Confidence Barometer. Getting it right. Appetite for dealmaking at two-year high. Economic outlook. Confidence continues to rise

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1 US October 2013 ey.com/ccb Capital Confidence Barometer Getting it right M&A Appetite for dealmaking at two-year high Economic outlook Confidence continues to rise Access to capital Credit is widely available Growth strategies Investment intent tops Capital Agenda 9th edition

2 Getting it right US executives will likely apply the same rigor to dealmaking they have imposed on their own capital structures. Key findings Companies will be looking to grow smart, not just grow fast deal rigor will be essential. A note from Richard Jeanneret, EY Americas Vice Chair, The US results of our latest Capital Confidence Barometer show a marked uptick in our respondents outlook, even after a half-decade of challenged global and persistently sluggish deal activity. While US corporate leaders tell us they see improvement in the metrics that support dealmaking, how this will play out in the next 12 months remains to be seen. 52% 4 65% 91% 49% expect US deal volumes to improve see the US economy improving consider their primary focus plan to pursue an acquisition have a greater focus on investing in emerging markets view credit availability as stable or improving plan to use debt and equity as their primary source of deal funding Looking outside of their organizations, US respondents are notably positive. They have confidence in the global economy; while less than half are positive about the US economy, that metric is up from a year ago. They view credit as widely available. They view asset quality as high and the opportunities as numerous, and they believe deals have a high likelihood of closing. However, within their organizations, overarching conservatism spurred by persistent economic uncertainty has had a powerful effect on the boardroom agenda. Note that large majorities still say their boards are emphasizing capital structure optimization. Companies know they will not be able to wring much more via organic means but neither will they plunge headlong into acquisition mode unless they see solid bets. In short, if dealmaking is to increase significantly, companies will be looking to grow smart, not just grow fast. Deal rigor will be essential indeed, US executives will likely apply the same rigor to dealmaking they have imposed on their own capital structures. Ultimately, the good news for the M&A environment is that the deals that are done will likely be stronger, marked by transaction diligence and improved deal success. For that, we can all be encouraged even if the long-anticipated return to dealmaking has been slow to arrive. A note from Pip McCrostie, EY Global Vice Chair, Confidence in the global economy is at a two-year high. Companies have weathered a prolonged period of uncertainty during which time they strengthened their balance sheets and optimized their capital structures. Having warehoused cash for a number of years, and with ready access to credit, leading corporates are in a strong financial position to do deals they now have more confidence to pull the trigger. This does not mean we will see a return to boom-time dealmaking. That was unsustainable but so is the M&A recession we have experienced since For many companies, operational efficiencies and a focus on cost-cutting can no longer meet mandates. As a result, the signs are that M&A will once again be a preferred route to achieve. 1

3 Economic outlook confidence continues to rise The number of US executives who believe the global economy is improving grew to 65% from a year ago. Confidence in their own economy, at 4, is considerably lower, but it is also up from the prior year. Informing this confidence is a global economy on sounder footing improvement in economic conditions in mature economies and stabilization in major emerging markets. Even in the United States, despite political uncertainty, economic has persisted, and corporate earnings, employment and credit availability are all improving. The outlook for Europe has brightened in the last six months. Higher levels of employment, rising GDP and better access to capital provide evidence the region s economic downturn is subsiding. How this growing US confidence will affect dealmaking remains to be seen. US companies continue to seek greater economic certainty before pursuing major acquisitions. Confidence in economic stability Economic confidence improving US executives economic confidence, both globally and domestically, has risen over the last 12 months. However, their confidence is greater in the global economy; US political instability has tempered their optimism for the US economy. Overall, executives confidence is fueled by stable underlying fundamentals, particularly in mature markets: growing GDP, strong credit availability and increased job creation. What is your perspective on the state of the economy today? Global economy Improving Stable Declining 11% % US economy Improving Stable Declining 6% 16% 4 40% 46% 44% 4 of executives believe the US economy is improving By how much do you think/expect the economy to grow in the next 12 months? Global economy US economy Growth expectations continue to rise The vast majority of US executives anticipate economic in both the global and US economies. This correlates with companies increasing ability to invest and stakeholders demand for meaningful. More than 5% 3% 5% 1% 3% Zero 0% 2% 15% 10% 59% 69% More than 5% 3% 5% 1% 3% Zero 2% 3% 26% 25% 63% 57% 73% of executives expect the US economy to grow in the next 12 months Negative 2% 6% Negative 1% 2% Some of the world s most mature and influential markets are increasingly confident in the strength of the global economy Chinese respondents are the most upbeat, but mature markets such as the UK, Germany and Japan also have high confidence. US respondents rank slightly above the global average and, like most developed economies, believe global economic fundamentals are sound. Developed economies will prompt global dealmaking Countries with the most positive view of the global economy China 82% France 80% UK 76% Australia 6 Japan Germany % of executives have a positive view of the global economy US 66% Global average (65%) 2 3

