Corporate reshuffling: an origination opportunity?

Katharina Semke
23 November 2015

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For large corporates, a continued focus on core business activities instead of growing larger conglomerates has fuelled M&A activity for quite some time. Experts suggest this trend is likely to accelerate in the next year or two, offering compelling opportunities for private equity. Katharina Semke reports

M&A activity has returned to the fore this year, with Europe positioning itself as a hotspot for mega-deal activity. Indeed, according to figures from Mergermarket, deals worth more than €5bn in the first half of the year accounted for 46% of activity, representing a 46% increase compared to last year's results. For private equity, the reappearance of mega-deals could spell good news as these transactions often result in the disposal of non-core assets.

Furthermore, there is reason to believe this trend will be even stronger in the coming months. Alexander Kron, partner at EY and head of transaction advisory services, explains why: "There is a number of mega trends happening at the moment: digitalisation, demographic change and globalisations are the most prominent ones. They force companies to adjust their business model, which can include the exit of assets. I see that happening a lot at the moment." According to Kron, EY is currently assisting a growing number of companies in their transformation process.

Christian Hess, head of Investec's financial sponsor transaction group, expects corporate disposals to be more common in 2016: "I believe we will continue to see a bigger preparedness and a strategic desire on the side of the corporates to optimise their portfolios, including selling off subsidiaries and divisions that are no longer seen as absolutely core."

A banking source told unquote" that improving portfolios is not the only driver behind disposals; there can be more personal reasons as well: "Today, there's more pressure on CEOs and chairs to acquire or dispose of assets – they want to leave a legacy."

However, Jacques Callaghan, co-head of European investment banking at Canaccord Genuity, disagrees: "It's not necessarily about legacy. The key drivers of the merger and acquisition market are the stock market, how cheap debt is, where the economy is, and the fourth reason is CEO confidence." He believes a combination of these four drivers, with particular emphasis on recent increased CEO confidence, explains why companies are more active in looking externally for growth.

Deutsche Beteiligungs AG (DBAG) facilitated a corporate spinout in November 2014, when it invested in the management buyout of German industrial business Pfaudler from former US parent Robbins & Myers. Following Robbins & Myers takeover by National Oilwell Varco, Pfaudler was deemed a non-core asset, hence it's DBAG-backed spinout. "This was a typical situation for a corporate spin-off; a strategic buyer acquires a company, but is only interested in parts of the business. It then sells certain assets," explains Torsten Grede, spokesman of DBAG's board of management.

Although DBAG scored a deal as a result of M&A activity, Grede does not believe this is a sign of more activity to come, at least for Germany: "I believe that there won't be a larger number of spinouts in the next 12-18 months. Looking at the market and its activity, I don't see this happening."

Sizzling sectors
Despite Grede's pessimism, for wider Europe there have been some more active sectors in terms of M&A activity. Callaghan recognises three in particular: "I think that telecommunication, healthcare and technology have been active in the last 12-18 months. There has also been some activity in consumer." He believes that those sectors will continue to see activity and that another one is in the starting block: "We haven't really seen a pick-up in financial services yet, but at some point that will come." Of these bustling markets, Callaghan believes technology will be the most interesting for private equity.

Comparing deal volumes of the last two years, the predicted upward trend is not showing yet. Looking at private equity buyout deals in general, all three of the aforementioned sectors (telecommunication, healthcare and technology) saw no increase in deal volume in 2015 compared to 2014, according to unquote" data as of early November 2015. Telecommunication remained steady with five deals in both years, the technology sector is only eight deals short of 2014's 58, while health care fell from 52 to 35 buyouts.

European M&A activity rose in the technology sector, according to data from a Mergermarket report about global and regional M&A activity. H1 2014 saw a deal value of $14.5bn, with a rise to $41.7bn in H1 2015, accounting for 9.3% of deals, compared to 3.0% in 2014. The continent's M&A telecommunication deal value fell from $68.4bn to $47.5bn, and healthcare fell too, from $85bn to $47.5bn.

EY's Kron identifies slightly different sectors than Callaghan: "Classical machinery construction and classical industry goods have been continuously popular, but also TMT and consumer, the latter being very high up on European-wide shopping lists."
Similar to technology, private equity's buyout activity in the consumer sector indicated a downturn in 2015, from 113 to 79, but the M&A deals rose from a deal value of $39.1bn to $47.4bn. European private equity buyouts in industrials fell from 217 in 2014 to 145 this year, while the M&A deals saw a softer decline from $56.9bn to $45.4bn.

Merger splurge
Looking at M&A movement that resulted in carve-out deals for private equity, the industrials sector was the most fertile in recent months. For example, Sun European Partners acquired the French hydraulic brake hose designer Flexitech from its corporate parent Mitsubishi in October. Another carve-out in the industrial sector was FSN Capital's acquisition of two panel manufacturers. The deal saw Norwegian business Fibo-Trespo and UK-based Respatex International move hands from building contractor Byggma Group to FSN in an MBO that was thought to be valued at NOK 440.6m.

Private equity saw fewer carve-outs in all other sectors, but consumer offered a few opportunities. Danish GP Erhvervsinvest, for example, acquired jam and pickle maker Samsø Syltefabrik and freeze-dry products provider EFD from animal feed co-operative DLG in August.

According to Investec's Hess, increasing activity in the corporate M&A market will underpin a higher proportion of primary deals. He sees that private equity is lacking those at the moment, especially in the DACH region, but remains optimistic for the months to come: "With the increase of a strategic M&A focus and higher activity levels, there is now a bigger percentage of new deals that become available for private equity to look at. A better mix of primary and secondary buyouts is a good thing for the industry overall."

Given recent activity in the global M&A market, and its predicted rise in activity, private equity firms struggling to put cash to work due to ever-rising valuations would do well to dig around portfolios of large corporates and work out which divisions suit them best. Especially as carve-outs can often push down pricing thanks to their complexity.