Mergers & Acquisitions Outlook through Summer 2014 and Full Year 2013 Review

We are in the first quarter of 2014 and data is now available for deal activity through the end of 2013. In this report, we will review ClearRidge’s most active industry sectors and provide an outlook through Summer 2014. These 8 industries are also among the most active sectors that drive M&A Activity in the Oklahoma and the Southern Midwest region:

i. Aerospace & Defense
ii. Aircraft Parts, Maintenance, Repair and Overhaul
iii. Chemicals
iv. Construction & Engineering
v. Energy: Oil & Gas
vi. Healthcare
vii. Industrial Manufacturing
viii. Transportation, Logistics, Distribution

Note: In the report, you will see that some of the deal data is for larger public companies. The most reliable and timely data tends to be for the larger companies in each industry; however, deal activity of largest corporations is also a good barometer for M&A activity among midsized companies in the same industry.

I. Aerospace & Defense

Compared to 2012, both deal volume and deal value dropped in 2013. In the past decade, there were an average of 268 aerospace and defense deals. In 2013, there were 242 deals, but more significantly the deal sizes were a small fraction of the ten year average, and approximately half the average deal value of 2012. So, a similar number of transactions, but most were middle market companies averaging $55 Million in transaction value in 2013.
Private-equity group (PEG) demand for Aerospace & Defensive companies dried up last year as many PEG owners became sellers. Strategic buyers were net purchasers of aerospace companies from PEGs.

One reason that demand remained weak within Aerospace & Defense was due to the increased investment by strategic companies in growing their own operations. Simply stated, many aerospace companies felt their dollars were better spent within their own production lines and R&D efforts. Despite recent media headlines about competition from Asian manufacturers, this industry remains American centered, and is likely to remain that way in the coming years.

According to a Price Waterhouse Cooper’s report, there is a “pent-up” demand for defense companies, and this demand could breathe some life back into this industry.

II. Aircraft Parts, Maintenance, Repair and Overhaul

Within Aircraft Parts, Maintenance, Repair and Overhaul, MRO made up 68% of M&A transactions in 2013, up from 32% just four years ago. One reason for the proportional surge of MRO is that spending and acquisition within the purely defense segment of aerospace has contracted due to government cuts and a lagging focus on the middle-east wars by the current political administration. There is an expectation that MRO activity and valuations will increase in 2014.

III. Chemicals

Year-over-year deal volume decreased by 30%, while total deal value decreased by 44%. More than half of all chemical deals last year occurred in Q4, suggesting a large uptick in demand for the first time last year. Financial investors were more influential in M&A in 2013 than the previous three years, with about 1/3 of all deals comprising PEG buyers. The chemicals industry is forecast to grow in 2014, providing a driver for increased M&A demand. Strategic investors will likely remain the dominant buyers in this space.

IV. Construction & Engineering

2013 Construction & Engineering M&A activity was adversely affected by Federal government sequestration and political uncertainty. The long cycle of this industry makes it particularly vulnerable to an unfavorable macroeconomic climate, and leaves managers slow to act. Still gun shy from the 2007 collapse, M&A Activity in the space remains constrained by risk aversion. This uncertainty hampered 2013 deal volume and value statistics, continuing a four year M&A decrease within C&E. During Q4, 2013 there was a solid pickup in deals compared to the first half of the year, but still a decrease when compared to Q4 2012.

In January 2014, a mega-deal occurred as AMEC purchased Swiss company Foster Wheeler. This $3.3 billion transaction is the largest in three years. This deal combined with an accumulation of positive housing data may be a harbinger of good times in C&E. US housing prices are at a respectable 150 on the Case-Schiller Index (as of February 19, 2014), and housing starts are on the rise too. The U.S. Census bureau claims that building permits and housing starts posted a 17.5% and 18.3% (respective) increase from 2012.

Note: ClearRidge’s investment banking experience engineering tends to focus more on industrial, energy and telecommunications applications.

V. Energy: Oil & Gas

Overall activity in oil & gas:
The first half of 2013 was sluggish after pent up demand from PEGs in Q4 2012 left a demand vacuum for the first half of the year. In Q3 2013 M&A Activity resumed, and Q4 witnessed another stellar quarter. The industry finished 2013 strong with 182 oil and gas company acquisitions during Q4. Many may criticize these numbers for not quite reaching Q4 2012’s record-setting breakout of 238 acquisitions, but demand is still strong. Within the U.S. economy, oil & gas remains one of the brightest spots, and Oklahoma is poised to absorb much of that growth.

If current trends continue, America is in the early stages of a petro-based economy renaissance. The 1970s actions of President Carter and OPEC led to America’s diminished role as the world’s oil capital. However, after forty years of net importation, the U.S. may be approaching the days when it can become more oil independent and, if de-regulated, will become an oil-exporter again (the 1975 quota and exportation ban still remains). The recent combination of high energy prices and improved technology allow for “tight oil” to come to market, leading to a boom in the heartland of the United States. Areas that many casually referred to as “tapped out” a decade ago are no longer being viewed as such.

M&A within the oil industry turned its focus to Shale in 2013, which has gained increasing investment attention from private equity. Shale is attractive because of its “quick hit” nature—these proven reserves are tapped more easily, and exhausted quickly. This allows companies to produce large quantities of oil when the price of crude shoots up, but still allow them the flexibility to decrease investment in production as soon as the price of oil begins to fall. This is an attractive proposition for PEGs; conventional oil wells often lead to negative economic profit (“dry” wells) and are three times slower to exhaust than tight-oil wells. Most PEGs prefer to exit out of investments within just 6 years of acquisition, and are often loathe to making large capital investments after buying companies, making shale play extremely attractive. This bodes well for the future of oil M&A.

