Barometer. 10th. Pursuing value in growth. Middle East and North Africa Capital Confidence M&A

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1 Middle East and North Africa Capital Confidence April 2014 ey.com/ccb 10th edition Barometer Pursuing value in growth M&A Transaction outlook improves as valuation gap narrows Economic outlook Economic prospects rebound amid improved political stability Access to capital Credit availability is stable as cash dominates deal finance Growth strategies Cost reduction challenges growth in boardroom agenda

2 Pursuing value in growth Encouraged by strong business and economic confidence locally, plus an increase in corporate earnings expectations, the outlook for Middle East and North Africa () transaction activities remain optimistic. Key findings 74% 78% 69% 54% 75% 33% 41% see improvement in the local economies have confidence in corporate earnings a significant improvement from six months ago (57%) say they will finance deals primarily with cash in the next 12 months anticipate increased job creation in their organization expect local M&A deal volumes to increase over the next 12 months expect to pursue acquisitions over the next year see either no valuation gap between buyers and sellers or a gap of less than 10%

3 Economic confidence and the willingness to do deals has improved, amid a slightly more stable regional political environment and greater comfort with current valuation levels. A note from Phil Gandier, Service Line Leader, Transaction Advisory Services Our latest Capital Confidence Barometer sees a number of indicators supportive to the transaction environment. A strong growth outlook, combined with easy credit access and robust earnings expectations looks likely to encourage companies to pursue acquisitions primarily in emerging markets, as well as in mature economies. As a blend of frontier and emerging markets, countries possess a number of unique advantages. Cash levels in businesses continue to remain high; this coupled with a diminishing valuation gap between buyers and sellers could lead to more deal closures over the coming months. Additionally, many companies have promising deal pipelines which could be a catalyst for more transaction activities. Encouraged by strong business and economic confidence locally, plus an increase in corporate earnings expectations, the outlook for deal volumes remains optimistic. When it comes to the propensity of companies to engage in M&A, there are more significant disparities across individual sectors than in the global sample. Companies in the automotive, life sciences and mining and metals industries report the highest appetite to acquire, while those in the oil and gas and power and utilities industries with a lower acquisition appetite. Despite the deep liquidity that has to offer an element of caution remains amongst the backdrop of continued global and regional political instability. A note from Pip McCrostie, Vice Chair, Transaction Advisory Services For leading global corporates, striking a balance between risk and reward has rarely been so difficult. Companies are grappling with geopolitical instability, a fragile global economic recovery, and seismic shifts in megatrends such as structural changes in the workforce and digital transformation all at a time of unprecedented shareholder activism. Many executives are now navigating this complexity with parallel priorities. Value is being sought today through a renewed focus on cost-management strategies and returning rewards to increasingly active shareholders. At the same time, some executives are also seeking value creation and top-line revenue through innovative organic growth and measured deal-making. Larger, more transformational M&A is on the strategic growth agenda. Pipelines point to only modest increases in deals as low volume becomes the hallmark of a low-growth environment. Increased deal values, rather than volumes, will likely be making headlines in the coming year. After a prolonged financial crisis and M&A market malaise, companies and boards are opting for quality rather than quantity. 1

