Can complex geopolitical uncertainty and record M&A coexist? Global Capital Confidence Barometer June 2017 ey.com/ccb/industrials 16th edition

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1 Industrials Global Capital Confidence Barometer June 2017 ey.com/ccb/industrials 16th edition Can complex geopolitical uncertainty and record M&A coexist? Despite policy uncertainties, companies are giving the green light to deals in the search for growth.

2 Key findings M&A outlook Dealmaking is set for a strong Concerns about an overheated market are countered by growing deal discipline. 96% 57% 87% see the global economy as stable or improving up from 73% six months ago expect to actively pursue acquisitions in the next 12 months expect their pipeline to increase or remain stable in the next 12 months Digital disruption Industrials companies are keenly aware that digital will change their business models and competitive environments. 24% 31% 21% say the most difficult part of digital transformation is change management believe future-proofing their business is the most important question leaders need to answer say the impact of digital technology will be the most prominent issue for their boards in the next 12 months Deal valuation and completion challenges As industrials companies look ahead to possible increases in asset valuations, many are targeting smaller deals. Deal exit rates are higher among industrial companies than among their global counterparts (76%). 38% 55% 82% expect the price/valuation of assets to increase in the next 12 months are planning to pursue deals no larger than $250 million exited or canceled a deal within the last 12 months

3 M&A appetite returns, and industrials look to deploy capital in the search for growth Industrials companies continue to show strong interest in growing through acquisitions, according to the most recent edition of the Capital Confidence Barometer. The potential impact of changes to US tax and trade policies has introduced an element of uncertainty to the dealmaking environment. Despite this, companies are ready to put their capital to use as 57% intend to pursue M&A in the next 12 months. More than a third expect M&A activity will increase as the year progresses. Deal fundamentals are mainly supportive of elevated M&A activity. However, there are some negative pressures emerging as industrials executives are less enthusiastic about the number and quality of acquisition opportunities. Higher valuations will make selling businesses more attractive, but buyers are encountering more competition for what executives see as relatively scarce opportunities. Executives are keeping all options on the table to remain nimble during a time of transformation. Among companies planning acquisitions in the next 12 months, 35% report having at least one deal in the pipeline, and 30% indicate they have five or more deals in the pipeline. This split suggests an eagerness to pursue and close deals, but also a recognition that the potential deal failure rate is high. Although respondents indicate that the majority of Industrials transactions will be less than US$250m, we expect to see large deals continue in the chemicals space as this subsector continues to experience a massive transformation. The US$73b Dow Chemical and DuPont merger and the US$66b deal between Bayer AG and Monsanto represent the consolidation that is reshaping the industry. Smaller deals will focus on helping to bring technology into the industrial landscape, including the Internet of Things (IoT), robotics, automation and the manufacturing floor of the future. As the emphasis on customer preferences increases, industrials will need to adapt their operations, supply chain and distribution channels. Organic growth zeroes in on operational improvements Although the appetite for M&A is on the rise, the majority of industrials companies continue to view organic opportunities as their best avenue for growth. However, organic top-line growth is difficult to attain, and previous focus on operational improvements and working capital leaves little room for additional organic margin improvement. As a result, industrials are increasingly shifting their attention to M&A to improve sales and earnings. Although industrials companies are centering their attention more toward acquisitions, joint ventures (JVs) and alliances continue to provide a source of innovation opportunities and avenues for market expansion. These types of deals are particularly favorable in emerging countries, where deal environments can be more complex and involve higher levels of geopolitical and economic risk. David Gale EY Americas Industrials Leader Looking ahead With 96% of industrials executives viewing the global economy as stable or improving, M&A is expected to remain active over the coming 12 months. Companies will use acquisitions to gain new technologies that can support innovative new products. However, as valuations continue to rise, industrials companies are exhibiting greater deal discipline and will take their time to find the right deals. Capital Confidence Barometer 1

