M&A to take centre stage as deal volumes remain steady
2014 is a landmark year for South Africa. Because of the events of the past two decades, there will be a lot of reflection on how the country has progressed over the past two decades, as well as what the future holds for the country.
But we don't even have to go back 20 years to see why the current landscape is being shaped the way it is. We only have to go back to 2009, and the financial crisis that caused the world to relook at the way they do business. Because of this, costs within certain industries increased significantly, making barriers to entry and barriers to survival significantly high.
Mergers and acquisitions, the industry's saving grace
In order to survive, small and medium sized organisations were being bought out by larger companies. While 2012 and 2013 were not overly active years on the merger and acquisition (M&A) front, auditing firm Ernst and Young (EY) expects 2014 to be a very active year.
A report by EY shows that large acquisitions look set to steal the M&A headlines over the next 12 months as global companies place fewer but bigger bets on the deal table. The report shows that the global environment for major transformational acquisitions has significantly strengthened as leverage returns and companies take measured bold moves. However, appetite for acquisitions at 31% will keep deal volumes flat for the next year.
Global companies' intentions to engage in larger deals, those greater than $500 million, have doubled in 12 months from 12% to 27%. Those intending to do the bigger deals over $1b have also more than doubled to 12% in the past six months.
Pip McCrostie, EY's Global Vice-Chair, Transaction Advisory Services, says: "Value, not volume will be making headlines in the near future, with prominent large deals being part of an emerging trend. In 2014, we have seen a 25% increase in deal value but an 11% fall in volume globally. After a prolonged financial crisis and M&A market malaise, companies and boards are opting for quality rather than quantity.”
He adds that shareholder activism is ensuring that managing costs and delivering measured growth remains a permanent feature of a complex business landscape. "With growth harder to come by in a low gross domestic product world economy, many executives are adopting a twin track approach. On the one hand, companies are looking at innovative organic growth strategies – to develop new products and open new markets – and selective but bold inorganic moves in the market. On the other, they are looking at more creative ways to drive down costs.”
Valuation gap narrows
One of the aims of M&A deals is for the company making the purchase to purchase the best asset at the lowest possible price. While this proved to be difficult in the past, the EY report shows that the gap is contracting between the price companies are willing to pay for assets and underlying valuations.
Sandile Hlophe, EY's Africa Leader Transaction Advisory Services, confirms, "Fundamentals for high-value deal making are very favourable. Historically this would have translated into a wave of global M&A. However, the complexity of the challenge facing executives today means M&A is more measured. Geopolitical instability, a fragile global economic recovery, seismic shifts in far-reaching mega-trends such as structural changes in the workforce and digital transformation are all key considerations and all at a time of unprecedented shareholder activism.”
Growth a priority but cost management is still king
Hlophe concludes, "Given the trends affecting the market, there is no surprise that many executives are balancing confidence and caution. The result is a strategic focus that combines cost management and growth.”
"The much-anticipated convergence of economic confidence and strong deal fundamentals into notably higher deal volume globally is still not in sight. As we look forward to the future, looking back at the M&A boom years should no longer be the yardstick to compare deal activity. Expectations need to be revised down as the deal volume ‘norm' is reset lower in this continued slow growth environment.”
The regulatory factor
There is one trend, which is currently unique to South Africa, which the EY report did not point out as a factor that will contribute to the expected M&A activity that will take place in 2014; that of regulatory pressure.
The Financial Services Board looks dead set on implementing new pieces of regulation such as Solvency and Asset Management (SAM) and the Retail Distribution Review (RDR) in an effort to bring the South African financial services industry in line with international markets. While this is a necessary move, the implications on the industry could prove to be far reaching.
When looked from the viewpoint that one piece of legislation complements the other, RDR hopes to redefine the industry while SAM provides a practical way to improve administrative and reporting functionality within companies.
However, compliance will be expensive. The penalties for non-compliance will be significant, so companies will be eager to make sure that they do comply. This will be costly as new systems and processes will need to be put in place to achieve this. Larger companies will feel the initial pinch, but will be able to make up the costs over the long term. Smaller companies may not be able to and will be incorporated into larger businesses.
Remuneration policies will change under RDR and independents may no longer be able to rely on the commission safety net for survival. They will therefore need to be backed up by larger companies who can provide the necessary support structures to survive in this new world.
Editor's Thoughts:
If mergers and acquisitions benefit the market, then we may see a strengthening of an industry that was affected by the financial crisis. However, we can't afford to see a situation where a company makes an acquisition and then cuts jobs in an effort to reduce costs. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts jonathan@fanews.co.za.