4 Economic outlook Economic prospects rebound amid improved political stability respondents remain more confident about both the global and local economic outlook than they were six months ago. This shift is particularly notable in attitudes toward the local economy, where the number of respondents seeing a decline has dropped sharply since October. Respondents are also substantially more bullish about market conditions in general, compared with six months ago, with a majority expressing confidence in both corporate earnings and equity valuations. Like their global counterparts, companies see the future of work (i.e., meeting the skills required for the future workforce), including the competition for talent, as the most important global trend affecting their business and acquisition strategies. They are more likely than global executives to cite it as the most important trend having an impact on their business strategy. executives continue to maintain an element of caution as more than half of the respondents selecting global political instability as the greatest economic risk to their business over the next 6 to 12 months. confidence in the global and local economies remains strong respondents remain positive about the state of the global economy, with 61% saying the economy is improving, up from 32% six months ago. They are even more bullish about local economic conditions, with 74% seeing improvement the highest number in the past year. Significantly, just 3% say the economy is declining, down from 15% six months ago and 14% a year ago. Optimism about corporate earnings and market outlook Strong evidence that the recovery is real can be found among our respondents perception of various financial indicators. At a global level, confidence in corporate earnings is high; and year-over-year growth in indicators such as stock market outlook and short-term market stability show similar conviction. In, executives are substantially more upbeat about local market conditions than they were in October, with 78% positive about corporate earnings 21% higher than six months earlier. Similarly, 60% are optimistic about equity valuations the highest number in the past year. Future of work megatrend to shape corporate strategy Macro trends affect companies corporate strategies, which can have a direct impact on acquisition behavior. When asked about which trend could have the greatest impact over the next 12 months more than half of global executives pointed to the trend commonly called future of work skills shortages, competition for talent and changing employer-employee obligations, among other issues. This trend, particularly in skills shortages and competition for talent, is likely to have the strongest impact on companies over the next year, with 67% expecting it to affect business strategy and 51% seeing an impact on acquisition strategy. 2

5 Renewed confidence Q: What is your perspective on the state of your local economy today? Improving Stable Declining economy 16% 21% 23% 22% 13% 32% 46% 61% 66% Improving Stable Declining economy 23% 12% 25% 3% 15% 14% 74% 73% 61% 74% say the local economy is improving Q: Please indicate your level of confidence in the following: economy economy Corporate earnings Equity valuations/ stock market outlook Short-term market stability Credit availability 61% 37% 67% 57% 38% 52% 53% 44% 47% 43% 47% 40% Corporate earnings Equity valuations/ stock market outlook Short-term market stability Credit availability 78% 57% 65% 60% 51% 44% 59% 48% 62% 53% 59% 53% 78% of executives are upbeat about corporate earnings Q: Which of these global trends is most likely to impact your business and acquisition strategy over the next 12 months? Select up to two. Future of work Digital transformation rebalancing Resourceful planet Rethinking government economy 54% 42% 39% 41% 38% 34% 30% 35% 28% 31% Future of work rebalancing Rethinking government Resourceful planet Digital transformation economy 24% 23% 21% 21% 20% 34% 67% 51% 50% 44% 67% of executives expect competition for talent to affect business and acquisition strategies Business strategy Acquisition strategy 3

6 Economic outlook, cont d. Executives remain confident in the local economy Continued job creation in the region At the global level, job creation expectations have decreased across multiple sectors. Employment continues to lag behind the economic recovery, which in turn may reflect longerterm structural changes in the workforce. However, there is a positive outlook within as more than half of respondents (54%) expect to create jobs or hire talent, up from 49% six months ago. This can be linked to an upturn in economic activity prevalent in the GCC markets; particularly in the UAE, Qatar and Saudi Arabia. Political instability is seen as a leading economic risk Throughout the five-year history of the Barometer, geopolitical shocks have persistently held back our global respondents economic and business confidence. While corporate leaders now factor some global risk into their business, specific macro events can affect near-term confidence. For the next 6 to 12 months, executives see this factor as a more prevalent threat compared to their global peers whereby more than half (53%) of those surveyed in see political unrest as the greatest risk to their businesses, compared with 30% of global respondents. 4

7 Q: With regard to employment, which of the following does your organization expect to do in the next 12 months? 17% 11% 10% 41% 48% 52% Reduce workforce numbers 48% 42% 31% 6% 5% 12% Keep current workforce size 40% 46% 28% 54% 60% 49% Create jobs/hire talent 54% of executives see changes leading to more job creation Q: What do you believe to be the greatest economic risk to your business over the next 6 12 months? Increased global political instability Continued slower growth in key emerging markets Inability to effectively manage quantitative easing (tapering) Pace of structural reforms in Eurozone Inflation Deflation 30% 26% 21% 14% 6% 3% Increased global political instability Continued slower growth in key emerging markets Deflation Inflation Inability to effectively manage quantitative easing (tapering) Pace of structural reforms in Eurozone 53% 29% 7% 6% 4% 1% 53% of executives see political unrest as the greatest economic risk to their business 5

