Investment bankers don’t get paid to be pessimists. Throughout the current slump in takeovers, mergers and acquisitions (M&A) advisers have said a recovery was around the corner, awaiting a stronger U.S. economy, rising stock markets, or an end to the European debt crisis.
All three of those conditions have now been satisfied, yet deal-making has remained stagnant as CEOs continue to worry about the viability of the economic recovery. The final three months of 2013 saw announced takeovers slide by almost a third from a year earlier, even as the outlook improved in Europe and North America, according to data compiled by Bloomberg.
The sustained slump has flummoxed M&A bankers, whose employment depends on the prospect of deals. It may portend a shift to lower takeover volumes, which are now at their lowest ebb as a proportion of stock-market capitalization since the 1990s, Deutsche Bank AG data show. The best bet for a deals recovery in 2014, some bankers say, is a run of economic growth that’s not propped up by U.S. Federal Reserve bond-buying, which the central bank this week began to curtail.
“As an industry, we have been a little bit naïve in anticipating a more rapid recovery,” Hernan Cristerna, global co-head of M&A at JPMorgan Chase & Co., said in a Bloomberg Television interview. “We’ve been working on so many great deals that have not seen the light of day, because boards wanted to see a nine or a 10 out of 10—an eight was not enough.”
Global takeovers in the fourth quarter through yesterday fell 31 percent from a year earlier, to about $505 billion as of yesterday. The value of deals in North America and Europe dropped about 40 percent, while Asia declined 18 percent.
For the year, transactions rose just 0.4 percent to $2.25 trillion, well short of the $4.1 trillion high-water mark of 2007, while the number of deals fell 5 percent. This year’s volume was buoyed by one giant trade: Vodafone Group Plc’s $130 billion sale in September of its stake in Verizon Wireless, the largest M&A transaction in a decade.
On paper, “this is a great environment for deals based on incredibly low interest rates and an abundance of available capital,” said Gregg Lemkau, the global co-head of M&A at Goldman Sachs Group Inc. in London.
Yet CEOs haven’t felt an urgency to act, with no certainty about the timing of a rise in rates, Lemkau said. They also remain cautious about the economy as monetary policy rather than “real underlying outperformance of companies” drives equity prices, he said.
Federal Reserve Chairman Ben Bernanke this week extended the timeline for keeping interest rates near zero, while announcing a $10 billion reduction in monthly asset purchases. Bernanke said the measures were aimed at keeping “the level of accommodation the same overall” in the world’s largest economy.
A dearth of deals in banking and natural resources is partly to blame for bankers’ mistaken predictions of a rebound.
Purchases of financial-services companies totaled $120 billion this quarter, down 28 percent from a year ago. Large mergers are all but unthinkable for financial institutions dealing with U.S. and European regulatory changes, and are likely to face tough questions from governments wary of creating too-big-to-fail banking giants.
A recovery in financial sector M&A could develop once Europe’s banking union regulations are finalized, stabilizing the regulatory landscape, said Tom Cooper, co-chairman of global M&A at Deutsche Bank.
For energy and mining firms, weaker prices for oil, gas and metals and a long list of failed transactions from the 2002-2012 commodity boom are keeping chief executives from pulling the trigger.
Writedowns on aluminum and coal deals led to the ouster of Rio Tinto Plc CEO Tom Albanese earlier this year—part of the hangover from a $1.1 trillion M&A spree in natural resources over the last decade. Energy and mining companies spent about $66 billion in transactions in the quarter, less than half the $155 billion in the same period of 2012.
In the U.S., while the shale gas and oil boom has led to increased takeovers of energy services and pipeline companies, it has depressed dealmaking in the exploration market, said Alan Klein, a partner with law firm Simpson Thacher & Bartlett LLP.
“Prices have sharply declined in gas and to some extent have been flat in petroleum,” Klein said. “There is less interest in acquiring or consolidating in that area.”
Asia, where the growing economies of India and China have driven global demand for energy and minerals, is also unlikely to see “a full return of deals” in the natural resources sector, said Samson Lo, head of Asia M&A at UBS AG in Hong Kong. Chinese state-owned oil and gas enterprises are distracted by corruption probes while the tapering of Fed bond purchases will make global investors more cautious, Lo said.
Still, some companies in other sectors are taking the plunge. Dealmaking has remained busier in healthcare as well as telecom, media, and technology, or TMT—industries in which companies are contemplating takeovers to cope with, or take advantage of, the quickening pace of innovation.
The largest health deal of the quarter was San Francisco-based McKesson Corp.’s agreement to acquire German pharmaceutical distributor Celesio AG for about $4.9 billion, contributing to a total of $45 billion in spending on the sector, up from $30 billion last year.
In TMT, Portugal Telecom SGPS SA and Oi SA, which offers mobile services in Brazil, led the way with a merger valued at about $14.3 billion in October. Today, Oracle Corp. said it agreed to pay about $1.5 billion for Responsys Inc. to gain marketing software.
The current level of overall transactions is still respectable by historical standards, argues Scott Moeller, a former Deutsche Bank banker and professor at London’s Cass Business School. It’s similar, he said, to that of the pre-boom period of the early 2000s—around $2 trillion to $3 trillion a year compared with upwards of $3 trillion at the 2006-2007 peak.
“That’s not Armageddon,” he said. “This plateau that we have is a huge figure, even taking inflation into account. We should not be complaining. This is a good healthy number for where the economy is right now.”
Banks aren’t as pleased, and are trimming headcount as the slump in advisory fees persists. The 10 largest global securities firms will probably cut about 3,000 front-office jobs in 2014, Deutsche Bank analyst Matt Spick said in a Dec. 4 note.
“We’re not done, not even close, to the industry shrinking down,” said Scott Bok, chief executive officer of advisory firm Greenhill & Co. Inc.
Historically, the level of M&A has hovered around 7.7 percent of the total value of global stock markets, according to Deutsche Bank. The current figure is about 4.6 percent, meaning a rise even to 6 percent would require takeover volumes to increase by just under a third.
That won’t stop bankers from looking on the bright side, said Moeller.
“Remember, nobody is ever hired to be an M&A banker, and nobody ever gets promoted to managing director, who is not an optimist,” he said. “They are people who see the glass half-full, even if it’s really only a quarter full.”