M&A volume down, but PricewaterhouseCoopers sees opportunities in second half

By Angela McDaniels

Tacoma, Wash., June 23 - The second half of 2008 will be ripe with merger and acquisition opportunities as companies look to trim fat by disposing of non-core assets, overseas investors hunt for bargains and businesses look to get ahead of regulatory changes, according to a new report from the transaction services group of PricewaterhouseCoopers LLP.

The group made its forecast even while acknowledging the greater difficulty in securing financing and recent lower deal volumes.

Total announced U.S. deal value and volume through May totaled $428.6 billion and 3,750 deals respectively, down from $699.8 billion and 4,754 deals for the same period in 2007, PricewaterhouseCoopers said in a news release, quoting the American Bankruptcy Institute.

Bob Filek, a partner with PricewaterhouseCoopers' transaction services, said mergers and acquisitions in consolidating industries such as automotive, consumer products, energy, financial services, manufacturing, technology and retail are fueling activity in 2008.

"If you look across all industry sectors, whether corporate or private equity, everybody is assessing their core competencies and doing transactions that make them lean, nimble and more competitive," Filek said in the release.

In PricewaterhouseCoopers' view, industries that continue to present consolidating opportunities include:

• Financial services - The advisory firm said the financial services industry is taking a beating with credit problems continuing to worsen and affecting sectors beyond subprime, affording opportunities for industry players with strong balance sheets to acquire assets at a discount and to infuse capital in cash-strapped companies;

• Automotive - PricewaterhouseCoopers expects automotive deal activity to continue as companies seek ways to cope with high material costs, shifting consumer demand toward fuel efficient vehicles and a depressed U.S. market;

• Energy - With the price of oil increasing and the pressure to seek alternative means to address the growing energy need mounting, energy companies look to acquire and build up their portfolios. A wave of consolidation is underway in the equipment and services sector, and the company said this should run into 2009.

Master limited partnerships, still struggling with competition and deal pricing, are "modestly" moving ahead, PricewaterhouseCoopers said. Industry watchers are looking for signs that a consolidation of MLPs is starting. Should this happens, the company expects substantial deal volume.

In the upstream space, the company said commodity price volatility has resulted in gaps between seller and buyer expectations. That said, there is more bullishness on natural gas than oil, and PricewaterhouseCoopers expects continued interests from both strategic and private equity investors;

• Consumer products - Consumer products companies continue to shed non-core assets and non-performing brands. Sources of growth continue to be a priority, the company said, and ethnic products and emerging markets continue to be the driving forces of growth;

• Technology - In the technology industry, PricewaterhouseCoopers considers the internet to be the bright spot. Although the sector is maturing, it is still growing, particularly for online advertising-driven businesses. Consolidation in other sectors continues, the company said, and inbound acquisitions from Asia and Europe will also drive broader sector activity.

"This environment is ripe for opportunities. Acquisitions done in challenging times such as these consistently rank at the top of transactions with the best returns," said Filek. However, given the credit and economic uncertainty, rigorous due diligence and detailed scenario and downside modeling are a must, Filek added.

U.S. for sale

Inbound investments into the United States will continue for the remainder of the year and accelerate into 2009, the company predicted.

However, PricewaterhouseCoopers said foreign interest in the United States hasn't been at the level one would expect considering the appreciation of foreign currencies: for the first five months of 2008, there were 598 announced inbound transactions, down from 761 for the same period in 2007.

"The U.S. is for sale. Our currency is deflated and that is attractive for international buyers. That said, inbound investments into the U.S. will be tempered due to the uncertainty of the U.S. economy. We will continue to see activity but it won't accelerate until the U.S. economic picture gains some clarity," Filek predicted in the release.

On the outbound side, PricewaterhouseCoopers said U.S. companies continue to tap into high-growth emerging markets of China, India, Indonesia, Eastern Europe, South Africa and the Middle East, with the preferred form of transaction in these markets being joint ventures.

Regulation changes

The looming threat of a capital gains tax increase may cause an uptick of merger and acquisition activity in the fourth quarter of 2008 as these businesses seek to monetize prior to the end of the year, PricewaterhouseCoopers said.

Additionally, the new business combination accounting standard FAS 141 - Business Combinations - is likely to motivate companies to close transactions by Dec. 31. This will allow some costs to be added to the purchase price rather than be expensed, the company explained.

Another regulation the company expects to raise M&A activity includes changes to how companies account for noncontrolling interests or minority investments, FAS 160 - Non-controlling interests in consolidated financial statements, starting for some companies in 2009.

PricewaterhouseCoopers anticipates that companies will expedite their timeline to obtain control of their current minority investments before the rule takes effect. After the implementation, these transactions will trigger gains and losses as well as balance sheet revaluations for the investment.

Fewer leveraged loans

In the current credit market where access to syndicated loans to finance large transactions is limited, PricewaterhouseCoopers said private equity firms looking to buy are getting creative.

At $96.7 billion, U.S. leveraged lending for the first quarter of 2008 represented a 69% decline from the same period last year and a 91% drop from the fourth quarter of 2007, the release said, quoting Thomson Reuters. PricewaterhouseCoopers said the downward trend underlines the difficulty for private equity firms to secure financing for large transactions.

"Because large deals, which had been private equity's sweet spot, are not getting done due to the contracted lending environment, many private equity firms have returned to their roots and are buying distressed and other assets," Greg Peterson, a partner with PricewaterhouseCoopers' Transaction Services group, said in the release.

The number of U.S. businesses filing for bankruptcy totaled 8,713 for the first three months of 2008, the highest quarterly filing since the fourth quarter of 2005 and the highest first quarter since 2004, according to the release. Should this trend continue, PricewaterhouseCoopers expects to see more distressed M&A activity.

Private equity funding fewer deals

Private equity accounted for 26% of the U.S. deal value and 17% of volume for the first five months of 2008, compared with 37% and 19%, respectively, for the same period in 2007.

Peterson said he foresees transaction structures will change in the short term as private equity firms need to put in more equity to get desired deal financing terms. He said, however, that private equity firms are not pressured by their limited partners to spend capital raised as they did during the last distressed cycle in 2001 and 2002.

"Private equity is patient money. These firms do not have to make any rash moves. Expect to see more creative structures from private equity including partnering with strategic buyers for sector specific opportunities," Peterson said in the release.

PricewaterhouseCoopers is a New York-based accounting firm. Its transaction services group focuses on mergers, acquisitions, sales and financing transactions.

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