M&a Profits Up, but Confidence Still Falling

July 25, 2012 /

The largest companies around the world, in almost all sectors, are anticipated to return to profit growth and are driving down debt, which is creating substantial capacity for M&A activity, according to KPMG’s bi-annual ‘Global M&A Predictor’.

However, while profit predictions and cash positions are positive, price to earnings ratios, which indicate corporate appetite to do deals, have fallen 3 percent. Indeed the calculation used in the Predictor to test appetite shows that the UK is the only major M&A market with an increasing appetite for M&A activity.

David Simpson, Global Head of M&A at KPMG, commented: “The largest companies around the world, viewed through an M&A lens, are confusing places to be. On the one hand profit expectations are up 7 percent compared with 6 months ago. On the other hand, the lack of longer term stability can be seen in the lag of market capitalisations behind profit expectations – profit expectations might be up 7 percent but market capitalisations are only up 4 percent. Companies are also driving down their net debt, compared to earnings, but this is not translating into confident acquisitive activity.”

Simpson added, “Confidence or appetite to do deals looks incredibly negative in some countries. In the major M&A geographies, Japan has the most negative outlook with the largest companies’ pricing compared to earnings down 13 percent. This may partly explain why Japanese acquirers are focusing on foreign acquisitions rather than domestic ones. One ray of hope is the UK, which is the only major market to have moved into positive territory, albeit at a low level (pricing compared to earnings is up 1 percent). Given the gloomy global backdrop, a grain of positivity is meaningful even if it simply suggests that we are neither in the Eurozone nor too dependent on slowing emerging markets.”

KPMG’s ‘Global M&A Predictor’, established in 2007, is a forward looking tool that enables clients to forecast worldwide trends in mergers and acquisitions. The Predictor looks at the appetite and capacity for M&A deals by tracking and projecting important indicators twelve months forward. The rise or fall of forward P/E (price/earnings) ratios offer a good guide to overall market confidence, while net debt to EBITDA (*earnings before interest, tax, depreciation and amortization) ratios help gauge the capacity of companies to fund future acquisitions.

The Predictor covers the world by sector and region. It is produced bi-annually, using data comprised from 1,000 of the largest companies in the world by market capitalization. The financial services and property sectors are excluded from our analysis, as net debt/EBITDA ratios are not considered relevant in these industries. All the raw data within the Predictor is sourced from S&P Capital IQ. Where possible, earnings and EBITDA data is on a pre-exceptionals basis with the exception of Japan, for which GAAP has been used.

The global outlook for large corporate M&A activity broken down by sector shows that energy has the least appetite of the sectors with price compared to earnings down 10 percent, with consumer discretionary closely behind with price to earnings down 9 percent. By contrast, healthcare has the strongest M&A appetite of the sectors with the price to earnings ratio up 4 percent.

Simpson went on to say: “Profit expectations for consumer discretionary businesses are extremely positive with a 20 percent increase but it’s perhaps no real surprise that pervasive uncertainty is dulling corporate appetite to put hard earned cash on the table for deals. While small and mid cap exploration and production continues to demonstrate opportunistic deal activity, the appetite for energy majors to contemplate large cross-border corporate M&A is being limited by strained balance sheets, uncertain economic and policy environments and a depressed commodity price outlook.”

Simpson concluded: “The only sector globally, which has both increasing capacity and appetite to do deals is healthcare. The largest healthcare companies have seen the largest increase in price compared to earnings of 4 percent (compared with energy at -10 percent). The increase in appetite is most pronounced in the Asia Pacific and North American regions. Our own client activity shows that the M&A market is proving resilient in the healthcare sector, with continued growth in demand for healthcare products and services around the world helping to support pricing, despite a backdrop of tighter government funding gradually pushing more of the cost of care on to the consumer in some regions. In pharmaceuticals, the patent cliff continues to be a factor for the drug majors in undertaking inorganic growth to ensure their future pipelines.”


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