4 Economic outlook, cont d. Improved fundamentals support increased dealmaking Commitment to job creation underscores plans for investment US companies plans for job creation are up considerably from a year ago, highlighting the need to hire as they prepare for a coming wave of. The sectors where most jobs will be created are oil and gas, technology and life sciences, which are also among the sectors most likely to pursue acquisitions. With regard to employment, which of the following does your organization expect to do in the next 12 months? 42% 6% 47% 47% 12% 56% 32% Reduce workforce numbers Keep current workforce size Create jobs/hire talent of executives expect to create jobs/hire talent Global political instability outweighs economic concerns Global political instability particularly the recent unrest in Syria and Egypt is believed to pose the greatest near-term risk but is unlikely to derail the fundamental push for. Among US companies, the Federal Reserve s potential withdrawal of Quantitative Easing measures remains a concern, especially in light of muted US and political and market instability. What do you believe to be the greatest economic risk to your business over the next 6 12 months? Increased global political instability Failure to manage the withdrawal of US quantitative easing Continuation of the Eurozone crisis Continued slow in China 15% 42% 42% of executives perceive global political instability to be the greatest economic risk to their business Confidence spans leading economic indicators Companies are broadly positive across economic indicators US executives rate all six global metrics higher than they did 12 months ago, and five out of six US metrics. However, companies are carefully managing the rate at which they implement their and investment strategies. As such, any dealmaking resulting from this economic positivity will likely be tempered. Please indicate your level of confidence in the following: Global economy Economic Credit availability Employment Corporate earnings 2 30% 34% 33% 47% 46% 52% 72% US economy Economic Credit availability Employment Corporate earnings 2 44% 36% 3 40% 55% 76% 76% of executives have confidence in US economic Equity valuations/ Stock market outlook Short-term market stability 14% 19% 25% Equity valuations/ Stock market outlook Short-term market stability 19% 31% 26% 21% 4 5

5 Access to capital credit is widely available Over the last six months, US executives report their access to credit continued to improve, even as their debt-to-capital ratios remained largely constant. This disciplined use of leverage suggests that companies are able to access the credit markets, enabling transactions that would deliver. Companies slight uptick in willingness to use leverage could also indicate a shift in the dealmaking environment. However, dealmaking will likely be controlled and risk-averse. The fact that companies plan to use limited leverage points to the conservatism that has marked this recovery. Companies will apply rigor in altering their debt-to-capital ratios. Modest shift toward leverage Credit availability inspires The vast majority of US executives are confident that credit availability is stable or improving. Furthermore, the sentiment on improving credit is almost double what it was 12 months ago. This confidence coupled with positive views on the global economy and sound economic fundamentals equips companies for dealmaking. Please indicate your level of confidence in credit availability at the global level 9% 39% 52% 91% 30% 42% 2 of executives now consider Declining Stable Improving credit either stable or improving, compared with 70% a year ago What is your company s current debt-to-capital ratio? Debt-to-capital ratios will be carefully managed Over the last six months, debt-to-capital ratios remained largely constant, while access to credit continued to improve. This disciplined use of leverage ensures companies have the capacity to access the credit markets if they choose to undertake larger transactions. Less than 25% 25% 49.9% 74.9% 75% 100% 17% 21% 16% 30% 33% 40% 43% of companies have a debt-to-capital ratio between 25% and 49.9% Use of debt and equity may signal potential deals The confidence to use more debt and equity to finance deals even if that shift is modest represents a move away from risk aversion and smaller, cash-based transactions. The use of more leverage may also highlight the need for larger deals to address mandates, while also signaling a return to a more active M&A environment. What is the likely primary source of your company s deal financing in the next 12 months? 17% 32% 51% 15% 29% 56% 15% 29% 56% Equity Debt Cash 49% of executives say they will use more debt and equity to finance larger deals 6 7

