global M&A market 05/09/2007. Source: KPMG. 
KPMG Corporate Finance’s Global M&A Predictor suggests that global merger and acquisition activity is about to peak, and forecasts a fall in overall deal volumes this year. Although liquidity remains high, and deal values continue to rise, the firm expects global deal volumes in 2007 to be below those achieved in 2006, a year during which both average deal size and the number of deals hit record highs. The forecast, based on a detailed analysis of KPMG Corporate Finance’s Global M&A Predictor – a forward looking index of 1,000 leading companies’ net debt to EBITDA ratios and Price Earnings ratios [1] – reveals that pressure on the accelerator pedal has come off, as regards international asset prices, with 12 month forward PE valuations (the valuation ratio of share price to estimated earnings per share) increasing only marginally.[2]
KPMG’s research also highlights that significant cash and debt capacity remain[3]. However, a modest decline in deal appetite and confidence, rather than capacity or average deal value, is expected to prevail in the coming months.
KPMG Corporate Finance’s Global 1,000 M&A Predictor suggests that the current M&A cycle is about to peak, and believes that Dealogic's latest data, which shows increasing average deal size on lower volumes, indicates a "final hurrah" with fewer, but larger deals, being done. Importantly, due to the relatively sound market fundamentals and generally strong corporate balance sheets, KPMG believes that, in contrast to the steep dot-com collapse of 2000, the slow-down will be gradual.
Stephen Barrett, International Chairman, Corporate Finance at KPMG, comments: “Macro-economic fundamentals remain strong. However, the momentum, which delivered record M&A growth in 2006 is not likely to be sustained. Global activity is about to peak, certainly in terms of deal volume, and we foresee a continued fall in deal numbers during the course of 2007. Acquisitive companies will remain alive to the prospect of good assets, but they will be more cautious about the prognosis for extracting real value from targets during this ‘cooling off’ period for M&A, while increased attention to creating value through balance sheet restructuring will increasingly return to the CEO’s agenda.”
Forecast M&A Activity by World Region
KPMG’s Global 1,000 analysis shows that, in the first five months of 2007, there was a significant discrepancy between the key trend indicators of deal values and volumes. The last time the market witnessed this kind of ‘disconnect’ - where the average deal size rose, but the number of deals fell - occurred at the height of the dot com boom in 2000. A sign that the market is starting to cool came in H2 2006 when the total number of deals fell for the first time since H1 2003 (dropping 8 percent compared to H1 2006).[4]
KPMG’s analysis shows that the appetite for M&A transactions appears to be slowing, despite conservative balance sheets. Twelve month forward PE valuations rose marginally to 17.1x compared to 16.8x in both June and December 2006 which implies a restriction on the available “bid” premium in the marketplace. Balance sheet capacity remains conservative but has tightened marginally from 0.85 times to 0.91 times.
Of the major global regions, Europe remains the most positive in terms of potential M&A activity, due to rising PE momentum, while AsPac once again looks the weakest. The U.S. remains static in terms of valuation, suggesting the potential for a slow down.
In terms of sector regions, the best M&A prospects appear to reside in Utilities Europe, Basic Materials North America, Oil and Gas North America, Industrials Europe and Consumer Services Europe with the weakest prospects being Consumer Services AsPac and Consumer Goods AsPac.
Europe
KPMG’s analysis shows that Europe continues to exhibit the strongest M&A picture out of all the major global regions. Twelve month forward PEs for those constituents within KPMG’s Global 1,000 stood at 16.2x at the end of the first five months of 2007, some 7.3 percent above the 15.1x at the end of 2006. Net debt to EBITDA ratios for the region weakened slightly, from 0.8 times to 0.88 times.
By sector, Utilities are eliciting the most significant “activity” signals, with forward PEs up 12.7 percent to 19.8x. Net debt to EBITDA ratios in European Utilities remain typically among the highest of any sector and have deteriorated slightly from 1.44 x to 1.52 x. Industrials has also shown a strong tendency with PE’s up 10.9 percent to 17.7x, with net debt to EBITDA weakening slightly from 1.59 x to 1.65 x. Consumer Services and Telecoms were also strong (PE up 9.6 percent and 8.4 percent respectively). Oil and Gas was the weakest performer though balance sheets remain very strong with net cash, though this position has deteriorated during the past six months.
