2013: Prospects for global M&A

Adam Whitfield on the mergers and acquisitions that might happen this year

Last year brought us the US presidential elections, the fiscal cliff and continued eurozone woes and, as a result, it was hardly plain sailing for mergers and acquisitions. Despite generally strong balance sheets and low rates of borrowing, many companies chose to stall any plans to expand through mergers and aquasitions (M&A) as uncertainty hovered over the world economy. And it shows: M&A activity was down 11 per cent in 2012 from 2011, regardless of a sharp rebound in the last quarter. So are there likely to be many deals in 2013, and in which sectors?

Energy

The total value of M&A in oil and gas rose to a record $402 billion (£259 billion) in 2012, as oil production boomed in North America, the number of unconventional sources of energy continued to rise, and Chinese firms persisted with their search for technological know-how.

Cash-rich Chinese corporations like CPC Corporation and Cheung Kong Infrastructure have led a mass flow of mega deals over the past couple of years. Since the beginning of 2011, energy and resources have accounted for more than 70 per cent of all outbound deal activity from China. There's more to come too, as CNOOC's planned $15.1 billion acquisition of Canadian energy producer Nexen Inc. looks set to go through in the coming weeks.

The words "shale gas" will be popping up in boardrooms of energy corporations all over the world this year, if they're not already. But doubts hang menacingly over the environmental implications of extracting it. Bulgaria joined France last year in banning "fracking" - the most common method of releasing the gas. Nonetheless, the chances of seeing considerable M&A activity in energy companies involved in shale gas extraction over the next 12 months are high, and growing.

If oil prices continue to remain relatively stable, regulation on nonconventional energy sources stays generally loose, and the BRIC economies continue to hunt for increased resource security, don't be surprised to see energy forcefully retain its title as the biggest contributor to worldwide M&A in 2013.

Mining

Although the mining sector struggled through 2012 in a turbulent environment of slow growth and volatile prices, there was talk of one potential deal that could change the industry: the long-awaited merger of Glencore and Xstrata. It's been hailed as the largest mining transaction ever, and it's hoped that it will spur on the ambitions of other big resource corporations. The likes of BHP Billiton and Vale are holding hefty reserves thanks to sturdy profits through the post-crisis period, and might see M&A as a way to protect themselves against a beefed-up Glencore/Xstrata combo.

As with the energy sector, growth in emerging markets is a considerable buy-side driver, and will continue to be, despite recent growth setbacks in China and Brazil. African frontier nations were a significant target for the big corporations in 2012, with Africa the second most active region for mining M&A deals, despite the risks of political instability and civil wars that are often come with investment in the continent.

On the sell-side, with funding relatively scarce for smaller companies, merging with a larger player is a good way to finance expansion in a market that continues to scrap for scarce resources.

However, there are some factors that could hinder deal activity in the mining sector this year. According to research by Ernst & Young, resource nationalism - where governments assert control over natural resources - is the biggest risk facing mining companies in 2013 as cash-strapped governments look to increase their takings from the sector.

But as non-core asset disposals rise and valuations remain low, there will certainly be attractive M&A opportunities in the mining sector in 2013. But with confidence still down and funding scarce, we should keep an eye on lower risk activity; look towards joint ventures and minority holdings for this year's biggest plays in mining.

Technology

The constant innovation that defines the technology industry and drives it forward is also propelling M&A in the sector. The dynamic technology middle market has been the shining star of recent years, as big corporates like Apple, Google and Microsoft look to gain control of valuable patents before their value is fully realised. According to some estimates, the top ten global technology companies currently have $300 billion in cash waiting to be deployed.

Unsurprisingly, the technology with which we have all become so familiar over recent years is also driving dealmaking: social networking, mobile phone services and cloud computing are all top of the pile, as companies look to take advantage of the considerable growth prospects here. If, as expected, an abundance of potential divestitures appear in 2013 as companies look to sell off assets they think are past their sell-by date and concentrate on what they see as new avenues of growth, valuations should also fall, propping up activity.