6 Growth strategies investment intent tops Capital Agenda Growth is the primary focus for US companies: appetite for has increased to 65% from 46% last year. Companies have weathered a prolonged period of uncertainty. During this time, they have strengthened their balance sheets and largely optimized their capital structures. A close examination of company responses, however, reveals a continued underlying conservatism. Although companies are intent on investment, they continue to cite the need for operational efficiency and cost control. Thanks in large part to these optimization efforts, companies have shifted their focus almost entirely out of survival or stabilization mode, toward mode, in a year. Companies will not pursue if it will affect the optimization they have already achieved. So while their focus on points toward increased dealmaking, it also means executives will likely employ the same rigor in dealmaking they applied to their capital structures. Growth is the priority Focus on is at two-year high Over the next 12 months, 65% of US companies say is their primary focus. Continued operational efficiency and cost-control measures, as well as an improving global economy, have largely eliminated US executives concerns about stability and survival. Which statement best describes your organization s focus over the next 12 months? 1% 5% 2% 11% 5% 30% 26% 29% 26% 23% Survival Stability Cost reduction and operational efficiency Growth 65% 61% 46% 40% 65% of executives say their primary focus is on over the next 12 months Excess cash used to retire debt, fund Companies say they will primarily use excess cash to pay down debt one of the remaining ways to optimize their capital structures. Additionally, a total of 43% of companies plan to use excess cash to fund, both organic and inorganic, with a slight bias toward organic strategies. If your company has excess cash to deploy, which of the following will be your company s focus over the next 12 months? Inorganic (e.g., acquisitions, alliances and JVs) Organic (e.g., investing in products, capex, talent retention, R&D) Invest in 19% 16% 12% 36% 36% Return to stakeholders Buy back stock Pay dividends Pay down debt 6% 9% 6% 10% 29% 31% 45% 43% of companies with excess cash plan to invest in over the next 12 months Organic strategies will center on core products and existing markets To address their need for, companies will initially focus on lower-risk organic platforms: known products, channels and markets. This strategy allows them to pursue while maintaining financial discipline and governance objectives. As they exhaust lower-risk options, companies will pursue higher-risk organic strategies: new products, channels and geographies. 8 9 What is the primary focus of your company s organic over the next 12 months? More rigorous focus on core products/ existing markets New sales channels Lower risk 22% 15% 27% Increase R&D/ product introductions Changing mix of existing products and services Investing in new geographies/markets Exploiting technology to develop new markets/ products Higher risk 4% 4% 4% 15% 2 19% of executives say their organic efforts will focus on core products and existing markets

7 Growth strategies, cont d. Investment tops companies Capital Agendas Which statement best describes your organization s focus over the next 12 months? Raising: A company s ability to raise capital is integral to achieving its imperatives and financial well-being. The decline in focus on capital-raising suggests companies are already well-capitalized. Moreover, with credit increasingly available and more attractive, companies now indicate a desire to take on more leverage, which signals that increased dealmaking may be imminent. 9% 21% 19% Raising Investing Investing: Executives sentiment indicates a more robust investment climate is imminent, and as required levels of and returns increase, companies may look to M&A. Improving economic fundamentals may also enable more deal-powered. 43% 46% 61% Boardroom discipline has strengthened companies Capital Agendas, enabling them to pursue strategies The Capital Agenda 2% 9% Preserving Optimizing 2 12% 26% Preserving: A company s ability to access liquidity, control costs and engage with key stakeholders is essential to preserving capital amid shifting market forces. Since most companies were forced to focus on preservation in order to survive, they are now able to concentrate on other areas of their Capital Agendas. Optimizing: Companies continue to employ a disciplined approach to optimization, with an enhanced focus on governance and fiscal rigor. With capital structures largely optimized, executives today are primarily focused on refinancing to retire maturing debt and position themselves for more leverage

