Strategic deals and “mergers of productivity” to drive M&A in 2010

Difficulties accessing capital ease while middle market challenges accelerate

Add-ons remain focus of private equity transactions

NEW YORK – DEC. 16, 2009 – There have been signs of life in the deal market during the second half of 2009, and mergers and acquisitions (M&A) activity is expected to pick up in 2010, according to PricewaterhouseCoopers’ (PwC) Transaction Services practice. While credit markets are easing for some participants, financing will remain the dominant challenge to M&A activity next year, increasing the pressure on middle market deals. Strategic buyers with strong balance sheets and robust cash reserves will be well-positioned for strategic M&A opportunities. As these strategic buyers take advantage of their ability to maneuver in the face of a challenging deal environment, PwC predicts they will pursue deals with a focus on synergies - including enhancing productivity, providing cost-savings and adding revenue volume to their businesses.

"Those who have built their balance sheets for a rainy day might come out of last year’s storm to find the rainbow, and at the end of it, nicely-valued acquisition targets that provide opportunities for revenue growth and enhanced productivity,” said Bob Filek, Partner with PricewaterhouseCoopers Transaction Services. “As a result, M&A activity in 2010 will be driven by strategic buyers who have access to capital and the strategic vision to capitalize on some of the best values we have seen in recent times.”

"Companies have taken aggressive actions on costs; the low hanging fruit is gone, and to drive further efficiency they will look to combine with similar players to drive scale and enhance productivity. The ‘merger of productivity’ will be a driving force in 2010 as companies look to drive revenue growth and enhance margins," continued Filek.

Through the first eleven months of 2009, there were 6,772 deals worth a total of $614 billion, compared with 8,890 transactions worth a total of $1 trillion during the same period last year, according to financial data provider Thomson Reuters.

The credit freeze has impacted transactions across the board, including private equity (PE) and middle market transactions. The number of private equity acquirers in year-to-date November 2009 was down by 32.7% to 1,171, while value dropped by 21% to $146 billion from $184 billion over the same period in 2008. In the middle market, deal volume declined by 45% to 261 from 480 in 2008.

“There is still in excess of $1 trillion of capital committed to alternative investment funds sitting on the sidelines, waiting for the appropriate opportunities. The diversified private equity players have been bulking up their debt, hedge and distressed funds to take advantage of opportunities in distressed, reflecting their ability to evolve and successfully navigate choppy waters,” said Greg Peterson, Partner with PricewaterhouseCoopers Transaction Services.

Regarding private equity exits, "we expect to see more IPOs coming to market in 2010 from private equity as the markets continue to firm up," noted Peterson. More the half of the IPOs completed during 2009 were by financial sponsor-backed (primarily private equity) companies, a trend expected to continue through the remainder of 2009 and 2010.

“Financing is the main factor contributing to the instability of middle market deals. With so many traditional sources of lending now unavailable, including the rapidly increasing number of banks being shuttered by the FDIC, it remains a challenge for some companies and dealmakers to find capital,” continued Peterson.

The divestitures market will also be a factor in fueling deals, as more companies decide to rid themselves of holdings they don’t consider to be part of their core business. A recent PwC Transaction Services survey, “Doing divestitures in difficult times,” concluded divestiture activity was poised for a higher level of activity in the next twelve months, especially among corporate buyers. Of the survey respondents, 69% anticipate similar or increased divestiture activity in the coming year. The percentage of M&A activity contributed by divestiture transactions has begun to increase in recent months, suggesting this is already taking place as 2010 quickly approaches.

Sectors that continue to present opportunities include:

