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KPMG’s Global M&A Predictor: Global deal activity set to hit bottom in Q2/Q3 of 2009

KPMG Corporate Finance’s Global M&A Predictor forecasts that 2009 will see a continued fall in global mergers and acquisitions (M&A) but that deal activity should slowly return late in the year as liquidity improves and attractive value is recognised in certain sectors.

The latest Predictor reveals a significant fall in 12-month forward corporate valuations and therefore appetite to do deals (down globally 22.2 percent from 15.3x end May 2008 to 11.9x at the end of November 2008). Forecast Net debt to EBITDA ratios have moved from 0.93 times to 1.06 times, a 13.5 percent deterioration, signaling a decreasing capacity to do deals.

Alex Verbeek, CEE Chairman of KPMG’s Corporate Finance, commented: "Findings from our latest Predictor confirm our view that 2009 will be a bad year for M&A activity. We expect global deal volumes to continue to fall through to Q3. With less liquidity in the market and reduced availability of debt, appetite and capacity for doing deals will continue to decline."

"However, our analysis of the results of KPMG’s Predictor, coupled with historic M&A cycle trends, leads us to believe that the corner may well be turned late in the second half of this year. I believe that those people who ended 2008 feeling tired and disappointed from endless bad news stories, have started the New Year with a desire to kick-start the deals market. This will be facilitated by the opportunities which will inevitably emerge for value investors in certain regions and sectors.

I also believe that the market players to watch will be those able to execute cash deals - such as companies who have preserved cash funds; some sovereign wealth funds; and private family offices. Within 12 months, we will start to see some clear signals of a slow, but purposeful, recovery in the M&A transactions marketplace. A reliable indicator that this time has arrived will be when quality assets come on the market and go for reasonable, rather than fire-sale, prices."

When KPMG’s Predictor of June 2007 called the top of the M&A market, the latest peak in global deal activity was followed by a significant decline in the average value in deals. The January 2008 Predictor then provided compelling evidence of a decreasing appetite for deals and a deterioration in the capacity to do deals across all regions and all sectors.

This latest Predictor indicates that by Q2/Q3 of 2009 the point will come where deal appetite will improve as cash-rich investors find it hard to resist the very low valuations in the market. This forecast pick-up in M&A activity, may provide one of the positive indicators needed by economic commentators if they are to signal an upturn in the broader economy.

Alex Verbeek continued: “While this M&A downturn is different from previous ones in character, I think we can draw some parallels between the current situation in the deals market and how we emerged from the last big deals recession in the early 1990s. I am feeling very optimistic that we will see a similar pattern emerge this year and next. By the close of 2010 we will be able to put this M&A downturn behind us and look forward to a sustained recovery in transactional activity. In my view, the global M&A marketplace will be back in business.”

Forecast M&A activity by world region

• For the first time, the Predictor indicates a declining valuation trend in all regions of the world (see Figure 1)demonstrating the global decline in M&A activity.
• As last time, the region which had the biggest drop in valuation was Africa and Middle East (PEs down 31.6 percent from 13.3x to 9.1x).
• Latin America had the second largest fall (28.7 percent from 16.1x to 11.5x) followed by North America (24.6 percent down from 15.9x to 12.0).
• In contrast to the last Predictor in which Europe experienced the second largest fall, six months on, Europe saw the second smallest fall (21 percent from 13.5x to 10.7x) behind Asia Pacific down 19.9 percent from 17.0x to 13.6x.

Although the capacity to do deals (see Figure 1) has decreased with the global forecast Net Debt to EBITDA ratio moving from 0.93 times to 1.06 times, some regions have seen an improvement in their balance sheets.

• Latin America and Africa and the Middle East bucked the trend and both saw improvements of 3.2 percent and 35.7 percent respectively with Africa and the Middle East ratio of 0.33 times, the most modest of all.
• Europe maintains its position as having the highest regional ratio of 1.15 having moved from 0.97 times, a deterioration of 19.0 percent.
• The ratio that saw the greatest decline was Asia Pacific at 28.1 percent and now stands at 1.14 times.
• North America saw the smallest decline from 0.94 to 0.95 times.

Looking at prospects in Europe and the Americas, Alex Verbeek commented: “Whilst the Americas and Europe have all witnessed significant falls in forward PE ratios, balance sheets remain robust in North America and Latin America, suggesting that some corporates will remain in a strong position should value enhancing acquisitive opportunities arise. Within Europe however, balance sheets have deteriorated by 19 percent, implying that these companies are increasingly less likely to execute deals in the near term.”

