Frankfurt/Main – While the economic parameters are not yet signalling a real crisis, the relevant indicators are deteriorating. German companies are already preparing for an economic downturn. Companies are less interested in acquisitions, with the focus now switching to reducing costs. One indication of this is that corporate M&A managers expect significantly more carve-outs. That is the finding of this year’s second survey of the M&A panel polled by international commercial law firm CMS and FINANCE magazine. Senior employees from M&A departments at German companies plus investment bankers and M&A consultants provide anonymous assessments of the market for the survey.
Cost cutting gaining in importance as a deal driver
A look at the current key deal drivers shows that companies are hunkering down for challenging times. In boom periods, M&A motives such as accelerating growth, expanding into new markets or acquiring suppliers are frequently cited. Now, indicators associated with crisis situations, such as cost cutting and consolidation, have gained in importance. The surveyed corporate M&A representatives widely agree with the proposition that market consolidation is essential in order to survive future crises, with a score of 6.22 out of 10 (spring value: 5.67; 10 = full agreement). Accelerating growth nevertheless remains the most important deal driver for M&A professionals, with a score of 8.07. Having said that, cost cutting has become a significantly higher priority than in the spring survey, ranking 6.04.
Wave of carve-outs on its way
Along with the increased importance of cost cutting and consolidation as deal drivers, the surveyed company representatives anticipate substantially more carve-outs. Two thirds of the respondents expect more spin-offs within the next two years, i.e. a slight to moderate rise. None of the respondents expect a decline, while 33% expect no change. Dr Thomas Meyding, Corporate partner at commercial law firm CMS Germany, has noted the trend towards more carve-outs in his work for some time now: “Carve-outs are in vogue: divisions are being spun off and sold, large groups split up to create holding structures – often without any urgent need for a transaction.” Carve-outs often go hand in hand with M&A transactions, added Meyding. This could be because the company wants to divest itself of non-core operations, needs to raise cash, or due to a major M&A transaction requiring the disposal of a division – possibly as a regulatory condition. Meyding stressed that companies considering spinning off a subsidiary need to be aware that carve-out processes are extremely complex and require careful preparation.
Focus on core business
Around two thirds of the surveyed corporate M&A representatives cited a stronger focus on the core business as the main motivation for spinning off subsidiaries. 30% give low profitability of a division or lower growth compared to other business units as the reason for a spin-off. Only 10% of respondents report that carve-outs are used to create financial leeway for new acquisitions. It’s noteworthy that carve-out processes are not only initiated by companies themselves. As Dr Thomas Meyding observes, activist shareholders often demand the sale of a subsidiary: “Activist shareholders push for highly profitable subsidiaries to be sold off. Many large corporations are already responding to this trend by creating holding structures, making each of the divisions legally independent in order to be prepared for turbulence ahead.”
In line with the expected increase in carve-outs, companies are generally being more cautious in their M&A activities. The surveyed M&A managers still see themselves clearly in the buying camp, as evidenced by a score of 7.53 on a scale from 1 (firmly seller) to 10 (firmly buyer), but this is the first time in two years that the score has fallen below 8.
Automotive activity at record low
Looking at the M&A consultants included in the survey reveals that they agree with corporate M&A managers in many respects. Respondents from consulting firms and investment banks likewise attach increasing importance to cost cutting (up from 5.89 to 6.08) and sector consolidation (up from 7.14 to 7.58) as deal drivers compared to the spring survey. They are particularly wary of cyclical sectors such as automotive and mechanical engineering, where they have recently seen the lowest levels of M&A activity. On a scale from 1 to 10 (very active), the consultants rate the automotive sector at just 4.52 (the lowest figure since February 2011). Engineering is similarly unpopular, with a score of 4.73. “It’s hardly surprising that M&A activity is declining in sectors such as automotive and engineering,” said Dr Oliver Wolfgramm, Corporate partner at CMS Germany, echoing the panel’s findings. The effects of declining activity in the M&A market are being felt most strongly by industries that are under huge pressure to innovate, are very export-oriented and are currently undergoing massive transformation, according to Wolfgramm. Yet this also opens up opportunities for buyers with a different focus: “We are seeing investors who recognise opportunities in an M&A environment where competition is less intense.”
Drop in deal flow forecasts for small, mid and large cap deals
The cautious stance of companies in some industries is already being reflected in the workload of M&A consultants. At 1.25, they still rate their current project deal flow as slightly above average (on a scale of -5 to +5, where 0 represents average project deal flow). However, this figure has been falling steadily since February 2018 and is currently at its lowest level since autumn 2014. The drop in deal flow is being felt by the surveyed M&A advisors across all transaction sizes. “So far, it looks like 2019 will trail 2018 in terms of M&A activity,” commented Dr Oliver Wolfgramm with regard to the current situation. Ultimately, he added, it remains to be seen how international crises and trade disputes continue to affect M&A activity, along with the future relationship between the UK and Europe.
After the latest sobering experiences, consultants have also cut their most recent very optimistic forecasts for future project deal flow. Looking ahead to the next three to eight months, they are now only forecasting project deal flow of 1.23, the lowest score since this projection indicator was first included in the survey in autumn 2014.
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