Adjusting to the New Normal: 2012 M&A Outlook

As we emerge further from the credit crisis and great recession of 2008–2010, the lessons learned during the crisis and existing economic externalities shape our outlook for 2012 M&A activity. Our focus is on the private middle and micro market, where we and many Midwest businesses serving the M&A market operate. We model our M&A forecasts and related estimates for demand for legal services on a composite of data sets and professional viewpoints expressed by various market research firms, economists and deal experts. Despite general improvements in credit and economic conditions, we believe continued volatility in the debt and equity markets, sustained unemployment and underemployment, the European debt and related political crisis and depressed worldwide economic conditions will hamper any robust growth in M&A activity over 2011 levels. Notwithstanding, we believe 2012 will sustain current M&A activity and be defined by opportunistic M&A
in certain industries, market segments and specific targets.  

While some market participants have said they anticipate a better environment in 2012, thanks in part to signs of stabilization in the US economy, many others predict neutral to weak activity. Notwithstanding conflicting market sentiment, unlike the boom of the mid 2000s where the rising tide lifted all boats, we believe that in 2012, buyers, both strategic and financial, will be focused on a more limited population of specific, attractive opportunities rather than general M&A growth.

Large private and public company transactions will likely be inhibited by lower corporate profits, general depressed economic conditions and domestic and foreign political and economic externalities. Accordingly, we expect mega deal activity to be relatively flat during 2012. Exceptions to this will likely exist in specific industries, including the energy sector, healthcare and troubled company targets, including banks and other financial institutions. We do, however, expect an increase in corporate spinoffs of non-core divisions and units of public companies.

A number of factors contribute to our views for 2012 middle market M&A. Critical to deal activity is better alignment of buyer and seller expectations. Buyers, sellers and their advisors have learned to better absorb the volatility in the market, accept valuations which are lower than pre-crisis levels and be more amenable to alternative financing structures, including seller financing, equity retention and other deferred purchase price mechanisms.  The appetite of sellers to consider such alternative structures will continue to have an influence over whether and when a transaction will occur. We further anticipate that the demand for targets will come from both domestic as well as foreign sources, which continue to increase their share of U.S. based transactions.

Also driving deal activity is the amount of cash on corporate balance sheets and dry powder at private equity firms, which is estimated at several trillion dollars. Pressure for shareholder returns and use of limited partners’ capital commitments will drive deployment of this capital for both strategic and financial buyers.  Additionally, many private equity firms were unable to divest investments during the financial crisis and provide a return to their investors. Accordingly, many of these funds will pursue exit strategies in 2012. These transactions will involve exits to strategic buyers, IPOs and financial to financial transactions.

Additionally, certain industries, including, specifically, the energy, healthcare and technology sectors, and the products and services supporting such industries, continue to see consistent M&A demand. According to one study, the energy and power industry had the most deals by value in 2011, comprising 23% of deal activity; healthcare and technology represented 15% and 10% of activity, respectively. We anticipate 2012 will trend along similar lines. Finally, potential changes to U.S. tax policy (i.e. increase in tax rates) may also motivate sellers to a 2012 exit, as we saw in 2010 with the potential lapse of the Bush tax cuts.

Notwithstanding certain factors leading to positive M&A activity, a number of factors also inhibit robust M&A growth. Due to depressed economic conditions and lower valuations than pre-crisis levels, many potential sellers are electing to continue to hold until improved company performance and general market conditions. Additionally, bank lending, a large component of the deal, remains constricted. These constraints are both a reflection of more stringent lending practices as well as a lack of supply of qualified borrowers. These constraints may be alleviated by mezzanine financing and other non-secured lending sources. Due to historically low interest rates, we anticipate the demand for refinances and recapitalizations of existing debt to remain high in 2012.

In summary, while many opportunities for deals will continue to exist in 2012, we do not anticipate a dramatic increase in deal making over 2011.  

G. Robert Fisher is a partner at the law firm of SNR Denton and Frank C. Koranda is senior managing associate at SNR Denton.