The View from the International Investment Bank: Cross-Border M&A Activity in 2010
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Does 2010 mean a renewal of inbound M&A activity? We have put the question to well-qualified investment bankers to get professional views. Brian McDonald, a Managing Director in the M&A Group of Houlihan Lokey, an international investment bank, has some very positive views. Brian has been a banker for over 20 years, advising both publicly traded and privately held companies in various industries. He has advised on numerous cross-border transactions.
USAInbounddeals: Commentators have pointed out that the level of M&A activity in the United States for mid-market businesses was lower in 2009 that it had been for several years. Are you forecasting an increase in M&A activity involving mid-size U.S. businesses for the remainder of 2010 or 2011 over 2009’s activity level? Can you suggest what the reasons for any increase might be?
Brian McDonald: At Houlihan Lokey, we expect to see an increase in activity in 2010 and beyond, and we have already seen an increase in deal backlog. There is both pent up supply and pent up demand for transactions due to the lull in activity during the recent period of market disruption. Now that equity valuations have stabilized and the financing markets have begun to recover, we expect an uptick in M&A activity as buyers and sellers return to the market.
After the recent volatility in the equity markets, shareholders of family owned businesses are much more cognizant of the risks inherent in holding a significant portion of their net worth in illiquid stock of a single, small private company. Many such shareholders are now considering a sale, even though valuations are down from their pre-crisis highs. Also, long-term capital gains tax rates are expected to increase from 15% currently to at least 20% or 25% in 2011, providing an additional incentive for sellers to sell now rather than later.
Private equity sponsors with older vintage portfolio companies need to sell those companies to return cash to their limited partners, so the current stabilization in valuations provides an opportunity to market those transactions. Corporates are also rationalizing their portfolios and exploring divestitures to either deleverage or to redeploy capital in their core businesses.
Buyers also have a strong rationale to transact. Many large corporates have built up significant cash reserves by cutting expenses, reducing capital expenditures and reducing dividends. In 2009, many corporates were able to increase earnings even as revenues declined, because they reduced expenses significantly. This cannot be easily repeated in 2010. And since the economy is not expected to grow rapidly, these corporates will try to grow by using their cash reserves to make acquisitions.
USAInbounddeals: If you believe that an increase will occur, are you predicting an increase in the activity level of foreign-based buyers (including their existing U.S. businesses) in the U.S. market? Are you willing to estimate how significant this increase might be?
Brian McDonald: In recent years, foreign buyers have increasingly been active in the U.S. middle market. We believe that their demand for U.S. businesses will further increase in 2010 for a couple of reasons. First, the U.S. economy is expected to recover from its recession sooner and more rapidly than Europe. Therefore, European buyers will likely continue to look to the U.S. for growth acquisitions. Also, the recent sustained appreciation of the Euro relative to the dollar appears to be headed towards a reversal, particularly with the fiscal crisis in Greece. If European buyers conclude that their window for buying U.S. assets at “sale” prices will soon be closing, they may decide to jump in before the window closes.
Asian buyers, particularly Japanese and Chinese buyers, have also been active, but less consistently. We expect buyers from these countries to continue to appear in select middle market transactions.
USAInbounddeals: Do you believe that specific U.S. industries are more likely to see increased interest from foreign investors or buyers? What might those industries be?
Brian McDonald: We have seen the most foreign buyer interest in the industrial sector, real estate, and infrastructure services and materials.
USAInbounddeals: Are sell-side clients actively asking you to seek out foreign buyer interest?
Brian McDonald: Yes. Sell-side clients often seek foreign buyers for several reasons. Most importantly, sellers want to maximize value and they recognize that foreign buyers can often pay more due to a strong currency or unique strategic considerations. If a foreign buyer views a U.S. business as a way to establish a platform in the U.S. or gain access to U.S. distribution channels, they may place a significantly higher value on the acquisition than a U.S. acquirer would.
Another reason sellers like foreign buyers is that they often represent the least disruptive buyer for the employees. If the buyer does not already have a U.S. business with which to integrate the acquisition, the buyer will typically retain most employees.
USAInbounddeals: Are you aware of any concerns in the M&A marketplace that the U.S. government’s screening of inbound deals makes them more difficult to complete?
Brian McDonald: Yes. Companies that service the defense sector or that sell directly to the government are often reluctant to include buyers from sensitive countries on their buyers list. Even if the seller is willing to invite a foreign buyer into the sale process, some buyers are reluctant to participate if they are concerned that the U.S. government may reject the transaction due to national security concerns. We have even seen this behavior by private equity funds that have significant limited partner equity from countries in the Middle East, for example.
This article is intended for informational purposes only and reflects the opinion of Brian McDonald, a Managing Director in the M&A Group of Houlihan Lokey. The material presented reflects information known to the author at the time this article was written, and this information is subject to change.
About Houlihan Lokey
Houlihan Lokey provides a wide range of advisory services in the areas of mergers and acquisitions, financing, financial restructuring, and valuation. The firm was ranked the No. 1 M&A advisor for U.S. transactions under $3 billion in 2009 and the No. 1 U.S. fairness opinion advisor over the past 10 years by Thomson Reuters. In addition, the firm advised on more than 500 restructuring transactions valued in excess of $1.25 trillion over the past 10 years. Notable engagements cover numerous sectors and virtually all of the largest U.S. corporate bankruptcies, including Lehman Brothers, General Motors, WorldCom and Enron. The firm has more than 800 employees in 14 offices in the United States, Europe and Asia. Each year Houlihan Lokey serves more than 1,000 clients ranging from closely held companies to Global 500 corporations.
For more information on Houlihan Lokey, visit www.HL.com.
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Chinese regulatory authorities have taken an important initiative to encourage outbound FDI from China. U.S. private equity funds and other owners of businesses desiring investment should take note of these changes. These developments also are significant for investment bankers and other intermediaries, as the steps should enhance their ability to broker strategic arrangements. 