A BULLISH M&A FORECAST

Gaining market share and geographic coverage are top priorities driving deals

Retail continues to rally for deals in 2015, and the sector could be on the cusp of another major year for mergers and acquisitions. Already this year, we’ve seen speculation about a number of potentially massive deals — from a possible buyout of Rite Aid by Walgreens Boots Alliance to the proposed merger between Staples and Office Depot. Looking across the industry, as part of BDO’s annual Retail Compass Survey of CFOs, we asked chief financial officers at leading U.S. retailers about their deal flow projections for 2015. As it turns out, they were hardly modest in their outlooks.

In fact, CFOs responded with their most bullish forecast for M&A activity in the survey’s nine-year history. A resounding 59% of CFOs expect activity to increase in the months ahead, while 38% expect it to remain at 2014’s levels. In terms of the likely players behind this expected uptick in activity, a majority (56%) of CFOs say that strategic buyers will be the most acquisitive, whereas 44% point to financial buyers.

We likely won’t have to look far for M&A, either. According to CFOs, this ongoing consolidation will continue to be dominated by domestic deals: Seventy-three percent expect that activity will primarily occur in the United States, while 15% think Asia will be the hottest region for deals.

Within today’s retail environment — one that is simultaneously experiencing slowly improving sales along with ongoing, fierce competition — CFOs’ expectations are not particularly surprising, especially when it comes to strategic opportunities. It’s both challenging and expensive for companies to expand their brand and reach in this hypercompetitive marketplace, and as far as traditional brick-and-mortar retailers are concerned, growth options are even more limited. Not surprisingly, more CFOs cited M&A as their primary growth tactic for 2015, jumping to 16% from just 3% in 2014.

Surely, they’re on to something. M&A can provide an attractive avenue to achieve growth, either through consuming the competition or entering a new market altogether. Considering the year ahead, retail CFOs say that gaining market share (43%) will be the primary growth target for strategic buyers, while geographic coverage is growing in importance (noted by 24% this year, up from 8% in 2014).

Other driving factors of strategic deals include increased revenue and profitability (16%), acquiring technology assets and intellectual property (12%) and more distribution channels (6%). With traditional e-tailers like Amazon and Google now eyeing physical store locations to interact with customers and demo products, the latter could be a major contributor to deal volume within the next few years.

At the same time, financial buyers are also becoming more active in the space. With their strong cash reserves, private equity and capital investment firms are busily looking for opportunities to acquire new retail ventures, especially as consumer sentiment continues to rise and conditions across the U.S. economy gradually improve.

Whereas many financial buyers have been holding steady with their investments over the last three to five years to shore up value in the slowly improving economy, we’re beginning to see more activity in the buy-sell cycle. Consider the purchase of women’s apparel retailer J. Jill in March by PE firm Tower-Brook Capital Partners as a likely harbinger of greater financial deal-making in the months ahead. Meanwhile, as companies look to leverage the opportunity to consolidate in this improving market, buyers may also be willing to pay a higher price: Retailers anticipate an average EBITDA multiple of 5.2 this year, up from 4.2 in 2014.

On a related note, if retail CFOs’ robust deal flow projections were not convincing enough, their renewed focus on financial metrics offers a glimpse into their 2015 industry expectations. While the market may still be focused on gross sales as the key indicator of growth, a plurality (39%) of retailers point to EBITDA as their top metric for 2015.

As market conditions may continue to improve and align in the months ahead, retailers understand that the intense competition in the U.S. is not going anywhere. With their sights aggressively set on new opportunities for growth and expansion, retailers and financial institutions alike may increasingly opt for mergers and acquisitions as a way to achieve their 2015 goals.

Ted Vaughan is a partner in the consumer business practice of BDO USA, a professional services firm providing assurance, tax, financial advisory and consulting services to a wide range of publicly traded and privately held companies ([email protected]).