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COMMUNITY UPDATE

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Coming off the heels of 2009 where the mergers and acquisition market was relatively flat, does the news of Kraft’s continued attempt to acquire Cadbury signal a boon for the M&A market in 2010?
 
There is no doubt that fear is still pervading corporate decision-making, but is this fear causing organisations to miss out on good acquisition opportunities? Experts agree that although the economy still seems to be on shaky ground, the outlook for M&A is looking up. 
 
“Times may be tough but companies will still be looking for growth so there's bound to be increased speculation in the coming year about potential consolidation and M&A activity. The focus, though, will be on whether or not the deals deliver real long-term strategic value over and above some obvious short-term synergies,” says Stephen Pain, Chairman, Advisory Board, The Group.
 
Carlos Keener an M&A expert and Founder of Beyond the Deal, a consultancy specialising in merger and acquisition integration, contends that 2010 will see growth in the market: “Barring further market or economic shocks, 2010 is likely to be a year of cautious consolidation. We’re already seeing a marked increase of completion of deals postponed from 2009, and many of our clients are expecting to restart or accelerate their acquisition plans as the year progresses. Nevertheless, this does not mark the return of the optimistic acquirer.” 
 
The beginning of this new year seems positive, with stock markets on the rise, an upturn is likely. “M & A activity volumes tend to follow the stock market and mirror the economic cycle. This means, of course that most deals are done at the top of the market and at rich multiples,” says Tony Cowling, Associate, Criticaleye. “So, with the FTSE edging up, and GDP growth off the bottom we should expect a little more activity in 2010. But since business pick-up and confidence lag the FTSE plus the prospect of a newly elected Government that may introduce tough tax and/or spending measures in the second half of the year, I fear most UK companies will not be brave enough to open their wallets this year.”
 
It will take courage and initiative on the part of management teams and organisations to instigate deals in such a market. Thras Moraitis, Executive General Manager Group Strategy and Corporate Affairs, Xstrata plc asserts: “This is a period of great uncertainty and executive teams, in general, may be reticent to push the button on M&A which impacts their gearing levels, as the risks of a double-dip in the Organisation for Economic Co-operation and Development (OECD) countries still remains – especially as fiscal stimulus is withdrawn. However, on balance, I would expect M&A activity to increase as more adventurous management teams seek to improve the competitive position of their companies into the upturn by pre-emptively accumulating a set of unique assets and market positions.” 
 
Although the market is gearing up for more deals in 2010, it will take years before it is buoyant again. Scott Moeller, Director, M&A Research Centre, Cass Business School explains: “After a tough year for M&A, especially on fees paid to advisors, 2010 looks to be a year when the market will turn and there should be more deals announced than in 2009.  This will likely mark the start of a slow climb from the bottom of the market set in late 2008 and 2009, but it will be a few years yet before confidence returns to boardrooms for a robust new wave of deals.  In 2010, we project that there will continue to be more activity within markets (domestic deals) and few of the more risky cross-border mega deals.”
 
Much unlike the massive deal Kraft is trying to undertake with Cadbury Martin Graham, Former Director of Markets and Head of AIM, London Stock Exchange, believes that it will be the small to medium sized businesses that will see the most movement: “Last year saw a real recovery in larger company equity valuations and 2010 will certainly see a significant uptick in M&A activity as companies make use of higher valuations on an opportunistic basis.
 
“In the smaller company arena the signs are that we will see a plethora of activity. I think this will be driven by a number of aggressive consolidators taking advantage of the large number of distressed competitors currently trading at attractive valuations.”
 
The end of a downturn can be the ideal time to purchase companies. But the ideal is not always the case and many companies are still hedging their bets as 2010 begins. Siva Shankar, Director of Corporate Finance, SEGRO plc explains: "The latter stages of a downturn and early stages of recovery can be ideal for delivering significant value creating M&A deals, and such well timed consolidation activity could be a key differentiator between the ‘winners’ and the ‘also rans’ of the next decade.  While this significantly increases pressure on organisations to strike 'great' deals in 2010, some of the basics of delivering value adding deals should not be compromised: very thorough due diligence (you can never do too much DD as you dig into the underlying layers of the target), careful selection of advisors, a robust and credible integration plan (devised before completion, and not after deal completion), and giving critical attention to the people side of business combinations."
 
Tony concurs: “In my experience the best time to make an acquisition or merge is, as with buying stock, at the bottom of the market. However, contrary to buying shares, buying companies has a number of benefits which make the decision easier to make, including:
The stock market getting up off it’s bottom is itself an indicator that it is worth prospecting for deals.
The likely price and multiple will be lower, of course.
Usually the acquisition gives you a boost in sales (the most precious of assets in a downturn).
Often you acquire a more co-operative and pliable workforce, than you would if you had bought at the top.”
 
Although it may be a good time to investigate potential targets, as in 2009, it will be the banks who will determine which companies will be making acquisition. Carlos says:   “Acquisitions will continue to take longer than before as boards and investors continue to insist on hard evidence of achievability, and longer-term sustainability, of deal benefits; and as expectation gaps on price impact negotiations. 
 
“If the recovery remains slow and fragile, and banks continue to be selective in their lending practices, many of yesterday’s distressed targets will soon become today’s desperate sellers, increasing the risk of a buyer paying peanuts, but acquiring a ‘walking dead’ business with serious operational or management issues; this can end up dragging the acquirer down post-close. As the saying might go, ‘acquire in haste, repent at your own expense post-close’.”
 
It is this limited access to financing that will force companies to become more imaginative in the way that they will do deals. Thras asserts: “Within a context of some remaining uncertainty, less available acquisition finance and equity markets which are anticipating the recovery, M&A will require greater creativity than was the case in times of freely available low-cost debt. For example, share-for-share transactions and joint-ventures/alliances are likely to become more popular, as attempts to create options to complete acquisition at a time when there is more certainty and improved access to finance, for example, by acquiring ‘blocking stakes’ in desired targets. This will be an interesting time for companies with strong credit ratings, as they will have preferential access to debt finance and could move further ahead of competitors for whom debt markets are still relatively closed.”
 
Martin Balaam, MD, BT Engage IT concurs: “Most businesses have now restructured both their operations and balance sheets and have the energy to start to be looking forward strategically. I would expect that those with access to funds will be seriously looking at acquisition possibilities as the target companies will be showing what their real trading is during the recession and valuations will be much more realistic, though I expect valuations to start to creep up during 2010 as demand increases.
 
“My view is also that as companies financial performances stabilise in the recession the funding will become available to them for M&A activity. This will be both on their balance sheets and on the acquisition targets balance sheets.”
 
Tony gives some sombre concluding comments: “Those who have sought and bought in the trough should benefit in 2011 and beyond; but as for 2010, expect UK companies to be more the hunted than the hunters.”

If you are interested in today's topic we have a number of articles and papers on M&A in the 'Insights' section of the website. In the Write-up Sharpening M&A performance in a declining market Carlos Keener advises on how to best use M&A during tough economic times. Please also see the Event Accelerating Growth Through Divestitures and Carve-outs at which Thras Moraitis and others will be speaking. 

Please get in touch if you have any comments about the issues in today's update.
 
I hope to see you soon,
 
Matthew