Commenting from a European perspective, Netherlands Corporate Finance Head, Jurgen van Breukelen, said: “The European market remains largely buoyant. The key difference between now and then, however, is the dramatic influence of private equity, which continues to hunt-down stable cash flow, attractive growth prospects and profitable companies. Private equity players are accounting for a greater volume of deals being done, but more importantly average private equity deal size is increasing, with the likes of Carlyle and Blackstone highly prominent in Europe”.
He continued: “Market buoyancy is of course supported by an efficient debt market. Liquidity remains good, enabling highly-leveraged deals to be undertaken. Sector wise, deal activity is strong right across the board - with Utilities hitting the headlines due to the scale of the transactions. But there is lots of activity in other previously ‘new economy’ sectors such as ICT and Media, which are all now very profitable.
“Naturally, the sheer scale of M&A activity is putting pressure on asset prices, and deals from private equity players are increasingly impacting on quoted companies. At the same time, activist hedge funds are beginning to tinker with quoted companies, ensuring a squeeze on their public status”.
The Americas
The U.S. traded sideways in terms of valuation with an almost unchanged forward PE of 17.9x, slightly up from 17.7x six months ago. Similar to Europe, balance sheets remain robust though have deteriorated with net debt to EBITDA ratios of 0.82 times to 0.96 times.
Within the region, the most positive sector is Oil and Gas with forward PEs rising 13.6 percent from 11.7x to 13.3x. Balance sheets remain strong at 0.41 times indicating that this represents the comparatively hot sector going forward. Telecoms is close behind with forward PEs rising 11.2 percent from 15.7x to 17.5x, though net debt EBITDA ratios have deteriorated to 1.41 times. According to Dealogic data this is the fourth consecutive drop in deal volumes.
Most other sectors within the U.S. remain relatively stable, though Healthcare has experienced negative developments in forward PEs from six months ago (down 4.1 percent to 17.7x).
Commenting on M&A prospects in the Americas, KPMG Americas Corporate Finance Head, Peter Hatges said: “Liquidity in the market is still good so the ability to get deals financed remains high, fuelling M&A activity in North America. A lot hinges on the recovery for North American Auto Original Equipment Manufacturers and the impact it could have on the significant parts suppliers throughout the continent. Consolidation in the auto parts industries is expected to pick up pace. Furthermore, competitive global pressure on North American manufacturers has put significant pressure on CEOs to reach for increased economies of scale and penetrate new markets, which should support M&A activity in the medium term.
“North of the border, there may be a more robust picture. A large part of Canada's ever-popular income trust sector was halted last year by proposed changes to the Canadian Income Tax Act causing many of these mid-size public companies to evaluate their strategic options and participate in significant M&A activity. There are 250 income trusts in Canada with a market capitalization of approximately US$200 billion. Energy and resource companies are still expected to remain strong as world commodity markets experience strong growth from growing global demand”.
Asia Pacific
Asia Pacific has continued to experience a valuation decline, down a further 4.9 percent to 17.0x, compared to 17.9x as at the end of December 2006 and 18.9x as at the end of June 2006 continuing to suggest an “easing” of potential M&A activity. Contrary to North America and Europe, its balance sheet has strengthened with net debt EBITDA falling from 1.0 times to 0.97 times. Furthermore foreign direct investment in Asia is expected to remain strong, particularly China.
The biggest “fallers” contributing to valuation weakness and therefore falling appetite for deals in the region are Consumer Services and Oil and Gas. Consumer Services forward valuation declined 8.7 percent from 22.5x to 20.6x, with Oil and Gas forward PE down by 7.1 percent from 12.4x to 11.5x. Only telecoms remained “warm” with forward PE’s up 9.4 percent to 17.5x with net debt EBITDA remaining modest and 0.34 times.
Commenting on M&A prospects in the Asia Pacific region, KPMG Australia Head of M&A Robert Bazzani said: “Global findings show the number of deals falling for the first half year period since H2 2002, and forward valuations have now been static for four consecutive half-yearly periods. “However, fundamentals still look sound in the Asia region. Overall, interest rates remain low and show no signs of any significant increase - the debt markets are highly competitive although with recent signs of tightening. Currencies remain robust and the booming regional resources sector with demand driven commodity pricing is not expected to slowdown any time soon. However, while our data shows that valuations (forward PE) in the region remain high, they have declined markedly. Any fall off in the "price paid" by the market for earnings streams could signify an easing in the appetite for assets at perceived inflated levels”.
KPMG is a global network of professional firms providing Audit, Tax and Advisory services. We operate in 148 countries and have 113,000 people working in member firms around the world.
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