7th issue Outlook October 2012 April 2013 Global Capital Confidence Barometer Focused on fundamentals With a recovery taking longer than expected to arrive, companies are focusing on bottom-line improvements About this survey The is a regular survey of senior executives from large companies around the world, conducted by the Economist Intelligence Unit (EIU). Our panel comprises select Ernst & Young clients and contacts and regular EIU contributors. This snapshot of our findings gauges corporate confidence in the economic outlook, and it identifies boardroom trends and practices in the way companies manage their capital agenda. Profile of respondents Panel of more than 1,500 executives surveyed in August and September 2012 Companies from 41 countries Cross-section of respondents from 24 sectors 754 CEO, CFO and other C-level respondents More than 400 companies would qualify for the Fortune 500 based on revenue The Capital Agenda Based around four dimensions, it helps companies consider their issues and challenges, understand their options and make more informed capital decisions. 1. Preserving capital: reshaping the operational and capital base 2. Optimizing capital: driving cash and working capital and managing the portfolio of assets 3. Raising capital: assessing future capital requirements and assessing funding sources 4. Investing capital: strengthening investment appraisal and transaction execution The Eurozone crisis and slowing growth in emerging markets, such as China and India, have dampened global economic confidence and expectations around corporate earnings. This has led to significantly reduced organic and inorganic growth aspirations. The focus on growth in the near term will be mainly organic as the appetite for M&A has declined. Despite strong fundamentals for deals, including rising cash stock piles and adequate credit, there is a lesser appetite for acquisitions and divestments compared with any previous edition of our barometer. Contributing to the lack of confidence around M&A activity is the sentiment by many executives that acquisition targets are over-priced. What s next? Companies are refocusing on the basics: cost reduction, performance improvement, capital allocation and targeted organic and inorganic growth initiatives dominate the boardroom agenda. Those who execute in a disciplined way will be best positioned when economic confidence returns. Pip McCrostie, Global Vice Chair, Key findings Our seventh finds that leading companies see little immediate prospect of a recovery for the global economy. While the situation has stabilized in some markets, most executives expect this downturn to endure for at least a year, while many economists think it could persist for three years or more. 78% think the global economy shows no signs of improvement 66% expect the downturn to persist for more than one year 44% view credit availability as stable; declining view up modestly Appetite for M&A falls to 25% from 31% in April Intention to divest down to 19% from 31% in April
Economic outlook Global economic outlook has weakened As the slowdown persists in developed and emerging economies, companies are less optimistic about the future than they were six months ago. Only 22% of respondents believe the global economic situation is improving, down from 52% in April. There has also been an increase in the number of companies who report declining sentiment, from 20% to 31%. What is your perspective on the state of the global economy today? 26% 37% 37% Improving Stable 22% 52% 28% 20% Declining 22% 47% 31% view the global economy as improving compared with 52% in April More than half expect the global economic downturn to persist for another one to two years, while 15% predict it will last more than two years. With slow growth expected to continue, many companies are focusing on bottom-line improvements and low-risk organic growth opportunities. Few see the urgency for conducting major M&A transactions in such an uncertain climate. Viewpoint A new sense of commitment by policymakers Slowing economic growth around the world is a key issue for central banks and policymakers. Many had hoped that a return to growth in developed markets, along with strong momentum in emerging economies, would have sparked a global recovery and reduced the need for more drastic policy action. Recent months have seen policymakers reach even deeper into the toolkit. September saw bold action on a number of fronts. On 6 September, the European Central Bank (ECB) announced ambitious plans to buy theoretically unlimited quantities of bonds from struggling Eurozone countries. Six days later after our survey closed the German Constitutional Court backed the European Stability Mechanism, which commits the ECB to being a lender of last resort, with 700 billion of capital at its disposal. The following day, the US Federal Reserve announced it would buy US$40 billion of mortgage-backed securities every month to spur the real estate markets and hold up asset prices. This is an important moment in the global economic cycle. The policy actions taken in the Eurozone together with the promise of fiscal union could represent a turning point in the crisis, potentially decreasing volatility. And, by embarking on QE3, the Federal Reserve has also signaled its intention to take bold action. However, there remain deep-seated structural problems that will be difficult to overcome. These measures may only prove to have short-lived benefits, but they do demonstrate a renewed sense of urgency among policymakers to tackle the economic downturn once and for all. How long does your organization expect the global economic downturn to persist? 51% 27% 7% 0 6 months 6 12 months 15% 1 2 years More than 2 years 66% believe the economic downturn is likely to persist for at least another year 2
