Reports compiled by Rob Davies in Asia, Reg Crowder in Europe and Michael Fischer in the US.
Before the recent credit crunch, M&A activity was booming throughout the world. Families in Business compares and contrasts the Asian, European and US markets to ascertain what the impact has been on deals involving family businesses
For the better part of two decades, financiers have heralded the dawning of an M&A boom in Asia. The optimism proved misplaced due to a mix of regulatory issues and external shocks to the region's economies, such as the Asian Financial Crisis in 1997 and SARS in 2003.
In the past two years, however, Asian M&A volumes have increased from $324.5 billion (€238.8 billion) in 2004 to a record $472.5 billion in 2006, according to data from Dealogic. Up until the end of July, 2007 issuance stands at $337.9 billion, suggesting this year might be even better.
Euan Rellie, MD of boutique advisory firm Business Development Asia, feels current claims of a boom have more validity than in the past. "Firstly you have Western corporates looking for growth," he says. "Everyone is looking to Asia and an easy way to get a foothold is through acquisitions. Financial investors are in the same position. With reduced growth opportunities in the US and Europe, they are seeking alternatives. The positive news for Asian M&A is there is a lot of unsatisfied demand for assets among private equity buyers."
Many of Asia's largest conglomerates are family-controlled: from the Wang's in Taiwan – owners of Taiwan's Formosa Group – to the Li's who run Hong Kong's Cheung Kong Holdings, which includes Hutchison Whampoa, and the Tata family in India.
One impediment to Asian M&A historically has been the resistance of such conglomerates to divest assets. While this remains an integral part of business culture, there are suggestions successors may be more amenable to selling non-core subsidiaries/assets, as evidenced recently by Cheung Kong's sale for $941.5 million of its 33% share in One Raffles Quay, a prime office development in Singapore.
"We are seeing second- and third-generation business leaders coming through, many educated overseas," explains Glen Robinson, executive director of Asean Focus Group. "They want strategic direction, thinking it might be time to divest non-core businesses to focus on and acquire companies that add to their core competitiveness."
The leaders of listed conglomerates are being pressurised into similar moves by shareholder activist funds, which have become particularly vocal in Japan.
"Funds and shareholders generally are taking a more proactive approach on what they want from management of listed companies," asserts Ashley Woods, a consultant at Allen & Overy's Tokyo practice. "This is equally prevalent for high-profile names and less well-known companies; with funds seeking everything from higher dividends to questioning a company's capital management or expenditure programmes."
With transactions worth $182 billion in 2006, Japan is Asia's largest M&A market and is likely to remain so in the short- to medium-term. "Over the past two-years we have seen changes in the approach to deals and takeover laws, which should make it easier for transactions to take place that would not have been contemplated until recently," adds Woods. "There are a lot more small- to medium-sized enterprises listed in Japan than many other jurisdictions. Many are family-run and face succession issues, which makes them prime candidates for consolidation or acquisition."
Even so, for many observers, China and India – both boasting over one billion potential consumers – offer the most appealing long-term acquisition targets.
"Most of the focus is on these two countries, and we are seeing broad based interest," says Rellie. "The middle class population is increasing, while manufacturing companies – particularly exporters – are also sought after."
While private equity accounted for $59 billion, roughly 11%, of M&A activity in 2006, this was up 206.1% from 2005. Demand from buyout firms shows no sign of easing, even though market conditions have become more challenging.
"Private equity has enjoyed a great run where buyouts have been encouraged," explains Kathleen Ng, MD of the Centre of Asian Private Equity Research. "Firms were able to take advantage of benign market conditions and liberal regulations, enabling them to establish holding companies in various jurisdictions and enjoy favourable tax regimes. As the regulatory environment has tightened up, they have to work out how to do deals in ways that make economic sense.
"Nearly all the deals that have failed in China have been due to regulatory constraints and barriers to investment," continues Ng. "These are teething troubles, but it is all about risk and reward. We consistently see that those firms able to work through issues – devising innovative deal structures or bypassing regulatory problems – are the ones who are making great returns."
One of the most interesting features of the current market is the number of regional players seeking expansion via outbound acquisitions. This has been particularly evident among Indian conglomerates. Tata Steel made headlines with its acquisition of the Anglo-Dutch Corus Group in April for $12.5 billion. Hindalco Industries – run by the Birla family – made a similar stir in the aluminium industry when it purchased Novelis Inc for $5.9 billion.
