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M&A: Still a big deal "UBS research focus" of UBS Wealth Management Research

Hong Kong | | Media Releases APAC

Corporate strategic M&A will continue, but leveraged buyout deals have become harder to negotiate.

• Mergers and acquisitions activity between companies will remain buoyant despite some weakening in financial and economic conditions.
• Cross-border M&A activity will grow more important as companies seek global scale, but proposed deals may encounter protectionist obstacles.
• Financial and materials sectors are highly fragmented but have room to consolidate.
• Conditions for leveraged buyouts are no longer as favorable as during 2006 and early 2007, which requires private equity companies to change their strategy.

Mergers and acquisitions activity between companies will remain buoyant despite some weakening in financial and economic conditions, according to a new report from UBS Wealth Management Research entitled, "M&A: Still a big deal." Notwithstanding the potential for protectionist obstacles, the report also highlights the potential for heightened cross-border M&A activity to create global scale. The report highlights the financial and materials sectors as being highly fragmented and having room for consolidation. Meanwhile, conditions for leveraged buyouts are no longer as favorable as during 2006 and early 2007, which requires private equity companies to change their strategy.

M&A between companies poised to continue

Announcements of mergers and acquisitions activity posted a new record during 2007, but recent deterioration in economic and financial market conditions raises some questions about the potential for future deals. Despite a rash of profit warnings and weakening credit conditions during the third quarter of 2007, the report from UBS Wealth Management Research concludes that more M&A between companies is in store. The present subprime-lending crisis is taking a toll on leveraged buyouts but will likely do little to dampen the prospects for corporate strategic deals, provided that most of the fallout remains contained within the bank and brokerage industries. For equity investors, this is good news. Elevated levels of M&A activity tends to coincide with strong performance in equity markets and also gives a boost to the share price of takeover targets.

Corporate fundamentals support more deals

The report shows that the volume of corporate strategic M&A is hardly excessive by historical standards, especially after accounting for the effects of inflation and the rise of leveraged buyouts. M&A activity is also more globally diversified, and influenced by more participants, than ever before. Private equity firms, sovereign wealth funds (SWFs), and cross-border deals will likely remain permanent fixtures. When the current M&A cycle eventually comes to and end, it will most likely be remembered for four distinguishing features:

• Private equity firms and their use of leverage;
• Equity markets were not expensive;
• Cash was the primary source of financing, rather than equity; and,
• Company balance sheets had healthy leverage figures.

Global is better

Large corporate cash balances, reasonable equity market valuations, and a desire to gain global scale all support continued corporate consolidation, according to the new report. In addition, recent moves to bring financial markets and accounting standards into greater alignment increases the potential for cross-border merger activity. The emergence of large sovereign wealth funds, which aim to deploy capital to higher-risk assets, may also pave the way for more international linkages.

Financials and materials highlighted

Globally, the report highlights the financial and materials industries as having the greatest potential for M&A activity in the coming years. The report also points to M&A activity from the US and European consumer staples sector, as companies pursue growth through acquisitions in emerging markets. European media companies are set to consolidate regionally, while some small- to mid-size Japanese pharmaceutical companies look ripe to merge for benefits of scale, according to Wealth Management Research.

Leveraged buyouts lose their sheen

The report also points out that the conditions needed to support leveraged buyouts are no longer as favorable as they were during 2006 and early 2007. Private equity companies will continue to generate earnings from their portfolio of acquired companies, but new acquisitions will prove both more difficult and perhaps less financially advantageous. As a result, the private equity industry may need to alter its core business strategy in light of changing circumstances. This could involve a reduction in the industry's dependence on leveraged buyouts and an increased focus on minority investment positions, smaller acquisition targets, and more specialized buyouts of emerging market companies. Investments by sovereign wealth funds into the private equity industry may facilitate additional takeovers, despite the deteriorating macroeconomic and financial market conditions.

Total completed M&A by region

Sovereign wealth fund assets

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