Those Who Ignore M&A Risk Being Left Behind

By FOXBusiness

The old adage “you have to be in it to win it” rings true for companies trying to survive in a depressed economy, only it’s not the lottery they should be gambling on.

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Corporate mergers and acquisitions are expected to remain near decade lows through 2013 due to a weak global economy that has led to a decline in confidence, but perhaps the companies that take the biggest risks will be the most highly rewarded when things start to turn around.

“M&A is now simply much more important to corporate strategy than at any point in the last 30 years,” Nicholas Colas, ConvergEx Group chief market strategist said in a note. “That is because global growth – that tide that lifts all boats - is much slower than historical norms.”

Merging operations means reaching economies of scale and finding new synergies that help save costs, expand margins and improve companies’ abilities to invest in new strategic opportunities. It also helps consolidate industries, which can translate to better prices and help lift bottom-line results.

M&A, particularly large transformational deals like the 2010 United Continental (NYSE:UAL) merger, provides an additional way to drive value despite broader weakness. While fiscal uncertainty, slower-than-expected growth in emerging markets and economic turmoil in Europe may keep the risk-averse away from risky bets, M&A should be put higher up on the to-do lists of risk takers that have the capital and are looking to drive value.

"There is huge pressure for companies to grow in the sluggish economy and M&A opportunity exists for those companies willing to be bold in today’s market,” said Richard Jeanneret, Ernst & Young’s Americas Vice Chair of the transaction advisory services group.

Yet, deal activity was sluggish in the years during and after the Great Recession, with data from Ernst & Young showing a 10% drop in U.S. deals in 2012 to 6,357 from 7,077 a year ago, making it the slowest year since 2002.

And M&A is expected to continue to be soft at least through next year, which is a change in sentiment from a year ago when experts had been optimistic regarding a turnaround. The number of U.S. companies planning to execute a deal in the next 12 months fell to 23% among U.S. companies from 34% just six months ago, according to E&Y, a reflection of growing uncertainty around the fiscal cliff and worsening economic conditions in Europe.

Of the corporations that are considering striking new deals, 81% said they’ll consider transactions valued at $500 million or less, suggesting that deals will fall even from 2012 where overall deal worth slid 26% to $625.7 billion from $846.9 billion in 2011.

That means that even fewer transformational deals can be expected in 2013 unless there are some major changes to economic sentiment, as CEOs instead choose to focus on optimizing their portfolio through divestitures and spinoffs that yield quick capital but usually don’t dramatically alter a company’s value down the road or the sector generally.

“CEOs have been scouring their companies in the last few years, but they are running out of levers to pull and organic growth options,” Jeanneret said. It “is a sign that companies are prepared to grow, which may signal that deals are coming.”

Those companies that see opportunities faster than others, aren’t as susceptible to current risks or view the uncertainty as ending sooner than others may find they are rewarded if they take the risk and focus on investing in M&A before valuations start to change, Jeanneret said.

“Over the next 5-10 years M&A activity will be increasingly necessary to keep the tailwind of growth in almost every sector of the economy and capital markets,” Colas said. “M&A will have to dovetail more closely with fundamental business strategy.  There’s just no other way to grow."

Of course, some sectors and companies are better positioned than others. Despite the weak economic backdrop, M&A activity remains relatively robust among private equity firms, with total deals dropping just 1% from last year to 810 and the value of private equity transactions in the U.S. climbing 3% to $97.3 billion. That’s a reflection of both their confidence in the market as well as the fact that many are privately owned and don’t have to answer to shareholders.

PE firms are still sitting on a lot of unused capital, with E&Y estimating they have a total of $360 billion ready-to-be-deployed cash. Activity remains constrained for a variety of reasons, including a noticeable gap between buyer and seller price expectations and a shortage of quality assets.

Of course the risks associated with “bet the farm” M&A are abundant, and there have been plenty of deals that failed miserably.

Deal making will likely remain sluggish until at least one of two things are resolved: the fiscal cliff and the  eurozone crisis.

“Until you see resolution on those two issues, I don’t think you’re going to see much of a recovery in M&A,” Jeanneret said, though if the market perceives real progress on either of those fronts there could be a “modest run in the U.S.” of M&A activity, he said.

“It’s not going to be rocket ship growth, but growth where we haven’t had it,” he said.