4 Macroeconomic environment Industrials companies are feeling confident about the global economic outlook Positive economic indicators have industrials executives feeling more confident about the global economy than they did six months ago. A supportive outlook across all market fundamentals and a greater sense of stability in short-term markets and credit availability have industrials companies feeling more confident that it is a good environment to support investment and M&A strategies. However, some industrial companies have rising concerns about equity valuations, which could indicate a growing concern regarding possible overvaluation of acquisition targets. April 2017 October M 96% M see the state of the global economy today as stable or improving 73% M M 57% 22% have confidence that short-term market stability is improving see equity valuations and the stock market outlook as declining M M 58% 12% 2 Capital Confidence Barometer

5 Macroeconomic environment Currency and commodity volatility remains a key risk Despite the positive economic outlook, the volatility of currencies and commodities remains a key risk as the global nature of manufacturing and supply chains makes industrials companies susceptible to this type of economic exposure. Although industrials companies appear to expect some positive effects of the current geopolitical environment, such as increased defense spending and reduced regulatory compliance costs, uncertainty about increased government intervention and protectionism are raising some concerns. What do you believe to be the greatest economic risk(s) to your core business over the next 6 12 months? Percent High volatility in currencies, commodities and other capital markets Increasing government intervention in corporate decision making Slowdown in global trade flows/increase in protectionism Restrictions on the free movement of employees/barriers to travel Increasing global geopolitical instability Uncertainty about US Government policy 9 10 Cybersecurity threats 8 9 Economic and political instability in the European Union 4 5 Financial instability in China, including levels of corporate debt 4 4 Industrials Global Capital Confidence Barometer 3

6 Growth and portfolio strategy Organic growth is top-of-mind, but M&A becomes an increasingly important strategic lever Despite an environment that is exhibiting a pattern of slower growth, more than half of industrials executives (57%) report searching for growth organically as a key focus. However, given that organic top-line growth has been difficult to consistently achieve, M&A is increasingly seen as an important strategic lever for growth. This heightened focus on M&A is raising the pressure on industrials companies to identify the right targets and complete more deals. Although declining in favor from the previous survey, JVs and alliances still hold value for multiple reasons. Industrials are using JVs to partner with technology companies to help accelerate growth while mitigating some of the risk of entering unfamiliar businesses and complimentary sectors. JVs are also attractive in more complex deal environments where targets can carry a higher level of risk, such as in emerging geographies. From where do you see growth within your company over the next 12 months? Percent Organic M&A JVs Alliances Apr 17 Oct 16 Industrials look to answer the big questions of how to futureproof the business and attract and retain the right people The need to future-proof the business was one of the top two concerns identified by leaders at industrials companies. Leaders are keenly aware of the risk of disruptive trends and technologies impacting established products and processes. Hand-in-hand with this concern is the question of finding the right people with the right skills. Industrials companies, often faced with the public perception of offering mainly low-tech, low-skill jobs, face an especially steep set of challenges in attracting and retaining skilled talent. As industrials companies consider their options for growth, M 31% M 31% acquisition targets that can keep a company s business model current and competitive are becoming more attractive. Top-of-mind for many boardroom executives is the impact of digital on their business models, which was ranked higher by survey participants than increased competition and identifying opportunities for growth. Industrials companies are especially concerned about the disruptive forces that digital technologies such as IoT, robotics and automation present M 24% are looking to future-proof their business in an age of constant change want to improve their ability to attract, train and retain the people and skills required for future challenges say that implementing and enabling a digital innovation culture through change management is the most difficult part of digital transformation 4 Capital Confidence Barometer

