With the huge cash balances non-financial companies have built up during the past few years of global economic uncertainty and frozen corporate spending, the size of recent M&A transactions suggest money is ready to be redeployed. The fact that the fourth quarter confidence reading for U.S. CEOs also returned to a five-year high should also serve as support for broad equity markets for the balance of 2010.
Recent deals such as Yara International’s friendly takeover of competitor Terra Industries for US$4.1-billion and Simon Property Group’s US$10-billion offer for General Growth Properties (Brookfield Asset Management has also entered the fray) have sparked a deal revival that is likely to continue for the balance of the year, Dundee Securities strategist Martin Roberge said in a recent report.
He noted that global non-financial companies generated a record US$3.6-billion in free cash in 2009. As a percentage of enterprise value, the free cash flow yield for this group increased from 8.2% in 2007 to 10.3% in 2009. A high FCF yield not only means that excess cash sitting on balance sheets can be used to buy back stock and hike dividends, it also provides fundamental value for potential acquirers.
Calling Canada “a land of opportunity” in this respect, Mr. Roberge noted that the S&P/TSX non-financial index boasts a FCF yield of 11.7% – the highest amoung G7 countries.
The biggest FCF generators and yielders are the energy, industrial, consumer discretionary and telecom sectors. While telecoms offer a FCF yield of 15.6%, there are few M&A opportunities there. The group is, however, in the best position to increase dividends, which is why it represents the strategist’s favourite defensive play. As for energy and industrials, Mr. Roberge expects M&A transactions will take centre stage as both sectors remain highly fragmented.
With more deals on the horizon, investors should expect bidding wars and white knights to emerge.