CEE and the Czech Republic

The CEE and the Czech Republic will see a similar dramatic fall in deal activity.

Alex Verbeek commented: “In the past 3 months we have seen several almost finalised deals falling through at the last moment. This has been due to a combination of factors. On the one hand it has been very difficult to obtain bank acquisition financing and the other hand potential buyers are waiting for prices to come down further.

In terms of bank financing it has been extremely difficult in the past few months and this is expected to continue. If banks are already willing to provide finance in this market, then only at significantly increased interest margins (several hundreds of basis points) and at extremely low leverage. As what may seem a paradox, this shortage in debt availability is also likely to lead to new deal activity. Companies that are currently short term financed and need to refinance or companies that may come in breach of debt agreement covenants as a result of the economic crises, may be forced to sell assets. This will provide good opportunities for cash rich investors.

The impact of all this will very likely also be seen on the privatisation of CSA and Prague Airport. Even such strong assests will likely attract less potential buyers and will be sold for less.”

Forecast M&A Activity by Global Sector

The Predictor has shown a decline in forward PE valuation across all sectors, with Technology (18.4x to 12.6x), Basic Materials (13.8x to 9.6x) and Industrials (15.5x to 11.1x) registering the most significant deterioration.

Unlike the previous Predictor, Oil & Gas fell significantly (11.8x to 8.6x) along with Telecommunications (14.1x to 10.8x) Consumer Services (17.0x to 13.5x) and Health Care (15.5x to 12.5x). The smallest decline was the Consumer Goods sector (16.2x to 14.6x).

Utilities and Industrials continue to maintain the highest debt ratios, with net debt to EBITDA at 2.68 times and 2.27 times respectively. The Technology sector continues to show net cash which reflects a traditional balance sheet structure for this peer group but Health Care has moved from a net cash position to one of net debt.

Contrary to the last Predictor, the Net Debt to EBITDA ratio for Oil & Gas has weakened from 0.34 times to 0.48 times (though O&G retains the strongest balance sheets of all sectors bar Technology and Healthcare), a reflection of the falling oil price estimates, whilst Consumer Services has improved from 1.21 times to 1.10 times.

No sectors/regions have shown improvement in both valuation and balance sheet capacity in the last six months, providing evidence that all sectors and regions have seen a decrease in both appetite and capacity.

The biggest drop in forward PEs was witnessed by Industrial Africa & Middle East (17.9x to 7.3x) followed by Basic Materials Latin America (14.2x to 6.9x) and Health Care Latin America (17.4. x to 9.0x).

The sectors/regions with the greatest balance sheet deterioration were Technology Latin America (0.19 times to 0.34 times), Consumer Goods Europe (0.84 times to 1.49 times), Oil & Gas AsPac (0.39 times to 0.63 times) and Oil & Gas North America (0.31 times to 0.49 times).

Notes to Editors:

KPMG’s Global M&A Predictor tracks 12 month forward Price to Earnings (PE) multiples and estimated net debt to earnings before interest, tax, depreciation and amortization (EBITDA) ratios to track and establish the potential direction of M&A activity.

KPMG’s Global 1,000 comprises 1,000 of the largest companies in the world by market capitalization, with a representative weighting of countries and sectors, to help ensure appropriate inclusion. A Global 1,000 panel of KPMG firms’ professionals sits every half-year and reviews the constituents of the index to seek to ensure that it remains reflective of global changes in regional and sector weightings.

The data is sourced from FactSet, the corporate earnings estimates data provider. KPMG calculates 12 months forward PE ratios (expressed as a multiple) for each qualifying company of the 1,000, and aggregates these into regions and sectors to aid comparison. This valuation tool is used due to its transparency, the ready availability of data and widespread acceptance in the investment community. Our PEs test for “paper capacity” i.e. the relative ability of companies, sectors and regions to originate deals using shares only.

Net debt to EBITDA is calculated using estimates from FactSet, again by each company in our 1,000, and is a respected ratio that indicates capital structure and financial gearing. This ratio tests for “debt capacity” – that is, the relative ability of companies, sectors and regions to originate deals using debt only.

By comparing both sets of forward looking ratios, with sectors and regions weighted by market capitalization, KPMG’s Global M&A Predictor attempts to identify changes over time that could imply trends in appetite for deals and indeed capacity for deals. It also attempts to compare and contrast sector regions to highlight possible areas of deal flow. (Note: Net debt/EBITDA ratio calculations are considered not relevant (for the Predictor’s purposes) in the financial services and property sectors. These sectors have therefore been excluded from this analysis.)