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By Jeremy Glaser | 01-19-2012 10:00 AM

Don't Expect Transformational M&A Deals in 2012

There is room for smaller, tuck-in acquisitions this year, but blockbluster deals are likely off the table for a few years, says Morningstar's Bridget Freas.

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. What will the New Year bring for mergers and acquisitions? I'm here today with Bridget Freas. She is a senior analyst at Morningstar and also the co-editor of a new report on our insights into the M&A market.

Bridget, thanks so much for joining me today.

Bridget Freas: Thanks for having me.

Glaser: So, the first half of 2011 was big for M&A; then it really started to slow down in the second half of the year. As we look forward into this year, let's talk about some of the big trends. What do you think are some of the major things that are going to happen with M&A?

Freas: Yeah, well, I think we're going to see a continuation of what we already started to see in 2011. You're right, that we have encountered quite a bit of a slowdown in the back half of the year. That's mainly just due to economic uncertainty and more challenging credit markets. But overall the year was still pretty strong for M&A activity compared with 2010, albeit at a much lower transaction value, and we expect going forward that there is still plenty of opportunity for maybe small tuck-in acquisitions. And maybe those big transformational deals will be a little bit on the back burner until maybe couple of years down the road.

Glaser: So, when we look at some of the smaller deals, what are companies trying to accomplish with these? What are some of the big trends you're seeing there?

Freas: Well, I think there is a couple of different things. One is, on the international front, there are a lot of potential acquirers, I would think maybe with Diageo or a company like France Telecom, which has expressed interest on the international front, particularly in emerging markets. That's something we expect to continue. I think lower valuations might be a catalyst for increased takeover activity. We're seeing that as a driver in the health-care contract research organization space. We think there is opportunity in financial-services firms, as well. Then I think stable growth prospects and cash flow generation are on the minds for a lot of consumer and industrials companies. So, we might see companies look to maybe diversify their earnings stream and capture a little bit more secure growth prospects. Sometimes we think of M&A as a way to purchase growth when you're faced with fewer organic growth opportunities.

Glaser: So, when you're out there purchasing that growth, you need to have it financed somehow. Obviously, the banking sector is maybe little bit stronger than it was a couple of years ago, but it's still not totally healthy. How do you think that these deals are going to get financed?

Freas: The slowdown in the credit markets is really a major hurdle. We really don't see any major lending opportunity in Europe, and a little bit more so in the U.S., so I don't think it's going to be a big debt-capital finance. We don't think that there are going to be a lot of leverage buyouts. There is less interest from private-equity firms.

Then, on the equity share raise, just given the uncertainty in the equity markets, I think a lot of companies are going to shy away from wanting to issue shares to finance acquisitions. But we're still seeing some cash-rich balance sheets across many sectors, so we think that there is still plenty of opportunity to see more cash flow back to acquisitions.

Glaser: So that is probably what's excluding those mega deals?

Freas: Exactly.

Glaser: On the regulatory side, we recently saw AT&T have to walk away from its merger with T-Mobile from Deutsche Telekom because of regulatory issues. Do you see that being a trend in 2012, of it being challenging to get deals done because of the regulatory environment, or will the deals be small enough that they won't hit that radar?

Freas: Regulatory concerns are always a big issue, especially when you see industry consolidation, which is another trend that we could see this year. We think perhaps with energy-services companies or maybe wireless service providers, there might be some industry consolidation there. And regulatory concerns always play a role, but I would say that they play less of a role when you're looking at smaller-sized deals. So I think that will be just a small dynamic ahead.

Glaser: Then looking at sectors, which do you think are the most prime for a consolidation or the most prime for M&A this year? Where do you expect to see the most activity?

Freas: Well, I think health care is generally one that lends itself to M&A. In any given environment, there tends to be a lot of activity there, but I would say, particularly this year, just given the low valuations in health-care stocks, we think there is a lot of opportunity to drive deals. And on that front, I think energy is another area. We saw the valuations of energy companies pull back quite a bit just since our last report published in September. So I would say that's one to watch in the year ahead, as well.

Glaser: Well, Bridget, thanks for your thoughts on the market.

Freas: Thanks for having me.

Glaser: For Morningstar, I'm Jeremy Glaser.

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