Although he says it is too early to draw conclusions, Robinson believes the recent acquisitions highlight a desire by Asian companies to tap into technical expertise in the west, as well as developed retail markets. "I can see the whole region offering greater opportunities. Asian companies are looking to make strategic acquisitions in many markets. It may not have had a big impact yet, however momentum is building
gradually and exponentially."
Thanks to a disciplined focus on cash flow today and growth tomorrow, Europe heads toward the fourth quarter with the world's strongest corporate M&A market. That's the conclusion of a new valuation analysis by the accounting consultancy KPMG. Industry experts attribute Europe's striking success to the fact that the M&A business in Europe is driven by "strategic investors" – profitable companies buying other companies in order to increase their share of markets in which they are already successful.
Many of Europe's important M&A deals this year involved family-controlled public companies. Paris-based luxury goods giant PPR, shook up global retailing by taking control of sports equipment brand PUMA in a friendly takeover.
François-Henri Pinault, chairman and CEO of PPR, said the firm was merely following its customers into the stores when it decided to acquire PUMA. "This is the ideal moment to carry out this rapprochement because of the consumer trends," Pinault says. "We know our customers are diversifying their purchases of luxury products, mixing them with less exclusive products, particularly in sports."
PPR hit a brick wall every time it tried to wring from its consumer products businesses the kind of growth it gets from its luxury lines, notably Gucci. But Pinault says there are minimal barriers into the consumer products sector. This fact – and the ferocious competition it brings with it – has prevented PPR's consumer product lines from achieving the margins enjoyed by its luxury brands and Pinault believes PUMA may be the solution to that problem.
A descendant of PPR's founding family, Pinault today is particularly proud that, although the ink has hardly dried on the PUMA acquisition, it is already significantly contributing to the company's net income. Fully consolidated into PPR's financial statements from 1 April 2007, PUMA contributed 27.1% of PPR's net income for the period ending 30 June 2007.
Looking good in a group with free cash flow rising as explosively as that of PPR is no small accomplishment. PPR's first-half cash flow before taxes, dividends and interest increased by 38.8% in the first half, compared to the comparable period in 2006. Thanks to reduced working capital requirements and corporate taxes paid, that resulted in an increase in net cash flow from operating activities of 521.7%.
Pinault suggested PUMA probably won't be the last acquisition for PPR, which aims to use "retail branding" to bump up margins for its consumer goods lines. "Naturally, we are always receptive to seize any tactical acquisition opportunity that can flesh out our product categories, or strengthen our market position," Pinault says.
However, the vitality of Europe's M&A business isn't just restricted to the retail sector. Jurgen van Breukelen, KPMG's corporate finance head for the Netherlands, believes the
market is "buoyant" for every kind of business, new or old.
"Sector wise, deal activity is strong right across the board, with utilities hitting the headlines due to the scale of the transactions," he says. "But there is lots of activity in other previously 'new economy' sectors, such as ICT (information and communications technology) and media, which are all now very profitable." He says the private equity investors that are active in Europe go after "stable cash flow, attractive growth prospects and profitable companies".
The number that the buyers and sellers of companies watch most closely to measure the vitality of the M&A markets is the Price Earnings (PE) multiple. KPMG used PE multiples to rank the world's M&A markets. "KPMG's analysis shows that Europe continues to exhibit the strongest M&A picture out of all the major global regions," the report says. "Twelve-month forward PEs (the valuation ratio of share price to estimated earnings per share) for constituents within KPMG's Global 1,000 was 16.2 times the size at the end of the first five months of 2007; a 7.3% increase on the end of 2006." Over the same period, PE multiples stagnated in the Americas and declined in the Asia-Pacific region. On a global basis, according to KPMG, M&A activity is losing steam. "Pressure on the accelerator pedal has come off, as regards international asset prices, with PE valuations increasing only marginally," KPMG says.
Sometimes a family-controlled company is on both sides of the deal, as with Associated British Foods' (ABF) acquisition of Indian food company Patak's. Although the terms of the acquisition were not disclosed, Darren Shirley, an analyst in the Liverpool office of Shore Capital, believes ABF paid about €185 million ($251 million) for Patak's, 21 times the company's earnings before interest and taxes.
"To our minds, an important feature of the Patak's deal is that two members of the founding family, Kirit and Meena Pathak, will remain with ABF," Shirley says. "Kirit is becoming chairman and Meena a director of the 'world foods' operation." He predicts the entrepreneurial husband and wife team will drive continued strong growth for the Patak's brand.