Local economic sentiment weakens In line with the global results, local economic sentiment has also declined. Ten countries with the highest percentage of respondents holding negative views on their local economies Italy India Singapore Sweden Spain United Kingdom Netherlands France South Africa Malaysia 26% 25% 24% 37% 40% 40% 39% 39% 44% 59% 0% 10% 20% 30% 40% 50% 60% Viewpoint The Eurozone crisis continues to dominate A regional difficulty has become a global problem almost 90% of respondents cite the Eurozone crisis as affecting their business. Six months ago, the Eurozone was recognized in boardrooms as an impact, with contingency plans around currencies and which countries might exit the euro. More recently, however, the Eurozone has been recognized by companies around the world as a long-term structural issue to be considered in long-range business planning. While the ECB continues to take action to calm the crisis, the region s economic problems are far from resolved. As long as economic stagnation persists, the Eurozone will continue to be a drag on the broader global economy, affecting its trading and export partners, potentially for years to come. Leading companies are taking proactive measures, such as reducing costs to relieve pressure on margins, and better managing counterparty default risk and supply-chain risk. By and large, the countries with the most negative sentiment are those most affected by the Eurozone crisis and slowing growth in China. Confidence in earnings drops 89% believe the Eurozone crisis has affected their business There has been a marked decline in expectations for corporate earnings, with only 30% of respondents positive about the outlook in October 2012, compared with 44% in April. The decline in corporate earnings expectations is consistent across all geographies. What are the most significant challenges facing your business in light of the Eurozone crisis? (Select two) Revenue and margin pressure Counterparty default risk 28% 30% are positive about earnings, compared with 44% in April Credit availability Supply-chain risk Increased regulation Price/valuation of M&A assets Treasury management and banking relationships 12% 11% 21% 21% 20% Taxation 8% 3
Fewer expect to create jobs In light of economic challenges, the percentage of respondents planning to create jobs has decreased from in April to 28% in October. The percentage of those who plan to maintain their workforce has increased significantly from 47% to 59%. This may reflect a wait-and-see attitude among companies that are simultaneously unwilling to take risks but reluctant to lose flexibility should better times return. With regard to employment, which of the following does your organization expect to do in the next 12 months? 36% 28% 49% 47% 59% Create jobs/hire talent Keep current workforce size Reduce workforce numbers 15% 12% 13% 28% are seeking to increase their workforce in light of economic challenges, a significant shift from in April 4
Access to capital Modest decline in credit availability While credit is broadly available, particularly to large-cap enterprises, respondents do cite a modest decline in credit availability. Only 26% view credit markets as improving, compared with 30% in April. Compared with two years ago, banks are on a stronger footing and better capitalized. Yet this healthier picture does not always translate into increased lending. Many banks have tightened lending standards, particularly for small-to-medium enterprise (SME) borrowers. Banks also face higher capital requirements under impending Basel III regulations, which could restrict their ability to increase the flow of credit into the economy. Deleveraging continues Companies expect to continue to decrease debt levels. Eighty-two percent expect to see their debt-to-capital ratios remain stable or fall over the year ahead. Companies are choosing to retire debt and deploy capital more cautiously. How do you expect your company s debt-to-capital ratio to change over the next 12 months? 22% 51% 21% 45% 18% 49% Please indicate your level of confidence in credit availability at the global level 24% 30% 26% 27% 34% 33% 44% 45% 44% Increase Remain constant Decrease 32% 25% Improving Stable Declining 30% Refinancing slows Only 26% of companies plan to refinance their borrowings over the next 12 months, down from 34% in April. Most are doing so in order to optimize their capital structures, reduce the size of their interest bills or extend the maturity of their debt. Many European borrowers have used the US private placement market to refinance existing bank loans. 30% view credit availability as declining, compared with 25% in April Does your company plan to refinance loans or other debt obligations in the next 12 months? 29% 34% 26% 71% 66% 74% Yes No 5
Growth Declining growth sentiment What is the primary focus of your company s organic growth? Prioritization of growth has declined steeply as companies are more focused on the fundamentals. Compared with six months ago, our respondents report an increased focus on reducing costs, improving efficiency and optimizing capital. As executives assess how to compete in an environment where there is lower expected growth, this shift in emphasis toward improving bottom-line performance and seeking out new ways to improve internal performance is understandable. Nonetheless, growth remains the number-one objective, with reporting that growth is their primary focus. However, this is the lowest percentage of respondents citing growth as their top priority since October 2010. Those companies focused on growth tend to prioritize lower-risk organic strategies that are within their comfort zone. Rather than pursuing ambitious, transformational deals, they are hoping to deliver growth through better execution in existing markets, changing the current mix of products and services, identifying new sales channels, and developing new products and markets through the exploitation of technology. More rigorous execution of core products/ existing markets New sales channels Exploiting technology to develop new markets/ products Changing mix of existing products & services Increasing research & development 17% 16% 19% 22% are focused on growth, compared with 52% in April 26% Which statement best describes your organization s focus over the next 12 months? % focused on growth Growth Cost reduction and operational efficiency 51% 49% 52% 31% Maintaining stability Survival 46% 25% Oct-10 Apr-11 3% 6