Upstream led the charge for M&A in oil & gas in Q4 2013, comprising 59% of all acquisition activity in Q4 2013. 30 transactions were completed in Q4, at an average value of approximately $50 million.

Year-over-year, Q4 2013 saw a steep decline in transactions. Minimal midstream shale acquisition activity occurred, and as a result, only nine percent of all oil and gas M&A deals were primarily midstream.

A pickup occured during Q4. All of this follows a meltdown of only three deals in Q3 2013. Seven deals happened in Q4 at an average of $570 Million, and the current state of increased oil production means that refiners are poised to see growth in their business in the coming year.

Oilfield services:
Oilfield services experienced a decline in deal activity during Q4 2013. There were ten oilfield service deals announced in Q3 and only five during Q4.
Note: Within oil and gas, ClearRidge’s primary experience is in oilfield services, manufacturing and related industries.

VI. Healthcare

The fourth quarter picked up right where the third quarter left off in terms of growth for M&A. Q4’s 246 deals averaging $145 Million followed Q3’s numbers of 255 deals averaging $150 Million. Deal activity is strong right now, and reports suggest that 2014 will also be a great year for healthcare M&A. According to a Forbes report from December, four factors will prove essential to M&A activity in 2014: top-line stagnation, scalability, regulation, and consumerism.

Unable to grow the business through greater top-line numbers, companies will look to consolidate and differentiate themselves with bottom-line growth as their key goal and will achieve this growth by employing greater scalability. Regulation will require companies to manage and measure patient outcomes in more stringent ways than before; for example, new regulations dictate that healthcare providers will not be reimbursed for patient stays if patients enter the emergency room within 14 days of receiving treatment. Finally, greater consumerism surrounding healthcare will place a premium on healthcare marketing services.

VII. Industrial Manufacturing

Economic activity in the manufacturing sector expanded in October and, according to the nation’s supply executives in the latest ISM Manufacturing Report, the overall economy grew for the 56th consecutive month. The ISM’s January 2014 PMI number of 51.3 decreased from the seasonally-adjusted December number of 56.5 (a reading above 50 indicates expansion). In our last M&A report three months ago, the PMI number was at 56.4, indicating that the manufacturing economy was growing steadily. This month’s reading indicates a sector that is still growing, but with a slowing growth rate.
Industrial M&A ended the year poorly, with deal values matching a three-year low. Smaller deals became more prevalent. The strongest areas within industrial M&A are industrial machinery and energy related equipment. Compared to historical deal valuation, acquirers paid a premium for their new companies, suggesting that even with slowing activity in this sector, niche manufacturing is still attracting good valuation.

VIII. Transportation, Logistics, Distribution

After “anemic” transaction activity early last year, the Transportation, Logistics and Distribution industries ended with solid M&A activity. That said, deal activity was so slow during the first half of 2013 that even with the sharp pickup, 2013 was still one of the worst years in the past decade for M&A activity. In 2012 there were 210 deals averaging $412 Million, while 2013 declined to 185 deals averaging $350 Million.

The industry is trending toward fewer, but larger deals this year. On a positive note, Price Waterhouse Cooper forecasts 10.5% volume growth and 15.5% growth in deal value during 2014.

M&A across All Industry Sectors

Many analysts predict that 2014 is poised to be a record setting year for M&A activity. Seven years after the start of the financial crisis, companies are finally changing their attitudes about the economy. GDP growth is forecast at 3% for 2014, an improvement from the 1.9% realized in 2013, and a continuation on 2012’s positive 2.8% trajectory.

Understanding that top-line growth could be difficult to achieve following the financial crisis, many companies worked to become leaner. High levels of uncertainty led to risk aversion, particularly pertaining to expanding scale of operations. In response to the harsh environment, most companies refocused on improving operations in the five years following the crisis. This meant that companies divested non-core assets and released employees, raising cash in case of a further economic meltdown. The economy improved, and companies are now left with plenty of dry powder (excess working capital assets for deployment). Continued low-interest rates leave cash earning negative returns and make companies eager to invest money in growth initiatives and acquisitions, even if they are less focused on core operations. Positive economic forecasts suggest that 2014 may be the year when inactive capital is invested in both core opportunities and M&A.

ClearRidge Perspective for 2014

ClearRidge deal opportunities continue to gain very good visibility from industry strategic buyers and private equity groups, with the individual deal dynamics being the greatest determinant whether the buyer is a strategic, private equity or a blend of the two.

Bolstering our standard business practice at ClearRidge, our team is conducting extensive deal due diligence to remove obstacles to closing a transaction and ensuring that only the most likely buyers with the capital and commitment to close a transaction make it to the closing table.

Buyers are demanding increasingly thorough and professionally prepared information, earlier in their review of each acquisition opportunity, including deep level transactional and financial analysis. Companies that are better prepared prior to the sale process have been rewarded with higher valuations, smoother and less intrusive pre-closing due diligence, and a quicker cycle to closing the transaction.

Sources: This report has been compiled from government data, independent analysis, IBISWorld research, as well as PricewaterhouseCoopers, Deloitte M&A reports and other sources cited in the text.