Global M&A activity in 2012 was by all accounts well below that of 2011. Thomson Reuters reports a double digit drop in deal flow and a corresponding decrease in M&A fees. A significant part of weakness can be attributed to the European financial crisis, but the softness was not limited to Europe.
In the US, the M&A market is soft despite the spurt in deal flow driven by the impending capital gains tax increase. Business owners cashed out in record numbers with the expectation that capital gains rates will rise in 2013. This rush to exit may also mean that we will see a further slowing down of M&A activity going in to 2013.
As we look back on 2012, there were three big trends that transformed the M&A landscape: change in cross border M&A patterns, reverse break fees, and dividend recapitalizations.
1) Change in cross border M&A patterns
As to be expected, there was a sea change in cross border M&A activity due to the European financial crisis. Deal volume in both inbound and outbound deals decreased significantly from the 2011 levels. Year to date M&A in Europe is at a 10 year low. On the upside, the deal flow in BRIC, Australia and Asian countries saw a strong uptick in spite of the worldwide upheaval. We expect that this trend will continue into 2013.
Companies have traditionally been more comfortable and more eager to do M&A deals with Europe. In contrast, companies have typically been more leery about M&A with BRIC countries and there are continued concerns about regulatory environment, political pressure, corruption, and cultural integration.
In spite of these concerns, most companies see expansion into these growing markets as essential for future growth. Heineken’s acquisition of a 58% stake in Asia Pacific Breweries, valued at $6.6B is a recent example of this.
The inbound and outbound deal volume from these countries has remained strong through the world financial crisis and this is expected to continue in the coming years.
2) Reverse break fees
Thomson Reuters reports that the percentage of M&A deals with reverse break fees has grown sharply in 2012. Reverse break fees are now a part of the vast majority of private equity and strategic M&A deals.
Reverse break fees – fees that a buyer pays the seller when a transaction fails – have been a relatively new development compared to break fees, which are the fees that a seller pays a buyer if the buyer chooses to terminate a transaction.
When M&A transactions fail, the target companies take a disproportionate hit compared to the acquirer. It may sound reasonable that a buyer benefits from these break fees – however, such assumption is not always true. Neither is the widely held negotiating position that reverse break fee should be similar in size to break fee.
Two recent deals have raised the profile of reverse break fees, highlighting its power and likely prevalence in deal making. Google’s $12.5 billion acquisition of Motorola Mobility had an eye popping $2.5 billion reverse break fee. Fortunately for Google and Motorola, the deal was consummated.
AT&T, unfortunately, did not clear regulatory obstacles in its intended acquisition of T-Mobile and had to pay T-Mobile a $3B reverse break fees in addition to other considerations.
While the details behind the motivations and structuring of the reverse break fees are beyond the scope of this article, it should be noted that reverse break fees are a powerful deal making tool and should be structured carefully by the sellers and the buyers.
3) Dividend recapitalization
Dividend recapitalization has traditionally been a tool used by private equity groups to unlock the equity in a portfolio company and deliver an early payment stream to stockholders.
A dividend recapitalization occurs when a company raises debt to make a special dividend payment to its shareholders. This one time dividend event, in comparison to a normal dividend, is not paid from the company’s earnings, but by tapping into the equity of the company.
Dividend recapitalization is a great liquidity path for PEGs who might otherwise not be able to exit their investments through an IPO or M&A transaction. For example, Leonard Green and CVC Capital Partners repaid themselves the full cash investment they made in a $2.8 billion buyout of BJ’s Wholesale Club Inc. last year. According to the Wall Street Journal, BJ’s sold debt recently to help pay a $643 million dividend to the owners.
In 2012, dividend recapitalizations became a tool for business owners who were not in a position to sell their company in time to exploit the current favorable capital gains regime. The historically low cost of credit also makes dividend recapitalizations an attractive liquidity path for business owners. Given the confluence of factors, we expect to see a dramatic uptick in dividend recapitalization before the end of 2012.
Business owners should be aware that dividend recapitalizations are leveraged transactions and have hidden risks. Management should proceed with caution as unplanned dividend recapitalizations can make companies susceptible to business downturns.
All things considered, 2012 has been a year of considerable softness in the M&A market. This is remarkable considering that a significant part of the deal flow in the US was driven by impending capital gains increases. As the activity related to tactical tax situation winds down, there may be noticeably fewer deals to work with in the near future. The lower deal flow in turn could leave many companies and private equity groups deal hungry for a good part of 2013.
Chak Reddy is a Mergers and Acquisitions Advisor with Elite Mergers & Acquisitions, which specializes in selling and recapitalizing lower midmarket businesses with revenues between $1 million and $100 million. Mr. Reddy is a business M&A and Marketing expert, and is the chief deal maker at Elite. You can reach Mr. Reddy at creddy@elitemanda.com .
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