7 Growth and portfolio strategy Yet, for almost a quarter of executives surveyed, the most difficult part of becoming a digital organization is implementing a culture that will embrace digital innovation. Many executives are struggling to establish a common vision and strategy to achieve their digital goals. Industrials companies that have depended on consistent business practices and processes for decades are now facing the urgent need to adapt or risk seeing their business models quickly becoming obsolete or losing market share to competitors whose offerings are more advanced. For industrials companies, facilitating change across the organization as part of digital transformation is a critical component of creating innovative products and services. Which of the following will be most prominent in your boardroom thinking during the next six months? Impact of digital technology on your business model, e.g., new sales channels/markets, IoT, cybersecurity Sector convergence/increased competition from companies in other sectors 16 Percent 21 Identifying opportunities for growth, including M&A, JVs and alliances 15 Shareholder activism, including returning cash to shareholders 14 Portfolio analysis, including strategic divestment (spin-off/ipo) 12 Impact of increased economic and political instability 9 Changes in tax policy/rates 8 Increasing regulatory or governmental intervention 5 Industrials companies are reviewing portfolios more often as the pace of innovation accelerates Industrials companies are increasing the frequency of their portfolio review processes in response to disruptive forces. As they redefine the competitive landscape, these disruptive forces are leading industrials companies to revise the criteria by which they evaluate product categories and business lines, with an eye toward divesting operations that no longer support innovation or long-term growth. A drive for acquisitions may open up as competitors follow each other into new categories of products and services. Further complicating this issue is the increasing possibility of changes in trade policies, which is also a significant force causing companies to evaluate their portfolios; 41% of survey participants have already begun the process of reorganizing their global footprint in response to potential risks. Have you increased the frequency of your portfolio review process to capitalize on disruptive forces in your sector? Percent Yes: 76 No: 24 Have you begun actively reorganizing your geographic operations in response to potential changes in trade policies? Percent Yes, we have: 41 No, but we plan to: 37 No plans to: 22 Capital Confidence Barometer 5

8 Growth and portfolio strategy M&A appetite returns for industrials companies Appetites for M&A appear to be increasing, with 57% of industrials executives indicating that they intend to pursue at least one transaction in the next year. With 99% of respondents expecting the deal environment to remain stable or improve in the months ahead, we expect a robust deal market for the second half of the year. Do you expect your company to actively pursue mergers and acquisitions in the next 12 months? Expectations to pursue an acquisition 44% 41% 38% 35% 45% 40% 59% 31% 34% 25% 29% 28% 50% 35% 30% 21% 40% 36% 56% 50% 59% 56% 52% 50% 57% 57% 56% 53% Industrials average 44% Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Industrials Global Deal fundamentals remain supportive of M&A despite industrials executives reporting that the number and quality of acquisition opportunities are more limited. Among respondents, 38% say that the number of attractive targets is declining, and 26% suggest that the quality of companies being sold is down. At the same time, the number of industrials executives predicting higher acquisition prices has roughly doubled in the last six months. As higher prices make the prospect of selling businesses more attractive, buyers are facing increased competition for quality assets coming to market. April 2017 October M M M M 37% 38% expect the M&A market to improve in the next 12 months 32% anticipate that the valuation of assets will increase in the next 12 months 20% 6 Capital Confidence Barometer

9 M&A outlook Pipelines suggest industrials companies are considering multiple options Industrials executives are signaling that they are considering multiple options at a time of constant disruption. In terms of deal sizes, a majority are looking at bolt-on or start-up companies that are less than US$250m. There is also interest in deals between US$251m and US$500m (32%). Within the sector, strategic acquirers can potentially support higher valuations due to the ability to extract additional synergies, which assists industrials companies in offering competitive valuations. While competition for many targets is high, there is especially intense competition for high-tech start-ups with innovations that could set an industrial company ahead of its peers Mhave three or more deals in the pipeline 51% Mare looking at deal sizes of US$250m or less 55% 54% Mexpect to close at least one deal in the next 12 months While competition for many targets is high, there is especially intense competition for high-tech startups with innovations that could set an industrial company ahead of its peers. Capital Confidence Barometer 7

