European corporates: More action, less reaction

M&A has not been a major spread mover: While M&A headlines have had some effect on credit performance, it has been a secondary concern relative to operational stories such as Tesco, Phones4U and Banco Espirito Santo. In our view, this reflects continued discipline by management in making long-term, strategic acquisitions.

Despite rising M&A activity, we see few signs that corporates are undertaking excessively aggressive (or optimistic) acquisitions. While the focus has shifted away from disposals and rating-supportive manoeuvres, the emphasis is now on refocusing of businesses (by disposing of non-core assets) and cost reductions. Indeed, the major theme of H1 was (proposed) tax inversion deals by US large-caps, though the US government has since taken actions to dissuade companies from pursuing deals solely for this purpose.

What we have yet to see are blue-sky acquisitions (with optimistic growth forecasts and/or cost synergies for the acquired business) or corporate sprawl (in which companies expand beyond their core competencies). Activity has focused on mature assets with established business and growth profiles, as exemplified by the pass-the-parcel M&A activity in South American TMT assets. The highly consolidated and regulated nature of European markets has also been a factor on this front, with many proposed mergers requiring asset disposals to secure regulatory approval. Along similar lines, there have been a number of asset swaps as companies consolidate their business profiles, eg, GSK/Novartis and Diageo/Casa Cuervo.

M&A has not been a major spread mover: While M&A headlines have had some effect on credit performance, it has been a secondary concern relative to operational stories such as Tesco, Phones4U and Banco Espirito Santo. In our view, this reflects continued discipline by management in making long-term, strategic acquisitions.

Despite rising M&A activity, we see few signs that corporates are undertaking excessively aggressive (or optimistic) acquisitions. While the focus has shifted away from disposals and rating-supportive manoeuvres, the emphasis is now on refocusing of businesses (by disposing of non-core assets) and cost reductions. Indeed, the major theme of H1 was (proposed) tax inversion deals by US large-caps, though the US government has since taken actions to dissuade companies from pursuing deals solely for this purpose.

What we have yet to see are blue-sky acquisitions (with optimistic growth forecasts and/or cost synergies for the acquired business) or corporate sprawl (in which companies expand beyond their core competencies). Activity has focused on mature assets with established business and growth profiles, as exemplified by the pass-the-parcel M&A activity in South American TMT assets. The highly consolidated and regulated nature of European markets has also been a factor on this front, with many proposed mergers requiring asset disposals to secure regulatory approval. Along similar lines, there have been a number of asset swaps as companies consolidate their business profiles, eg, GSK/Novartis and Diageo/Casa Cuervo.

The IPO market has cooled: After a busy start to 2014, investor appetite for IPOs has waned in the second half, shutting off a potential exit avenue for sponsors. Facilitated by recent deal features such as portability and short non-call periods, this is likely to result in another round of secondary and tertiary buyouts next year.

LBO activity has ebbed slightly, but should rebound: Sponsors have raised significant capital and have ample access to debt funding at attractive levels, but deterioration in the growth outlook has reduced their willingness to pay for assets, relative to competing strategic buyers. A gradual improvement in growth prospects and strong demand for loans from ramping CLOs should boost sponsor purchasing power next year, leading to a modest pickup in LBO activity.

The key factor constraining corporate activity is the outlook for global inflation and growth: Consensus forecasts for European growth and inflation have fallen steadily over the course of 2014, which fed through to EPS expectations in the first half of the year. In our view, this decline in economic expectations is the key headwind to corporate activity. From a simple valuations perspective, the more pessimistic an acquirer’s growth expectations are, the less attractive M&A appears when viewed through the prism of PV calculations. While the cost of debt (all-in yields) has declined to record lows in both €-IG and €-HY, the fall in funding costs has been slower than the fall in nominal growth expectations

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