8 Access to capital Credit availability is stable as cash dominates deal finance executives generally report stable access to credit, and strong liquidity levels make cash the preferred form of deal financing for a large majority of those surveyed. respondents are more likely than their global peers to opt for cash as their primary source of deal financing over the next 12 months. While the majority of companies surveyed do not feel the need to refinance loans or other debt obligations, those that have plans to refinance are less likely to extend debt maturities compared to six months ago. Cash remains king continues to demonstrate its prominence as a key liquid market where deal financing does not hold them back when it comes to deal execution. Cash is clearly the preferred form of M&A financing for companies, with 69% saying it would be their primary source; this is significantly higher than the 36% of global companies who prefer cash. Confidence in local credit access remains stable Over half of respondents (53%) say they are confident in credit availability at the local level, equivalent to levels a year earlier, and down from 59% six months ago. Yet, the number reporting a decline in credit confidence has also fallen steadily to 6% in the current survey, compared with 10% six months earlier and 12% a year ago. Less demand to refinance The majority of executives (63%) do not plan to refinance loans or other debt obligations in the next 12 months. However, the drivers for those who plan to refinance are to extend debt maturity (27%), reduce interest cost (23%) and optimize their capital structure (23%). 6

9 Strong liquidity as cash remains king Q: What is the likely primary source of your company s deal financing in the next 12 months? 19% 19% 16% 30% 34% 45% 47% 54% 36% 7% 24% 12% 13% 31% 16% 69% 75% 53% 69% of executives say cash is their preferred source of deal financing Equity Debt Cash Q: Please indicate your level of confidence in credit availability at the local level: 6% 10% 12% 41% 31% 35% 59% 53% 53% 53% are confident in access to local credit Declining Stable Improving Q: Does your company plan to refinance loans or other debt obligations in the next 12 months? 61% 39% 63% 37% 65% 35% 76% 24% 71% 29% 50% 50% 63% of executives do not want to avail refinance or credit in the next 12 months No Yes 7

10 Growth strategies Cost reduction challenges growth in boardroom agenda companies are increasingly looking to optimize their capital position, with cost and efficiency concerns increasingly surpassing growth as the key driver of corporate strategy. Nearly half of those surveyed say cost reduction and operational efficiencies will be their main focus over the next 12 months, eclipsing the number who say they will concentrate on growth. This represents a reversal from preferences both six months and a year ago. A clear majority also say cost reductions would be the top item on their boardroom agenda, well ahead of their global counterparts. respondents expect inorganic growth to make a relatively small contribution to their company s business strategy in the current fiscal year. Cost optimization dominates corporate strategies The pressure remains for global companies to grow, in spite of slower long-term GDP growth. But lessons learned from the global financial crisis mean that closer scrutiny of cost structures and operational efficiency is now the norm. What is emerging is a model whereby companies increasingly seek out new growth opportunities but do so within a strong framework of operational efficiency and cost management. Just under half of respondents (47%) say their company s focus over the next 12 months will be on cost reductions and operational efficiencies more than double the 22% who said so in October, and well above the 32% who emphasized cost cuts a year ago. This signifies a shift from growth to optimizing capital activities. Acquisitions likely to make up a smaller portion of planned revenue growth Due to boardroom agendas having an increased focus on cost optimization and operational efficiency; executives report that acquisitions are expected to make up a smaller portion of revenue growth for the current fiscal year: 57% said acquisitions would account for less than 25% of growth, while just under a third said it would make up 25% 50% of revenue increases. 8

11 Focus on optimizing costs Q: Which statement best describes your company s focus over the next 12 months? 6% 17% 37% 40% 2% 8% 2% 15% 4% 21% 3% 24% 32% 31% 22% 47% 58% 52% 51% 28% 47% of executives say their company s main focus for the next year will be cost reductions 0% 24% 32% 44% Survival Maintain stability Cost reduction and operational efficiency Growth Q: What percentage of your planned growth for the current fiscal year is explicitly assigned to acquisitions? Less than 25% 25-50% Greater than 50% 6% 39% 55% Less than 25% 25-50% Greater than 50% 11% 32% 57% 57% of executives say acquisitions will count for less than 25% of growth 9