Another family-controlled business, F Hoffmann La-Roche Ltd, this year negotiated one of Europe's most important deals – the acquisition of American company NimbleGen Systems for an all-cash price of €201 million. André Hoffmann, vice chairman of Roche and member of the founding family, says the acquisition was an important milestone in the company's long-term strategy to "strengthen our position as a major player and complete solution provider in the genomics research market".
Henrik Aslaksen, co-head of European M&A at Deutsche Bank in London, believes Europe may well hold its leading position for some time. "In Europe, corporate activity remains strong, with most of the large announced and completed deals remaining between strategic corporates," he says. "A slowdown in private equity activity here will not derail M&A to the extent that it could in the US."
M&A activity in the US during the first half of 2007 soared, driven by a private equity feeding frenzy. However, market turmoil in July and August, stirred up by the subprime debacle, raised questions about whether this activity would continue during the remainder of the year.
M&A deals involving US companies amounted to more than $1 trillion (€737 billion) in the first half of 2007, out of a global total of $2.9 trillion, according to Dealogic. This compared with deals valued at $781 billion during the same period last year, out of a global total of $1.9 trillion. US transactions in the first quarter amounted to $430 billion, while those in the second quarter added up to an even more impressive $606 billion. One of the biggest deals was the Dolan family's acquisition of Cablevision Systems Corp for around $10.5 billion.
Private equity was the engine for much of the deal activity in the first half. A PwC report, citing Thomson Financial data, said that during the first five months of 2007, private equity accounted for 48% of M&A value, up from 20% in 2003. Private equity's dominance, it said, is a function of its capacity to do increasingly large deals as competitive lending practices while infusions of capital from institutional and overseas investors pushed up liquidity.
"There hasn't been a period where the top five deals in six months were private equity deals," says Bob Filek, a partner in PwC's Transaction Services group in New York. "That was probably a first. So, the public to private deals were noteworthy in the first half of the year, across a wide variety of sectors."
That so many sectors were involved is a sign that private equity is expanding its reach and getting into new areas from the old-fashioned companies it previously favoured, says Filek. Today, private equity funds are identifying opportunities in financial services, healthcare and media companies.
Increased activity in family business owed to several factors, according to Richard Allen, partner at de Visscher & Co in Greenwich, Ct. Traditional generational changes are heightened by the number of families that are approaching retirement age or looking to transfer their businesses.
Another key factor heightening these changes is that a lot of capital has been available from private equity and other sources in competition with traditional strategic buyers. "In addition," says Allen, "we've had a strong market and a financing environment for companies to expand internationally and particularly for good-quality brands and product lines."
Top brand names and product lines are always in demand, he says. "There remain a number of excellent family-owned businesses that possess those characteristics, so these are going to be attributes that shine through." Allen notes that international interest has significantly increased over the last five years. "Markets have become more international, communications have become so rapid and the spread of information is more readily available than ever."
In July, PwC reported that 70% of chief executives of private US companies, surveyed for the private company edition of its 10th Annual Global CEO study, expect to acquire all or part of another US company in the next two years. The report said that although 57% of company heads said they were very confident about growth over the next 12 months, they were relatively cautious about how this growth will be funded. More than 80% said they would finance growth through internally generated cash flows, while only 10% said they would do so through private equity.
Filek thinks the second half could have a strong close, but with a key difference: It will be driven by the corporates and multinational buyers. "The corporates still have a lot of cash. They're going to see the current environment with less competition from private equity in the short term and some depressed stock values as an opportunity to put some of that cash to work. I also think that with the strength of the European economy, [European companies] will be looking to do some shopping here in the US as well."
He admits that private equity loans are highly sensitive to economic conditions, and a major downturn in the economy, aggravated by continuing issues from the subprime fallout, could put some of those loans in trouble.
"As long as loans that are important to private equity continue to perform, we don't think it will create a major dislocation in the markets," says Filek. "The issues we're dealing with predominantly are tangentially related, driven by the subprime issues, but the performance of the loans that are subject to the private transactions to date have performed relatively well compared to historics."
Filek says that one of the things that has changed and won't reemerge in the short term is what he calls "borrower-friendly" loan provisions that existed prior to this most recent shakeout. "Some of the terms in the loans were very borrower friendly; we'll return to more traditional terms."