In mergers and acquisitions, as in most areas of life, confidence goes a long way and by the end of last year equity analysts had it in abundance. In an October research note, Goldman Sachs predicted a perfect storm for M&A in 2010, as capital markets reopened, equity indices stabilised and newly capitalised companies awoke from hibernation.
Similarly upbeat reports came from UBS and Deutsche Bank, setting the stage for a welcome return to activity after a two-year standstill.
However, while activity has bounced back in the US, Asia-Pacific and many of the emerging markets, European M&A suffered its worst month for almost 12 years. As of April 26, the total value of announced acquisitions of European companies stood at $20.6bn (15.5bn) from 679 deals, or just 15% of the global total of $133.8bn the lowest monthly proportion of global M&A since August 1998 and the worst month by both number and value of deals in more than five years, according to data provider Dealogic.
Leaving aside a handful of very large, high-profile deals like Prudentials $35.5bn bid for AIGs Asian business and Novartiss $39.3bn acquisition of Alcon, dealflow in Europe has so far not lived up to the expectations of many bankers. Daniel Stillit, M&A analyst at UBS, said: Europe has been extremely disappointing relative to the expectations of many involved in mergers and acquisitions.
This comes despite the fact that many of the traditional barriers to M&A have been overcome. Equity markets, normally closely correlated to M&A volumes, stabilised months ago. Capital markets, both in equities and bonds, reopened faster than many expected, with European high-yield bond issuance on course for a record year, according to Standard & Poors. While bank loans remain hard to come by, financing for M&A is available to those that want it.
Confidence among company bosses, that elusive but essential catalyst for M&A activity, is rising. In the UBS/Boston Consulting Group Senior Management M&A Survey, published in December, one in five European executives said they expected to make significant acquisitions in 2010 a healthy number by historical standards.
What, then, is causing this bottleneck and when do bankers expect it to clear?
One obvious factor is that Europe looks a much less stable place than it did in the fourth quarter. Last week the debt crisis that for several weeks seemed contained to Greece spread across the eurozone after rating agencies downgraded sovereign debt in Spain and Portugal. Fear of contagion caused equity markets to tank across the region and added to downward pressure on the euro, which fell 1.5% against the dollar in a day.
Scott Moeller, director of the mergers and acquisitions centre at the Cass Business School, said: The crisis in the Eurozone has created foreign exchange risk for potential buyers of European assets and companies are not willing to take a bet on the outcome.
The flip side is that if the euro continues to fall, European assets will start to look cheap again, attracting buyers from the US and emerging markets, according to Brett Olsher, co-head of M&A at Deutsche Bank. Olsher said: While cash levels are high, many companies do not yet feel sufficiently comfortable to part with their cash. There are still questions over growth in Europe compared to the rest of the world, and there is uncertainty around sovereign debt and impending financial reform. All this points to a marked upturn in 2011 rather than 2010.
Another issue has been the paralysis in areas of the market that are traditionally big contributors to overall activity in the region. Financial services M&A, which helped pull European deal volumes up in the aftermath of the financial crisis, has been shelved while global regulators formulate the new rules of engagement and finalise the new capital requirements banks and other institutions will be subject to under Basel III. Globally, the sector was down 80% in the first quarter year on year, and that hits Europe more than other regions.
M&A volumes in the UK, historically the largest European M&A market, fell 60% between Q4 2009 and the first quarter of 2010, while one of the closest election battles in memory rages. Businesses are loath to make plans when they are unsure which of the three main political parties all of which have different policies on financial reform, taxation and even takeover rules will be in power after May 6.
Simon Dingemans, managing director of European M&A at Goldman Sachs, said: While markets remain volatile and the economic backdrop is unstable, it is difficult for companies to forecast future earnings and therefore value a target with any confidence. What we, therefore, can expect to see are more hostile deals, reflecting the gap between buyer and target on price.
That has been demonstrated in recent transactions including US food group Krafts unwelcome approach for UK chocolate maker Cadbury, which completed in February, and US power technology group Emersons decision to go straight to UK rival Chlorides shareholders with its 723m (833m) bid last week, rather than seeking talks with the companys board first.
While macroeconomic factors may be dragging on the region, there is a strong sense of pent-up demand for deals. Europe is traditionally a few months behind the US, which has seen M&A volumes increase every month so far in 2010.
Clarity on financial regulation, a multilateral solution to problems in southern Europe and a UK general election will help to provide visibility for companies already committed to deals but not quite ready to pull the trigger.
Giuseppe Monarchi, head of the Emea M&A group at Credit Suisse, said: While the gap between buyer and seller expectations on price has reduced, it still remains a major obstacle to higher levels of activity.
That said, the backlog of transactions is substantially up on this point last year and general market conditions have improved. A further strengthening of the equity markets, together with a continued improvement in business confidence, may well help close the valuation gap and support the material rebound in M&A volumes that everyone is expecting.