The overall declining sentiment on growth is particularly pronounced. Even the appetite for organic growth reflects this trend. Respondents intentions with regard to excess cash underline the declining sentiment toward growth. Only 36% plan to deploy excess cash toward organic growth, compared with 50% in April. Returning cash to stakeholders shareholders and creditors is now the priority, with 31% of respondents planning to use excess cash to pay down debt, versus 18% in April. This provides further evidence that companies are focusing their attention on deleveraging and strengthening their balance sheets against a backdrop of ongoing uncertainty. If your company has excess cash to deploy, which of the following will be your focus over the next 12 months? Growth slows... Organic growth (R&D, capex) Inorganic growth (M&A) 13% 16% 15% 36% 50% 49% Viewpoint Are companies prepared for a return to economic growth? The focus on organic and inorganic growth has declined significantly as companies are positioning themselves for a slow recovery with low or stagnant growth rates. The Eurozone challenges, along with slowing growth in emerging markets, are driving this more conservative sentiment. What will it take to get growth back on track? Several ingredients must be in place continued bold moves by the ECB, the merging of fiscal and political agendas in the Eurozone, reform in emerging markets, and the knock-on effects of increased trade flows from emerging markets to the Eurozone in order for a return to growth. Interestingly, the sentiment by the majority of our respondents (87%) to maintain or grow their workforce is a sign that many companies are keeping key roles and infrastructure in place and maintaining flexibility to take advantage of any improvement in the economy. Cash is returned to stakeholders... Pay down debt 18% 22% 31% Pay dividends Buy back stock 5% 4% 12% 11% 10% 8% 51% with excess cash are focused on returning cash to shareholders and creditors 7
Mergers and acquisitions outlook Appetite for M&A declines What is the expected deal size? Amid uncertainty about the global economic outlook, companies are increasingly wary of acquisitions and their perceived risks. Just 25% of respondents now expect to pursue acquisitions over the next 12 months, down from 31% in April and a year ago. It is not just a lack of confidence in the business environment that is holding companies back many are also concerned about the gap between their valuation of potential acquisitions and the prices sought by sellers. 38% 46% For many companies, the intent around M&A has declined. Five years after the financial crisis, many executives are waiting for a sustained recovery before taking action. US$50m or less US$51m US$500m 9% US$501m US$1b 7% More than US$1b Do you expect your company to pursue acquisitions over the next 12 months? % saying yes 84% expect to do deals of US$500m or less Oct-10 38% Apr-11 31% 25% Respondents indicate a significant shift in sentiment on asset prices. Twenty-seven percent of respondents now believe deal prices will decrease, up from 16% a year ago. Significantly more respondents expect M&A asset values to decrease from a year ago, potentially slowing the pace of deals as buyers pause in anticipation of falling asset prices. Among those companies that do expect to engage in M&A, deal sizes remain small, reflecting an ongoing aversion to risky, transformational transactions. More than 80% say that they will do deals worth less than US$500m, and 38% say they will do deals under US$50m. This suggests that, where deals are being considered, they will extend existing businesses and fill strategic gaps. 34% in industrial products, 32% in financial services, 28% in oil and gas and 28% in consumer products expect to pursue acquisitions in the next 12 months What do you expect the price/valuation of M&A assets to do over the next 12 months? 28% with revenues of US$5b or greater expect to pursue an acquisition in the next 12 months Increase Remain at current levels 27% 31% 42% 57% Decrease 18% 16% 27% 8
Where will the deals be done? Top investment destinations, according to our respondents span developed and emerging markets, as companies seek to increase their exposure to markets that offer better growth opportunities. There is increasing evidence that developed markets are regaining momentum as top investment destinations. Four of the top five destinations for companies making investments are unchanged from April, with fifth-place Germany replacing Indonesia. While China remains a top investment destination, completing deals there remains challenging. Top investment destinations 1. China 2. US 3. India 4. Brazil 5. Germany Inbound investors into top five investment destinations Top inbound investors 1. US 2. UK 3. France 4. Brazil 5. Turkey Germany US China Top inbound investors 1. UK 2. Singapore 3. Germany 4. Canada 5. China Top inbound investors 1. US 2. Italy 3. UK 4. Singapore 5. Colombia Brazil India Top inbound investors 1. US 2. Germany 3. Japan 4. Italy 5. Brazil Top inbound investors 1. US 2. Singapore 3. Italy 4. Brazil 5. UK 9
