Optimism will breathe new life into M&A market

It would be an exaggeration to say that the mood in the
investment banking sector is optimistic; cautiously hopeful would be more
accurate.

After the loss of thousands of jobs and a truly horrendous first quarter, the
sense of doom has begun to lift and belief in an eventual recovery is starting
to take hold.

Despite a continuing stream of depressing economic news, the rally in the
equity market since the start of March this year has held steady. Among
corporate financiers, there is a hope that the equity market’s optimism is
bleeding through to mergers and acquisitions activity.

There have been a number of mega-deals this year, principally in the
pharmaceutical sector: in March, Roche paid $47bn for the 45% of Genentech it
didn’t already own, two months after Pfizer acquired rival Wyeth for $68bn.

But in the smaller echelons of the market that used to be awash with private
equity deals in the heady days of easy credit, there have been very few
transactions. Yet even here there is a sense that something is stirring.

Back from the dead
As James Stirling, director at Investec’s growth and acquisition finance
division, says, “The patient has gone from being completely dead to merely
comatose.”

Stirling’s view is shared by others in the market. BDO Stoy Hayward’s latest
quarterly survey showed there were 493 UK private company transactions in the
first quarter of this year, the same number as in the final quarter of last
year. “While the reduced volume of deals and prices remain a frustration, there
are reasons to be cautiously optimistic about the future,” says Christopher
Clark, corporate finance director at BDO Stoy Hayward.

The government’s attempts to restore normal lending practices in the banking
sector are beginning to have some impact, says Clark. “An increasing number of
blue-chip funds are actively seeking investment opportunities. While the banks
say they are open for business, it will take time for this to transform into
actual transactions. We do not expect the number of transactions to pick up
until the end of the year,” he says.

Stuart McKee, partner in the corporate finance practice at
PricewaterhouseCoopers, is another who shares this mood of cautious optimism.
“While the mid-market is still a market that is very much hamstrung by the lack
of availability of debt and the impact of the current economic environment,
there are reasons to believe that life will return.”

McKee’s reasons to be cautiously optimistic stem from a number of areas.
“Large companies are starting to carefully examine their businesses, looking to
make things simpler and more streamlined. In tough times, it makes sense to go
back to what you know best,” says McKee.

“This means there are a growing number of companies that are willing to sell
off businesses’ non-core units even though those businesses may be strong. In an
environment of uncertainty, strong businesses will sell much more easily.”

Some businesses are also increasingly willing to sell non-core activities to
provide the necessary finance to expand their core business areas, adds McKee.
And there are signs that buyers could be returning to the market.

“The debt markets are fragile, but they have stabilised and packages of debt
are starting to be put together. But lending is nowhere near the levels we saw
previously.”

When the collapse of the credit markets pricked the balloon of private
equity, conventional wisdom said that trade buyers which had been squeezed out
of the market by big-spending financiers would have a chance to buy the
companies they wanted at more reasonable prices.

But trade buyers have also stayed away from the market. “Businesses were
reluctant to sell; they felt their firms were being undervalued and companies
were reluctant to buy when they did not believe they had not reached the bottom
of the market,” explains McKee.

Bottomed out
There are signs, however, that the market bottom has been reached which should
prompt FDs looking to either sell or buy businesses to venture back into the
market.

“There is a view that the market will have bottomed out over the next six to
nine months. Not only do people feel that the equity markets have stabilised,
but there are some signs that the UK economy has also steadied,” says McKee.

But it’s important to emphasise that while most believe the worst is behind
them, hope remains fragile.

“We can now glimpse the light at the end of the tunnel,” explains McKee. “But
once we get to the end of the tunnel, we will not be travelling at 100 miles an
hour; it will be more of a slow stagger and it will take a long time to pick up
speed.”