10 M&A outlook New technologies and production capabilities a higher priority for industrials than for global respondents across all industries Although moving into new geographies and growing market share top the list of reasons for making an acquisition, industrials companies are more likely than their global counterparts to look for new technologies and production capabilities as they seek to future-proof their business. What do you believe to be the greatest economic risk(s) to your core business over the next 6 12 months? Percent Move into new geographies Grow market share Acquiring technology or new production capabilities React to customer behavior Acquiring innovative start-ups Acquiring talent 7 7 Secure supply chain 3 3 Industrials Global 8 Capital Confidence Barometer

11 M&A outlook Deal discipline and trust in the due diligence process have industrials walking away if deals don t feel right Concerns about the potential for an overheated market are countered by growing deal discipline, as 82% of industrials executives say they have failed to complete a planned acquisition in the last 12 months. Intense competition for deal opportunities is leading industrials companies to pursue a wide range of targets with expectations that a many of the deals are not likely to close. Further, 43% of respondents indicate the reason a deal did not close were issues uncovered during due diligence. This suggests that industrials companies are placing increased reliance on the due diligence process. Companies are more likely to start the acquisition dialogue with a higher number of prospective targets and to rely on due diligence to identify key risks. US is seen as the most attractive deal destination In terms of where industrials are looking to invest, top destinations include the US, Germany, China, France and Canada. The attractiveness of the US is driven in large part by the specialty chemical and plastics industries. While companies are investing in new geographies, the investments are being directed to established markets. Although considerable uncertainty remains in the US business environment in areas such as tax and trade policies, industrials companies still view US targets as providing access to a business environment with a positive long-term growth outlook. Companies headquartered in established economies can also offer opportunities for growth in new markets through global subsidiaries. Top five investment destinations 1 US 2 Germany 3 China 4 France 5 Canada The attractiveness of the US is driven in large part by the specialty chemical and plastics industries. While companies are investing in new geographies, the investments are being directed to established markets. Capital Confidence Barometer 9

12 Contact For a conversation about your capital strategy, please contact: David Gale EY Americas Industrials Leader Ernst & Young LLP david.gale@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. Global contacts Global Steve Krouskos EY Global Vice Chair EY Global Limited steve.krouskos@uk.ey.com Follow me on Julie Hood EY Deputy Global Vice Chair EY Global Limited julie.hood@uk.ey.com Follow me on Barry Perkins EY Global Lead Analyst EY Global Services bperkins@uk.ey.com Americas William M. Casey EY Americas Leader william.casey@ey.com Asia-Pacific Harsha Basnayake EY Asia-Pacific Leader harsha.basnayake@sg.ey.com Europe, Middle East, India and Africa (EMEIA) Andrea Guerzoni EY EMEIA Leader andrea.guerzoni@it.ey.com Japan Vince Smith EY Japan Leader vince.smith@jp.ey.com 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 set of skills, insight and experience to deliver focused advice. We can help you drive competitive advantage and increased returns through improved decisions across all aspects of your capital agenda EYGM Limited. All Rights Reserved. EYG no GBL ED 0418 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/ccb About the 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 the EY framework for strategically managing capital. It is a regular survey of senior executives from large companies around the world, conducted by Euromoney Institutional Investor Thought Leadership (EIITL). Our panel comprises select global EY clients and contacts and regular EIITL contributors. In March and April, we surveyed a panel of more than 2,300 executives in 43 countries; 58% were CEOs, CFOs and other C-level executives. Respondents represented 14 sectors, including financial services, consumer products and retail, technology, life sciences, automotive and transportation, oil and gas, power and utilities, mining and metals, diversified industrial products, and construction and real estate. In this survey, we had 324 respondents from industrials companies. Surveyed companies annual global revenues were as follows: less than US$500m (21%); US$500m US$999.9m (23%); US$1b US$2.9b (17%); US$3b US$4.9b (10%); and greater than US$5b (29%). Global company ownership was as follows: publicly listed (62%), privately owned (32%), family-owned (3%) and government- or state-owned (3%).