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Forex Market News - Credit Market Analysis -Why global M&A will remain strong this year

Credit Market Analysis

Why global M&A will remain strong this year

Global M&A volumes have already surpassed $2 trillion this year
Global mergers and acquisitions (M&As) activity surged to $3.5 trillion in 2006, according to Bloomberg data, up 36% on the previous year. So far in 2007, M&A volumes have already reached $2.2 trillion, up about 55% on the same period of 2006, suggesting a possible total of over $5 trillion this year. This is a significantly higher level than $1.1 trillion for the whole of 2002 which was related to the bursting of the dotcom bubble, as chart a shows. Since the turbulent events of the post-bubble shakeout, the corporate sector has been reducing debt and rebuilding balance sheets, while growth in developed economies has recovered and strengthened, boosting profits and supporting equities.

More recently, the benign macroeconomic and financial market environment characterised by low volatility has encouraged investors to take more risks and seek higher returns, while historically low interest rates and looser credit standards has led to an abundant supply of liquidity. This environment has encouraged corporates to releverage their balance sheets again, while the glut of liquidity has encouraged the increasing participation of new players, such as private equity funds.

How sustainable is the current M&A boom?
There are some notable differences between the global M&A boom this time compared with the previous boom in 1999-2000:

(a). Cash has become the dominate method of funding M&As in this boom. Bloomberg data show that 83% of deals last year were financed by cash, while only 9% of deals were financed by equity and 8% by a mixture of payments, see chart b. Debt is rarely used at the point of an acquisition. The increased use of cash reflects the cheap sources of finance available, which has led to an abundant supply of liquidity and also suggests that, unlike the period of the dotcom boom, firms are less inclined to use inflated equity valuations to fund M&A deals.

(b). New participants such as private equity funds have become increasing involved in M&A, buoyed by the abundant supply of liquidity and by demand for securitised products from investors seeking higher yields. This also suggests that risks are now spread among a more diverse set of investors. Bloomberg data suggest that private equity funds were involved in $675bn of M&A activity last year, or 19% of the total, up from 2% in 2001, see chart c.

(c). Growth in M&A in the emerging markets and the euro zone last year outpaced the US and UK. The volume of M&A activity rose just below 40% in the US and UK last year, while it increased 60% in the EU-12 and 63% in Asia-Pacific (ex-Japan).

(d). In addition, the sectoral breakdown of M&A activity is much broader this time. In 1999-2000, the communications sector, including media and telecoms, accounted for 36% of M&A volume, according to our calculations from Bloomberg data. In 2005-06, that sector accounted for only 14%, with rises in the proportion of M&A activity accounted for by other sectors, such as financials, real estate, energy and utilities.

(e). Deal premiums rose to 18% in 2006, up from 15% in the previous two years, and currently stand at 20% for the latest three months to May. However, this compares with higher average premiums of around 30%, during the dotcom boom period of 1999-2000, according to the Bloomberg data, see chart d. This suggests that M&A risk appetites are currently not significantly excessive, with still only two-thirds of their 2000 levels.

The M&A impact has been positive for equities, but less so for credit
The mere threat of a private equity buyout is leading to further consolidation in some sectors and a releveraging of balance sheets, benefiting shareholders. However, while rising equity prices are positive for the credit sector, the increase in M&A and related leveraged buyout activity at the current stage of the cycle suggests that the gains for credit are likely to be limited. Indeed, we expect default rates and corporate spreads, already at historically low levels, to widen moderately this year and into next year, see table 2 on the first page.

Overall, our expectation is that the current M&A boom, supported by abundant liquidity levels, may be more sustainable than the previous dotcom-related boom. After all, as we have shown, M&A activity this time is financed more by cash and is more broadly based in terms of sectors, while deal premiums remain well below levels in the previous boom. However, a slowdown in deal flow is 2008 is likely as monetary policy is tightened globally.
Hann-Ju Ho, Senior Economist

* All data and charts are sourced to Lloyds TSB Corporate Markets Economic Research, Merrill Lynch and Bloomberg.
Any documentation, reports, correspondence or other material or information in whatever form be it electronic, textual or otherwise is based on sources believed to be reliable, however neither the Bank nor its directors, officers or employees warrant accuracy, completeness or otherwise, or accept responsibility for any error, omission or other inaccuracy, or for any consequences arising from any reliance upon such information. The facts and data contained are not, and should under no circumstances be treated as an offer or solicitation to offer, to buy or sell any product, nor are they intended to be a substitute for commercial judgement or professional or legal advice, and you should not act in reliance upon any of the facts and data contained, without first obtaining professional advice relevant to your circumstances. Expressions of opinion may be subject to change without notice. Although warrants and/or derivative instruments can be utilised for the management of investment risk, some of these products are unsuitable for many investors. The facts and data contained are therefore not intended for the use of private customers (as defined by the FSA Handbook) of Lloyds TSB Bank plc. Lloyds TSB Bank plc is authorised and regulated by the Financial Services Authority and is a signatory to the Banking Codes, and represents only the Scottish Widows and Lloyds TSB Marketing Group for life assurance, pension and investment business.


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