Where are the M&A adventurers?

Last year was a shocker for merger and acquisition activity and the slump is set to continue. With global threats looming it's understandable, but there is still opportunity out there.

There is a sense of doom pervading the investment banking sector, with continuing job losses and the lowest levels of capital market and mergers and acquisitions activity for probably the best part of a decade, which is odd, given that the settings for corporate activity are actually quite propitious.

There is no doubt that 2012 was a terrible year for investment banks globally and they responded by carving into the ranks of their capital markets and advisory teams.

If one looks at the biggest locally-listed investment bank, Macquarie, its securities business lost $175 million in the March half and another $64 million in the September half. Macquarie Capital made a profit of $10 million in the September half, well down on the $77 million it generated in the March half.

Between them those two market-facing businesses shed nearly 500 people in 12 months, with the attrition continuing. Not surprisingly, given the drag on the entire group’s return on equity created by the poorly-performing businesses, there have been calls for Macquarie to exit those segments.

It isn’t just Macquarie. Globally investment banks have been ravaged by the low levels of corporate activity and have, if not exiting business dependent on equity markets and mergers and acquisitions, then significantly downsizing their staff in those businesses. It is a natural, rational and time-honoured response to the drying up of activity which is client-driven.

What’s odd about the stresses being experienced by the sector is that the broader settings ought to be conducive to a rebound in corporate activity and investment banking earnings.

Corporate balance sheets are generally in good shape, equity markets have rebounded – the Australian market is nearly 13 per cent above its level a year ago – the cost of debt is at historically low levels and offshore acquisitions look more appealing given the strength of the Australian dollar.

So far the only sectors to try to take advantage of the conditions have been private equity firms preying on distressed corporates, although the activity around Australand might been the first sign of a rekindling of traditional corporate activity by domestic entities (the US-headquartered Archer Daniels Midland’s stalking of Graincorp is, given the currency relativities, a quite unusual situation).

Australand’s majority shareholder, Singapore’s CapitaLand, is conducting a strategic review of its 59 per cent shareholding in the local vehicle after the "unsolicited" approach from GPT in December and speculation that Mirvac, too, had expressed interest.

With property yields strong, debt funding costs at historical lows, equity markets at their highest level for about 18 months and the property trust sector having been deleveraged dramatically since 2008, strategic activity within the sector makes a lot of sense. It is even more compelling if the potential vendor is an offshore group able to profit from that remarkable surge in the value of the Australian dollar over the past three years.

That basic equation of the historically low cost of debt, conservative balance sheets and reasonably strong equity markets ought to trigger a bout of corporate activity. It may, however, not do so.

Companies can be like lemmings. Mergers and acquisition activity tends to generate mergers and acquisitions activity, with companies feeling more comfortable with risk-taking when everyone else is taking risks. That’s probably why acquisitions generally don’t add value – they occur when values are inflated and there is competition, real or prospective, for assets, which causes companies to over-pay.

At the moment companies are exceptionally defensive and risk-averse and to the extent that they have excess capital or cash flows prefer to give some of it back to shareholders than use it to expand by investing significantly or through acquisitions.

That’s understandable. The global economy remains low-growth and brittle, with Europe still on the brink of something unpleasant, the US struggling to deal with its debt and deficits and China’s economy is volatile. Here there is a federal election looming this year which corporate Australia appears to be hoping will, whatever the outcome, end the experiment with minority government.

The pessimism and risk-aversion, however, when coupled with historically low interest rates and a relatively strong equity market ought to represent an opportunity of the "straw hats in winter" variety for companies otherwise struggling to see where their organic growth might come from and an obvious sales pitch for the investment banks that have been hanging onto their diminished presence in capital markets and corporate advisory in the hope of an eventual pick-up in activity.

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