Business Calcium Blog

This post is the last part of a two-part article. Read the first part of the article here.

In regards to the lower valuation of deals, we do not have any empirical data that suggests that valuations have increased, but would point out that greater access to credit markets and economic growth may push valuations slightly higher in the near future. In the article last year, we pointed out that lower valuations may push potential sellers not to sell. Better access to the credit access should mean that potential buyers have more access to the resources needed to close deals at a higher valuation. The M&A market is still a buyer’s market but not necessarily at “bargain basement” EBITDA multiples any longer.

The other factor we deem relevant these days from the glass half empty side is the increased due diligence that is taking place in regards to deals. Potential buyers are performing much more extensive business due diligence before a letter of intent is signed which may derail deals that would have closed in the past. As parties become more sophisticated with their due diligence, such parties may find more issues or dirty laundry that puts the thesis behind the intent to purchase in question.

We do not regard this development as unhealthy but may reduce deal flow as well as increase transactional costs and delay the timetable to closing. Hopefully this trend towards deeper and wider due diligence will reduce post-closing disputes and improve post-closing integration goals.

As we weigh the factors discussed in this article, we would argue that as far as the M&A world is concerned that the increased access to the credit markets now and continued increased access in the future will be key to answer the question in the title of this article in the positive. As we argued last year, private equity is not likely to come back as in the past in terms of number of deals, but it will resurface probably in the form of a consolidated industry and with more equity invested in each deal on average. Many private equity funds seem to be selling some of their portfolio companies and issuing distributions to their investors so as to prove to their investors that they can deliver returns and convince them to invest again.

A number of private equity funds may fail as they may not meet expectations and suffer from investor lower appetite for risk. The main driver of M&A currently as in the near future will be the strategic investors. These days strategic investors have hoards of cash with few investment vehicles to invest. Many see purchase of companies or assets as worthwhile as opposed to investing funds in research and development or stock buybacks. The record interest low environment also promotes the locking up of long term issuance of corporate bonds which can be used to finance acquisitions.

The proof may be in the data. According to Robert W. Baird M&A Market Analysis of March 2010, there was a 31.6% increase in the number of United States deals reported in February 2010 compared to February 2009. The 799 deals reported in February 2010 was well above the last twelve month average of 675 transactions.

In the article last year, we speculated that consumers outside of the United States may lead the world out of recession. While we do not have a way to know for sure that the consumers outside of the United States may have led the world out of recession, the Bureau of Economic Analysis reported in their second estimate of United States gross domestic product for the second quarter of 2010 that exports increased by 9.1% in the second quarter compared to 11.4% in the first quarter of 2010.

Our speculation in regards to consumers outside the United Stated led us also to speculate that there would be increased M&A deal flow in other parts of the world. Increased M&A deal flow and in some cases continued increased M&A flow did occur in some of the emerging economies in Asia and Latin America. In February 2010, the excellent growth in M&A continued in Asia excluding Japan with the deal count increasing by 19.9% compared to February 2009 and the dollar volume tripled. In Latin America, the total deal value was $88 billion in the first half of 2010 compared to $30 billion in the first half of 2009 (Half-year edition of Deal Drivers North America 2010 published by Remark a division of The Mergermarket Group in association with Merrill Datasite).

We regard this activity as an important barometer to the timing of a return to normalcy in United States M&A activity because it signals an appetite for dealmaking and leverage in parts of the world that did not suffer through the recession experienced in the United States or at least not at the same magnitude. Increasing deal flow in the context of high economic growth in those regions of the world may signal increased deal flow in the United States as the prolonged growth in those regions have a stabilizing effect on the United States. Indeed, we have seen an increased in deal making activity in the United States (see paragraph above).

The ongoing increased deal flow is also aided by cross border transactions. In August 2010, Zhejiang Geely Holding Group Co. acquired Volvo Cars (a European brand) from Ford Motor Co. (a United States car maker). The deal represents a trend in cross border transactions in which a company from an emerging nation buys a company or assets from a company of the developed world. Further, it also speaks to the idea of the consumer from emerging nations as aiding and leading the worldwide economic recovery. China has become the biggest car market in the world. Undoubtedly in our minds, the acquisition of Volvo Cars was motivated, in part, by the desire to cater to the Chinese auto market.

In conclusion, the M&A market is well on its way to coming back in the United States. Government policy and the behavior of the United States economy while not optimal nor satisfactory at many levels is accommodative to the M&A market. Increased access to the credit markets and the continued staged devaluation of the United States currency are positive developments for the M&A market. The lower valuation of deals compared to 2006 and 2007 and increased due diligence are developments that may counteract the tendency towards increased activity in the M&A market, but we do not believe that themselves are sufficient to counteract the effects of a more vibrant credit market and the continued devaluation of the United States dollar. Other parts of the world have experienced economic growth and increased M&A activity in the last few years which may have a stabilizing effect on the United States economy and the United States M&A market. Increased M&A activity in other parts of the world may serve as an important barometer to assess the timing of a return to normalcy in the M&A market in the United States.

About the Authors:

Andrew B. Sherman is a Partner in the Washington, D.C. office of Jones Day, with over 2,400 attorneys worldwide. Mr. Sherman is a recognized international authority on the legal and strategic issues affecting small and growing companies. Mr. Sherman is an Adjunct Professor in the Masters of Business Administration (MBA) program at the University of Maryland and Georgetown University where he has taught courses on business growth, capital formation and entrepreneurship for over twenty-three (23) years. Mr. Sherman is the author of seventeen (17) books on the legal and strategic aspects of business growth and capital formation. His eighteenth (18th) book, Road Rules Be the Truck. Not the Squirrel. (http://www.bethetruck.com) is an inspirational book which was published in the Fall of 2008. Mr. Sherman can be reached at 202-879-3686 or e-mail ajsherman@jonesday.com.

Alejandro Badillo is an Associate in the Washington, D.C. office of Jones Day. His practice encompasses many transactional areas, including mergers and acquisitions, securities offerings and compliance, venture capital transactions, and private equity. In the area of mergers and acquisitions, he has represented buyers and sellers in asset purchase, stock purchase, and merger transactions. Mr. Badillo can be reached at 202-879-3650 or e-mail abadillo@jonesday.com.