8 Mergers & acquisitions appetite for dealmaking at two-year high The confidence paradox the gap between deal-market outlook and deal intentions identified in our April 2013 Barometer has narrowed. For the first time in more than two years, we see intent to pursue deals by US executives greater than 40%. At the same time, fewer are calling for deal volumes to improve just over half, down from 61% in the last Barometer. In short, increasingly, US executives say they do not intend to wait for deal market before making a move themselves. Dealmaking fundamentals from credit availability to economic confidence have all improved over the past year. As seen in their strategies, companies have optimized their capital structures. Consequently, US executives will likely apply the same rigor to the dealmaking process they have to their organizations. This means increased transaction diligence. Executives also anticipate valuation gaps will increase, which points to a lack of clarity about how to value assets however, it also often portends increased dealmaking. What this means for the deal environment: greater rigor, improved deal success. A new deal environment Deal volumes expected to improve Three-fourths of US executives expect global deal volumes to improve over the next 12 months, while only 52% expect US deal volumes to improve in the same period. This discrepancy reflects how ongoing US political and economic uncertainty have checked the confidence of dealmakers in their own market. However, core fundamentals are in place for dealmaking: economic sentiment, credit availability and job creation. What is your expectation for local M&A/deal volumes in the next 12 months? Improve Remain the same Decline 4% 5% 20% US deal volumes 44% Global deal volumes 52% 75% 52% of executives expect US M&A/deal volumes to improve M&A expectations rise on improved deal metrics We have seen a significant increase in US companies planning acquisitions: expect to pursue a transaction in the next 12 months, compared with 23% a year ago. During the same period, we have also seen a notable increase in the number and quality of acquisition opportunities, as well as a significant improvement in the likelihood of deals closing. 40% 30% 20% 10% 44% 3 What is your expectation to pursue an acquisition and your level of confidence in the following at the global level? 36% Expectation to pursue an acquisition 31% 25% 23% 29% 29% Apr-11 Oct-11 Apr-12 Global US Level of confidence Likelihood of closing acquisitions Quality of acquisition opportunities Number of acquisition opportunities 32% 29% 42% 43% 39% 30% 37% 61% of companies expect to pursue acquisitions in the next 12 months 12 13

9 Mergers & acquisitions, cont d. Expectations on deal size and valuations both growing Improved sentiment toward large deals We have seen improvement in the two largest categories of deals: 20% of US executives say they plan to pursue deals larger than US$500m, up from 12% six months ago. The largest increase was in deals in the US$501m to US$1b range market-moving transactions that tend to trigger the dealmaking environment; intent to pursue these deals more than doubled from six months ago. These shifts may indicate a more robust dealmaking environment on the horizon. What is the expected deal size? 22% 5 16% 4% 29% 59% 6% 6% 3 43% 9% 10% US$0 US$50m US$51m US$500m US$501m US$1b Over US$1b 20% of executives expect to pursue deals greater than US$500m Valuation gaps expected to widen As transaction volumes accelerate, there is a natural divergence between buyers and sellers expectations on pricing. Executives increasingly expect valuation gaps to widen over the next 12 months. As buyers and sellers adjust their expectations at different rates, this widening is a natural result; the recent surge in US equity markets is also indicative of a growing valuation gap. Do you expect the valuation gap between buyers and sellers in the next 12 months to: Contract Stay the same Widen 14% 17% 1 22% 51% 61% 5 of executives expect valuation gaps to widen compared with 17% six months ago Widening valuation gaps are a precursor to an acceleration in dealmaking 14 15

10 Mergers & acquisitions, cont d. Top investment destinations span mature and emerging markets Which are the top countries (outside your local market) in which your company is most likely to invest? Top investment destinations Canada UK The interdependency between developed and emerging economies continues to increase The emerging markets are of continued and growing interest to dealmakers, and they allow for portfolio diversification. Top investors into US: UK Japan Mexico Brazil India China Next five top destinations: Mexico South Africa Vietnam Colombia Australia 16 17