12 M&A Transaction outlook improves as valuation gap narrows companies take an optimistic view of the prospects for local M&A deal volumes over the next year. Sentiment is also bolstered by the perception that valuations have reached more realistic levels. Most companies expect local deal volumes to improve over the next 12 months, with a third expecting to see their own company pursuing transactions this year. companies report more deals in the pipeline than their global counterparts. The general optimism over the deal environment is underpinned by a narrowing of the deal valuation gap since the last survey, with respondents expecting the valuation gap to contract further over the next 12 months. There are more significant differences across individual industries when it comes to the likelihood of companies to engage in M&A than is the case among global companies. Companies in the automotive, life sciences and mining and metals industries have the highest appetites to acquire, while those in the oil and gas and power and utilities industries are less likely to do so. Bullishness about local M&A volume growth as a whole companies are overwhelmingly upbeat about the outlook for M&A volume growth over the next year, with 75% expecting to see an improvement. companies report a larger deal pipeline than their global counterparts, with 38% reporting five or more deals on hand for the next year, compared with just 15% of global respondents. Willingness to pursue acquisitions on the rise companies are more likely to pursue deals in the next 12 months with 33% saying they planned to do so, compared with 31% of global companies. However, the confidence of respondents in the global number, quality and likelihood of closing deals remains relatively stable. Valuations come down to earth Optimism is being driven by perceptions that the valuation gap between buyers and sellers is narrowing. Forty-one percent of respondents believe there is either no gap at all or one that is 10% or less, compared with just 28% who thought so in October. Moreover, 39% of executives expect the valuation gap to contract further in the next 12 months, compared with 28% six months earlier. The number predicting the gap will widen is just 9% half of the 18% who expected a wider gap a year ago. 10

13 Deal appetites increase Q: What is your expectation for local M&A/deal volumes in the next 12 months? Improve 75% Remain the same 23% Decline 2% 75% expect improvement in M&A volumes over the next year Q: What is your expectation to pursue an acquisition in the next 12 months, and your confidence in the following at the global level? 50% 40% 30% 20% 10% 31% 19% Expectation to pursue an acquisition 27% 25% 46% 29% 35% 26% 33% 31% 0% Apr-12 Oct-12 Likelihood of closing acquisitions Quality of acquisition opportunities Number of acquisition opportunities Level of confidence at the global level: 32% 32% 41% 39% 51% 50% Likelihood of closing acquisitions Quality of acquisition opportunities Number of acquisition opportunities 49% 51% 49% 55% 60% 61% 33% of executives expect their company to pursue acquisitions in the next 12 months Q: Do you believe the valuation gap today between buyers and sellers is: 12% 11% No gap 6% No gap 5% 8% 12% 33% 30% Less than 10% 17% Less than 10% 23% 23% 19% 29% 39% 10%-20% 49% 10%-20% 41% 51% 49% 14% 10% 21%-30% 22% 21%-30% 13% 13% 16% 41% of executives believe the current valuation gap is 10% or less More than 30% 6% 5% 12% More than 30% 4% 10% 18% 11

14 M&A, cont d. New market entry and cost reduction are top acquisition drivers Deal appetite varies across sectors At the global level the expectation for larger deal sizes is consistent across most sectors, with few individual sectors standing out prominently. In contrast, respondents deal appetite shows a greater degree of variation than that of global respondents, with those in the automotive (50%), life sciences (40%) and mining and metals (40%) industries showing the highest propensity to acquire in the region. New market entry and increased profitability are main acquisition drivers Like their global counterparts, respondents identify the opportunity to gain share in new markets as their top driver for acquisitions, with 61% doing so in April. In the previous survey, expanding their share in existing markets was the top priority for companies. Just under half (48%) of respondents now cite lower costs and improved margins as their second most important priority in the deal environment, up from 30% six months ago, and well ahead of the 29% of global respondents. 12