Consumer Products -- As retailers continue to pressure margins and growth through private label strategies, consumer product companies are accelerating trade spend at the expense of margins. Watch for high-profile combinations as branded companies look to gain scale and negotiating leverage with retailers, while enhancing their scale to drive productivity. A focus on high-growth categories and emerging markets will also be in vogue in 2010.
Technology -- The headline transactions of the past year - transformative deals - will continue as the battle over the data center and end-to-end services continues to drive the larger players. The large, mature players will also continue to absorb smaller companies who provide intellectual property that can be leveraged - at an array of multiples - as some will be seen as desirable by multiple players and others are made attractive by a higher bar to access in the public markets. At the other end of the scale, there is more consolidation to come amongst weaker players, especially in semiconductors.
Energy -- The opening of the capital markets window (both debt and equity) will pave the way for increased M&A activity in 2010. The seller/buyer expectation gap is slowly narrowing. Large-cap exploration and production companies and Master Limited Partnerships have strengthened their balance sheets considerably and are ready to fuel growth again via the M&A route. PwC expects natural gas to continue to be a particular bright spot for acquisitions.
Financial Services -- As the FDIC continues to take actions with troubled banking institutions, watch for consolidation among the regional banks at the hands of the FDIC to be a key theme of 2010. One key question is if private equity will take more seats at the banking deal table. PwC expects the asset management sector will also continue to be popular in this space.
Automotive -- With the US automotive industry remade, it will be time for the suppliers to resize and adjust their business models to the new paradigm. Watch for a realignment of product portfolios and manufacturing footprints as tier-one suppliers adjust to the new reality. Low-cost country sourcing will be a continued theme, while Asian acquirers may start to acquire more US-based assets.
Healthcare -- Once healthcare reform has run its course, look for the industry to ratchet up M&A activity. Consolidation will accelerate in the services, managed care and pharma sectors, driven by the need to reduce costs and increase productivity. Watch for seasoned leaders to embark on new ventures to shake up the business-as-usual model. The pharmaceuticals sector will continue pursue smaller acquisition targets, and explore areas less dependent on government, such as consumer product applications, animal health, vaccines, and biologics.
Entertainment and Media -- Despite a sluggish economy, the Entertainment and Media sector still managed to pull off several high-profile entertainment deals in the second half of 2009. Look for strategic buyers to focus their efforts on content- and distribution-oriented acquisitions, both domestically and internationally, in response to favorable pricing in the market, as well as continuing to explore new media opportunities.

Other factors influencing M&A activity in 2010 may include the following scenarios:

Private equity’s ability to exit through Initial Public Offerings (IPOs) or acquisitions -- The IPO market has been re-established as a viable exit vehicle for private equity investments. IPO activity in Q4 of 2009 is expected to be the strongest quarter since 2007, with PE-backed deals contributing the majority of the volume in this deal channel. Assuming the equity markets do not experience a significant correction, PwC expects IPO activity to continue to increase in 2010.
The “Wild Card” -- How much would an economic double-dip rain on the M&A party? "We see continued weakness in key fundamental indicators, not the least of which is consumer demand," said Filek. "However, while we may see some challenges and market disappointments in 2010, the underlying fundamentals will outweigh the short-term stress, and companies will stay committed to their strategic vision and complete a lot of transactions in 2010."

• • •

How accurate was the PwC Transaction Services 2009 M&A forecast?*

Troubled companies will look to align with larger, stronger players in order to survive, creating the perfect storm for mergers of necessity

Correct. 2009 saw patient buyers take advantage of favorable pricing to achieve their strategic goals.

Innovation will be a key for private equity to evolve as an industry in 2009.

Correct. Private equity firms have succeeded in getting creative to gain control of businesses through nontraditional means. Taking control of debt positions became a tool of choice by private equity to gain control of a company.

The new administration and the stimulus plan would generate opportunities for both private equity and corporate buyers in healthcare, technology and energy.

Too early to call. We may have overestimated the speed to which the stimulus would flow into the economy. We’ll see what 2010 holds.

More traditional consolidation will drive results in financial services in 2009.

Partially correct. There were some consolidation plays in banking and asset management; however, overall deal value was not significant related to recent years. The FDIC-assisted bank deals led the stats in terms of numbers.

Automotive and oil & gas M&A activity will remain quiet.

Correct. M&A activity was stagnant in these industries.

Emerging markets will lead us out of the slump in deal activity with Brazil, India and China as the key regions of focus for those who sat on the sidelines over the last five years.

Partially correct. It was certainly true for the equity markets in these regions. The jury is still out on the extent of emerging market M&A.

*The accuracy of the PwC Transaction Services previous forecast does not guarantee future accuracy.

About PricewaterhouseCoopers Transaction Services Practice

The PricewaterhouseCoopers' Transaction Services practice provides due diligence for M&A transactions, along with advice on M&A strategy and integration, restructuring, divestitures and separation, valuations, accounting, financial reporting, and capital raising. With approximately 1,000 deal professionals in 16 cities in the US, and a global network of over 6,000 deal professionals in 90 countries, experienced teams are deployed with deep industry and local market knowledge, and technical experience tailored to each client's situation. The Transaction Services team can be involved from strategy to integration and employ an integrated business approach to uncover the realities of a deal. The field-proven, globally consistent, controlled deal process helps clients minimize their risks, progress with the right deals, and capture value both at the deal table and after the deal closes. For more information, visit www.pwc.com/ustransactionservices.

PricewaterhouseCoopers (www.pwc.com) provides industry-focused assurance, tax and advisory services to build public trust and enhance value for our clients and their stakeholders. More than 163,000 people in 151 countries across our network share their thinking, experience and solutions to develop fresh perspectives and practical advice.

"PricewaterhouseCoopers" refers to PricewaterhouseCoopers LLP or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

# # #

Joe LoBello / Jo Anne Barrameda
Brainerd Communicators, Inc.
+1(212) 986 6667
lobello@braincomm.com
barrameda@braincomm.com