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A backlog of M&A deals must be cleared before any new ones can be made, and that means raising more than $150 billion in leveraged debt
As the impact from the U.S. subprime loan crisis continues to reverberate on both sides of the Atlantic, Europe's mergers-and-acquisitions boom could be the latest casualty. Multibillion-dollar deals that once looked all but sewn up have been scrapped or delayed, and corporations and private equity players alike are reassessing their future takeover strategies in the wake of the downturn in the credit and equity markets.
Gone are the days when cheap credit and plentiful cash helped Europe jump to the top of the global league tables in M&A. Private equity deals alone topped $240 billion in Europe last year, up 41% from 2005, according to buyout firm Candover (CDI.L). And in the first six months of 2007, before the credit crisis unfolded, European M&A activity including both corporate and private equity takeovers hit a record $1.19 trillion, says researcher Dealogic (DL.L).
Now, to complete already announced deals, corporate and private equity buyers must raise more than $150 billion in leveraged debt. But with banks and other funding sources tightening their lending practices in the wake of the credit crunch, some of that money may never materialize, causing deals to be postponed or scuppered. The same phenomenon is also occurring in the U.S.
Distinction Between Deals
"In the short term, we will go through a period where a lot of deals will dry up," says Gabriel Stein, chief international economist at London's Lombard Street Research. "Banks are going to be unwilling to offer so much finance if they have to keep it on their own books."
One of the early warning signs of the impending tightening came on July 25, when gold-plated private equity firm Kohlberg Kravis Roberts failed to syndicate $10 billion in debt to finance a planned takeover of British pharmacy giant Alliance Boots. Just two days later, confectioner and beverage maker Cadbury Schweppes (CSG) shelved plans announced in March to spin off its U.S. drinks business due to "extreme volatility" in the credit markets.
The Alliance Boots and Cadbury stories underscore the new sentiment driving markets. Even in the current tense environment, deals will likely go through where financing is already secured or the attractiveness of the acquisition target is unquestionable. That's why analysts figure the Alliance Boots deal eventually will occur, because the drug distributor and retailer is seen as highly desirable.
Less Appealing Offers Uncertain
On the other hand, buyouts of distressed properties or acquisitions where the money is still to be raised could bite the dust. Cadbury's U.S. drinks business, for instance, faces uncertain prospects, even though it includes popular brands such as Dr. Pepper, 7 Up, and Snapple. That made a deal less appetizing for private equity buyers. "Things haven't panned out as Cadbury would have hoped," says Rob Mann, consumer analyst at London stockbroker Collins Stewart (CLST.L). "The only thing management can do is sit tight and ride this through."
The biggest question mark is the gigantic takeover battle for Dutch bank ABN Amro (ABN). The original bidder, London's Barclays (BCS), has offered $91 billion, some 63% of that in stock, yet its shares have tumbled nearly 25% since the acquisition was first announced, making completion of the deal uncertain. At the same time, a consortium of rival bidders including Royal Bank of Scotland (RBS.L) and Fortis (FOR.BR) has offered $95.9 billion, 93% of it in cash. But the banks still must raise $11.9 billion and $17.5 billion, respectively, to fund the deal. In the current market, they may not be able to dig up that money.
Strongest Still on Track
Other transactions look more likely to go forward. Analysts say that mining company Rio Tinto (RTP) has lined up most of the financing for its proposed $38 billion takeover of Canadian aluminum company Alcan (AL). Corporate mergers such as this, with strong fundamentals and concrete financial benefits for shareholders, are still on the fast track.
The same goes for the Imperial Tobacco's (ITY) proposed $22.3 billion takeover of Franco-Spanish rival Altadis (ALDS.PA). While the British tobacco company still must raise the needed capital in today's credit markets, analysts believe the company's core business remains highly lucrative, offsetting concerns about potentially higher debt costs. By creating Europe's fourth-largest tobacco company, the Imperial Tobacco-Altadis deal makes business sense, which shields it from the credit crunch.
Getting the Deals Done
Private equity deals that had already secured their financial backing before the recent subprime woes took their toll also should come through unscathed. Qatari-backed investment fund Delta Two, for example, remains confident it can pull off a $20.6 billion takeover of British supermarket chain J. Sainsbury (SBRY.L) despite the current credit issues, reassuring the market that it has the backing of its debt providers.
"Private equity firms are going to get these deals done," says Mark O'Hare, managing director of London researcher Private Equity Intelligence.
Still, the current correction is helping separate the wheat from the chaff, forcing players to reassess the economic value of deals. That's an essential step to bringing sanity back to the market after a prolonged bull run. "The global pipeline of leveraged loan deals that need to get placed before you can even think of new ones is huge at the moment," says Barnaby Martin, chief European credit strategist at Merrill Lynch (MER). That backlog has to be cleared out before Europe can even consider cranking up the M&A engines again.