15 Q: Sectors with the highest appetite to acquire (All sectors greater than or equal to 100 respondents; global percentage for all sectors) Financial Services Power & Utilities Life Sciences Oil & Gas Consumer Products Technology Automotive 35% 35% 32% 32% 30% 30% 28% Automotive Life Sciences Mining & Metals Consumer Products Financial Services Oil & Gas Power & Utilities 11% 50% 40% 40% 38% 33% 29% 50% of automotive companies plan to acquire, the highest deal appetite among industries Diversified Industrial Products 22% - Q: What are the main drivers of your company s planned acquisition in your chosen market/countries? Select up to two. Gain share in new markets (product or geography) Gain share in existing markets Reduce cost and improve profitability/margin Leverage distribution networks Access to technology/intellectual property 56% 65% 61% 43% 61% 45% 29% 14% 21% 27% 11% 17% 15% 14% 14% Gain share in new markets (product or geography) Reduce cost and improve profitability/margin Gain share in existing markets Access to technology/intellectual property Leverage distribution networks 0% 61% 40% 52% 48% 30% 35% 35% 55% 45% 17% 15% 13% 15% 35% 61% of executives see gaining share in new markets as the main driver for acquisitions 13

16 Increased shift toward optimizing capital Q: On which of the following capital management issues is your company placing the greatest attention and resources? Raising: A company s ability to raise capital is integral to achieving its growth imperatives and financial well-being. With credit broadly available companies indicate a desire to take on more leverage and plan for more dealmaking. 25% 27% 39% Raising Investing The Capital Agenda 3% 8% 15% Preserving Optimizing Preserving: A company s ability to access liquidity, control costs and engage with key stakeholders is essential to preserving capital amid shifting market forces. With companies largely out of survival mode thanks to an upturn in global economic prospects, they are now concentrating on other Capital Agenda areas. About this survey The Capital Confidence Barometer gauges corporate confidence in the economic outlook and identifies boardroom trends and practices in the way companies manage their Capital Agendas EY s framework for strategically managing capital. It is a regular survey of senior executives from large companies around the world, conducted by the Economist Intelligence Unit (EIU). Our panel comprises select global EY clients and contacts and regular EIU contributors. In March we surveyed a panel of more than 1,600 executives in 54 countries; half were CEOs, CFOs and other C-level executives. 14

17 Investing: Major increases in raising and optimizing capital have come at the expense of investment. This is a sign of companies setting the stage for later inorganic growth. Boardrooms with longer-term plans for acquisitions are now focused less on speed than on building dealmaking capacity and rigor. 15% 17% 18% Increasing leverage and further optimization suggests focused growth strategies and selective M&A investment 57% 48% 28% Optimizing: Debt-to-capital ratios have remained stable over the last year, but optimization is no longer about stabilizing capital structures. The next stage in optimization seen here in the significant increase in focus on this quadrant of the Capital Agenda is about companies preparing for the next wave of investment and, potentially, M&A. Respondents represented 22 sectors, including financial services, consumer products, technology, life sciences, automotive, oil and gas, power and utilities, mining and metals, diversified industrial products and construction. Companies annual global revenues ranged from less than US$500m to greater than US$5b: <US$500m (17%); US$500m US$999.9m (25%); US$1b US$4.9b (31%); and >US$5b (27%). More than 800 companies would have qualified for the Fortune 1000 based on revenue. Company ownership was publicly listed (68%), privately owned (21%), family-owned (6%), government/stateowned (3%) and PE/portfolio-owned (2%). 15

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20 For a conversation about your capital strategy and to receive a copy of the full results of our Capital Confidence Barometer please contact us Middle East & North Africa () Phil Gandier Service Line Leader Transaction Advisory Services phil.gandier@sa.ey.com Samar Obaid Markets Leader Transaction Advisory Services samar.obaid@jo.ey.com Mohammad Raza Business Development Leader Transaction Advisory Services mohammad.raza@ae.ey.com Also visit ey.com/mena EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Limited, each of which is a separate legal entity. Ernst & Young Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. The practice of EY has been operating in the region since For over 90 years, we have grown to over 5,000 people united across 20 offices and 15 countries, sharing the same values and an unwavering commitment to quality. As an organization, we continue to develop outstanding leaders who deliver exceptional services to our clients and who contribute to our communities. We are proud of our accomplishments over the years, reaffirming our position as the largest and most established professional services organization in the region EYGM Limited. All Rights Reserved. ED 0115 This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com/mena