Scoring

In a market rife with uncertainty, opportunity also abounds. Asset values are at their lowest levels in many years. And a global recession is highlighting the value many industries could potentially attain through consolidation.

Yet deal activity remains at a relative trickle. While getting beyond the impasse may take some doing, new and old dealmaking tools are surfacing that can improve the odds for completing a successful transaction.

Leading corporations, anxious to position themselves for growth in a rebounding economy, want to act. In fact, a June survey of more than 500 global executives by the Economist Intelligence Unit shows that 34% of companies plan to execute strategic acquisitions in their core sectors within the next 12 months. Meanwhile, 29% of companies say they in turn are also hoping to divest noncore or nonperforming businesses.

But while an appetite for transactions is evident, the lingering global credit crunch is starving the markets of much-needed investment capital. The same credit crisis that slowed the economy and lowered valuations is now inhibiting any recovery in deal volume.

Another drain on transaction flow is the disparity between buyer and seller perceptions of value. Buyers see current market conditions and expect to acquire assets at distressed prices. Potential sellers, for their part, still have a hard time understanding why the bids presented today are so much lower than valuations done less than a year earlier.

Sellers may know rationally that in today's conditions, these bids aren't that far from fair, but their hearts still cling nostalgically to the valuations of yesteryear. Result: a lingering gulf between bids and offers, which can't help but inhibit any meeting of minds.

Still, deals are taking place -- under specific circumstances. These usually fall under the category of "ideal conditions." Such a deal might feature a cash-rich buyer taking on the unwanted assets of a motivated seller. While many of these, depending on their size, are all cash, some include debt. If that seems surprising in today's tight credit market, the fact is that some companies now sport balance sheets stronger than those of most banks. Thus, financing via bond or commercial paper issuance, or even securing limited bank financing, poses no real hurdle.

Another characteristic of the deal market today is heavy equity participation. A major global bank recently divested its asset management business to a second major asset manager, retaining a one-quarter stake in the business. Of note was the fact that the business sold was neither nonperforming nor noncore. Rather, the sale was executed primarily to bolster a sagging balance sheet. Because the deal featured heavy equity participation, the seller achieved its goals while still keeping a hand in a desirable business. Meanwhile, the acquirer was able to expand both the scope and scale of its business, a move of great potential value when the
economy rebounds.

Deals are also being completed with the help of various nontraditional structures. Long dormant structures such as Reverse Morris Trusts or like-kind exchanges have been taken out of mothballs to enable changes in ownership. More transactions than in years past are now seeing significant seller financing, as well. Even if such structures sometimes provide for a less than ideal outcome, for many companies, something is proving better than nothing. The current market with its relatively low valuations presents numerous opportunities. In the closing weeks of summer, private equity firms and hedge funds have been noted in the press to be picking over distressed assets. As the realization sets in that valuations are at or near their floor, PE funds in particular could very well become an important source of deal volume.

It may take effort and ingenuity, but most bets are on the deal market resuming by year's end or early in 2010. In the June EIU survey, 21% of executives said that their plans for recovery included making strategic acquisitions in new areas of business. Current conditions mean that buyers can consolidate industries or pursue new ventures at a relatively low price while sellers can raise needed capital by divesting noncore or nonperforming assets. The trick is finding the means to do the deal.

Steve Krouskos is Americas accounts and growth leader at
Ernst & Young LLP's transaction advisory services.