The technology sector isn't all good news though; the dynamic nature of the industry can also pose substantial risks. Ideas that were once new and upcoming are often devalued massively and quickly through rapid change and innovation. This creative destruction has never been more ominous than it is now. What's more, expect chief executives to be behaving cautiously - HP's $8.8 billion write-down after its acquisition of Autonomy in 2011 has served to highlight how disastrous a badly-worked deal can be.

Historically though, the technology sector has consistently outperformed the rest of the market when it comes to M&A. Silver Lake and Microsoft's $24 billion takeover of struggling PC maker Dell, as well as Lenovo's reported interest in Blackberry, could set the tone for the rest of the year here. Look out for technology in 2013.

Retail and consumer

The retail and consumer sector outperformed the rest of the market in terms of dealmaking last year, but only just. Activity was driven, in part, by an increased focus on different channels of marketing and distribution as firms look towards e-commerce and mobile sales amid fears that the high-street marketplace is becoming obsolete. HMV's recent collapse is a prime example of how devastating the effects of a too slow response to an increasingly digital era can be.

Consumer sentiment here is improving too. Recent surveys in the eurozone indicate increases in confidence, while improving jobs figures and a recovering housing market are helping to sustain buoyancy in the US. What's more, it looks as if investment in retail into and out of emerging markets is due to increase. India has liberalised its retail market to allow multinational retailers to operate there, while the relaxation of strict capital controls in China should lead to increased inflows here too. In terms of outbound investment, China's growing appetite for strong European brand names isn't showing any signs of deceleration; between 2005 and 2012, the world's second largest economy invested $75 billion into western Europe, mostly in the last 2 years.

But there is one monstrous question mark pointing straight at the consumer and retail sector. Yep, you guessed it: the eurozone situation. Despite the EU's current eerie economic calmness, instability here has the potential to viciously disrupt activity not just locally, but worldwide. If things deteriorate, we could see the hunger for European retail and consumer companies dwindle rapidly.

But provided the macroeconomic environment doesn't give us yet more surprises this year, expect a bumper year for consumer and retail M&A, propped up primarily by cross-border activity into the eurozone.

Overall sentiment

There are plenty of reasons to be confident about M&A in 2013. Deal volumes in the final quarter of 2012 (not shown on the chart above) jumped to a four-year high and, with the American presidential election out of the way and America's fiscal can kicked down the road for a while longer, activity across the pond looks promising. Three big US deals have already provided optimism: Berkshire Hathaway's joint venture with Brazilian private equity firm 3G to acquire Heinz in a $28 billion deal, Liberty Global's £15 billion bid for Virgin Media, and the aforementioned Dell deal are bolstering investment bankers' hopes that 2013 could herald the return to pre-crisis M&A levels. While we shouldn't expect a smooth journey to recovery for the eurozone, prospects are certainly better than they were in this period last year and, while uncertainty still plays on the minds of many, valuations in the eurozone should remain low, presenting high-quality strategic opportunities for those willing to risk embarking on a deal. But the opposite problem has plagued many companies around the rest of the world: with a lack of high-quality opportunities available, valuations of attractive companies have been pushed skywards. If more good opportunities present themselves in 2013, expect to see valuations fall here, followed by a sharp increase in dealmaking.

However, there are signs that point towards yet more negativity in M&A in 2013. In mid-January, we saw the resignation of Rio Tinto chief executive Tom Albanese after the mining giant was forced to write down $14 billion of assets following its purchase of Canadian aluminium producer Alcan. Last summer, Microsoft announced it was facing a write-down of $6.2 billion after its $6.3 billion acquisition of advertising company aQuantive. Cases like these show how risky M&A can be, and mean it's not unreasonable to wonder whether increasingly conservative shareholders and worried chief executives might dampen dealmaking spirits this year.

All things considered, 2012 was generally a year of delaying when it came to M&A. Many corporates chose to devote their huge balance sheet reserves to paying off pension schemes, increasing share buybacks, (uP07) or handing out dividends. But that trend can't continue forever. Companies will need to start turning towards growth again and, with general confidence improving by the day, don't be surprised to see a bumper year for M&A in 2013.

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