0% 5% 0% 5% Fewer divestments expected after period of high activity There has been a sharp decline in the number of companies planning to make divestments in the next 12 months, from 31% in April to 19% today. Many companies have gone through the process of optimizing their portfolios and offloading those assets that did not fit their overall strategic objectives. This may indicate a shift from a divestment phase to a performance-optimization phase. Is your company likely to make an asset sale/divestment in the next 12 months? % saying yes 21% Oct-10 20% Apr-11 26% Top sectors planning to divest 1. Financial services 2. Industrial products 3. Technology 4. Consumer products 5. Automotive 31% 19% Optimization moves to the forefront Following an active period of divestment activity over the past 18 months, companies have now shifted their focus to optimizing capital allocation and improving performance. Viewpoint Boardroom agenda driven by capital optimization Since the onset of the financial crisis, the content of boardroom discussions has been transformed. Five years ago, topics such as efficiency and cost control key elements of capital optimization would rarely have made the boardroom agenda and would have been considered issues for operational management. Today, however, these activities are crucial drivers of value creation, particularly at a time when top-line growth remains elusive in most developed markets. Additionally, more than half of respondents say that optimizing capital allocation has moved up the boardroom agenda, as shareholders demand that boards direct capital toward the most promising investments and maximize returns. How do you think the boardroom agenda at your company has changed since the onset of the financial crisis? Efficiency and cost control Risk management 71% 25% 64% 29% 4% 7% What are the main drivers of your company s planned divestment activity? (Select two) Capital allocation Growth innovation R&D 52% 49% 36% 7% 15% Focusing on core assets Enhancing shareholder value Shedding underperforming business unit Funding inorganic/m&a growth plans 30% 25% 28% 22% 17% 32% 19% 17% 20% 48% 51% 56% Regulatory issues People (attracting/ retaining talent) Investor relations Growth investing in new markets 47% 43% 42% 42% 46% 35% 40% Greater focus today Stayed the same Less focus today 10% 16% 13% 25% Raising cash to compensate for underperformance of aggregate business 18% 23% 19% 10
Survey demographics Proportions of select industries represented What are your company s annual global revenues in US$? Consumer products Automotive $5b or more $1b to $4.9b $500m to $999.9m 24% 23% 35% Oil and gas Less than $500m 18% Life sciences* Power and utilities What is your position in the organization? Financial services C-level executive 49% Technology Mining and metals Head of BU/dept. SVP/VP/director 24% 27% Diversified industrial products Public sector What best describes your company ownership? Publicly listed 60% *Health care/provider care, pharma, biotech Privately owned Family-owned Government/ state-owned enterprise Private equity portfolio company 5% 4% 3% 28% 11
Contacts If you would like to discuss the comprehensive survey results or those specific to your sector or geography, please contact your Ernst & Young advisor or any of the contacts below. Name Telephone Email Global Pip McCrostie Global Vice Chair Steven Krouskos Global and Americas Markets Leader Michael Rogers Global Markets Americas Richard M. Jeanneret Americas Leader Europe, Middle East, India and Africa (EMEIA) Joachim Spill EMEIA Leader Asia-Pacific and Japan John Hope Asia-Pacific Leader Kenneth G. Smith Japan Leader Acknowledgements +44 20 7980 0500 pip.mccrostie@uk.ey.com +1 212 773 3975 steve.krouskos@ey.com +44 20 7980 0200 michael.rogers@ey.com +1 212 773 2922 richard.jeanneret@ey.com +49 6196 996 25366 joachim.spill@de.ey.com +852 2846 9997 john.hope@hk.ey.com +81 3 4582 6400 kenneth.smith@jp.ey.com Our special thanks go to the panel* for its contribution to this survey. * The panel comprises EIU senior executives and select Ernst & Young clients and contacts who participate in the Capital Confidence Barometer on a semiannual basis. The surveys are conducted on an independent basis by the EIU. Ernst & Young Assurance Tax Transactions Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of 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 www.ey.com. About Ernst & Young s How an organization manages its capital agenda today will define its competitive position tomorrow. We work with our clients to help them make better and more informed decisions about how they strategically manage capital and transactions in a changing world. Whether you re preserving, optimizing, raising or investing capital, Ernst & Young s Transaction Advisory Services brings together a unique combination of skills, insight and experience to deliver tailored advice attuned to your needs helping you drive competitive advantage and increased shareholder returns, through improved decision-making across all aspects of your capital agenda. About this survey Ernst & Young s Capital Confidence Barometer is part of Growing Beyond, our flagship program exploring how companies are finding new opportunities in challenging economic times. 2012 EYGM Limited. All Rights Reserved. EYG no. DE0361 This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. The opinions of third parties set out in this publication are not necessarily the opinions of the global Ernst & Young organization or its member firms. Moreover, they should be viewed in the context of the time they were expressed. www.ey.com ED None.