11 Mergers & acquisitions, cont d. Increased global dealmaking likely to be driven by mature markets Acquisition capital to be allocated primarily % of capital allocated 75% 100% to mature markets Mature economies are expected to attract the majority of acquisition capital over the next 12 months. This is largely attributable to a rebound in mature economies, as well as the perceived safety and quality of underlying opportunities. How do you expect to allocate acquisition capital in the next 12 months? 74.9% 25% 49.9% Less than 25% Mature markets 21% 27% 2 Marked commitment 72% of executives are willing to allocate 25% or more of their acquisition capital to mature markets Emerging markets interest grows Half of US executives indicate they have placed greater focus over the last 12 months on investing in emerging markets, as they search for new strategic opportunities and portfolio diversification. How has your sentiment toward investing in emerging markets changed versus a year ago? Greater focus on emerging markets Stayed the same Less focus on emerging markets 7% 43% of executives have a greater focus on emerging markets today versus 12 months ago Slowing- emerging markets require more transaction rigor While certain emerging markets have experienced slowing, executives remain largely optimistic about the opportunities they present, provided greater rigor is applied to dealmaking. Unlike their mature counterparts, emerging markets continue to rapidly evolve, requiring careful management of transaction risk. Which statement best describes your approach to M&A in those emerging markets experiencing slowing? Optimistic about opportunities, have not changed approach to assessing deals in emerging markets Optimistic but will apply further rigor when assessing deal opportunities in emerging markets Less optimistic and reconsidering emerging markets strategy Less optimistic and have already turned attention more toward developed markets opportunities 6% 7% 9% 16% 1 31% 65% 65% of executives remain optimistic but will apply further rigor in emerging markets Have discontinued emerging markets strategy for now 4% 3% 18 19

12 Mergers & acquisitions, cont d. Divestments are fundamental to driving strategic value Divestments enable corporate objectives Recognized for their strategic value, divestments are an effective tool to address a variety of corporate objectives. Companies will continue to shed non-strategic and underperforming assets as they optimize their capital structures and focus on their core business. Fewer plan to use divestments to raise capital, as credit is now more readily available. What are the main drivers of your company s planned divestment activity? (Select two) Focus on core assets Shed underperforming business unit Enhance shareholder value Raise cash to compensate for underperformance of aggregate business 15% 17% 22% 22% 30% 34% 40% 3 43% 49% 60% of companies plan divestments in order to focus on core assets Fund inorganic/ M&A plans 22% 1 Business-unit sales are the preferred structure for divestments At 57%, sales of non-core business units are expected to dominate the divestment environment, as companies continue to strengthen their corporate structures. What form do you expect your divestments to take? Sale of business unit Sale of entire business Spin/IPO of business unit Contribution of business unit to joint venture 17% 57% 57% of executives indicate the sale of a business unit is the expected form of divestment About this survey The Global 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 member firm clients and contacts and regular EIU contributors. We surveyed a panel of more than 1,600 executives in 72 countries; half were CEOs, CFOs and other C-level executives, while over 400 were from the US. Respondents represented more than 20 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, as follows: <US$500m (19%), US$500m US$999.9m (), US$1b US$4.9b (30%) and >US$5b (27%). More than 900 companies would have qualified for the Fortune 1000 based on revenue. Company ownership was publicly listed (65%), privately owned (20%), family owned (7%), government/stateowned (5%) and PE/portfolio-owned (3%). Executives were surveyed in August and September

13 For a conversation about your capital strategy, please contact us Americas Richard M. Jeanneret EY Americas Leader richard.jeanneret@ey.com William M. Casey EY Americas Deputy Leader william.casey@ey.com Sharath C. Sharma EY Global and Americas Sector Accounts Development Leader sharath.sharma@ey.com Jennifer Arnolie Ernst & Young LLP East Central Region Leader jennifer.arnolie@ey.com Mark F. Copeland Ernst & Young LLP Southwest Region Leader mark.copeland@ey.com Eric G. Janis Ernst & Young LLP Southeast Region Leader eric.janis@ey.com Nadine Mirchandani EY Americas Transaction Advisory Services Leader Financial Services Office nadine.mirchandani@ey.com Todd Moody Ernst & Young LLP West Region Leader todd.moody@ey.com Steve Payne Ernst & Young LLP Northeast Region Leader steve.payne@ey.com Christopher A. Smyth Ernst & Young LLP Midwest Region Leader christopher.smyth@ey.com 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 Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. About EY s How you manage your capital agenda today will define your competitive position tomorrow. We work with clients to create social and economic value by helping them make better, more informed decisions about strategically managing capital and transactions in fast changing-markets. Whether you re preserving, optimizing, raising or investing capital, EY s combine a unique set of skills, insight and experience to deliver focused advice. We help you drive competitive advantage and increased returns through improved decisions across all aspects of your capital agenda Ernst & Young LLP. All Rights Reserved. SCORE no. CE NY ED None 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