M&A and Facility Investment 'Cooling Down'
Companies' Safes Are Full
[Asia Economy Reporter Lee Seon-ae] The 'investment clock' of Korean companies has stopped. The mergers and acquisitions (M&A) market has contracted, and facility investments have also sharply declined. However, companies that have postponed investment decisions due to domestic and international uncertainties have ample 'cash assets' in their coffers. Although interest rates are rising as if pushed by immediate inflationary pressures and it is difficult to expect investment growth due to instability in the global financial market, advice is emerging that investment opportunities should be sought in companies with cash-generating capabilities that have not been able to invest aggressively as before.
M&A and Facility Investment Plummet
According to Hana Financial Investment on the 9th, global M&A volume in the first quarter of this year was $1.1 trillion, a whopping 25% decrease compared to the fourth quarter of 2021. The global M&A amount as a proportion of MSCI global market capitalization is only about 1.2%. This is the third-lowest quarterly level since 2000 (0.5% in Q2 2020, 1.0% in Q3 2009). This is due to the global financial market turmoil caused by the Russia-Ukraine war, COVID-19 lockdowns, and tightening moves by central banks worldwide, which hindered investments.
The domestic market situation is similar. The M&A market in the first quarter of this year is estimated to be around 2.5 trillion KRW in acquisition transaction value, about 30% lower than the previous year. This is even less than the first quarter of 2020 (2.69 trillion KRW) during the COVID-19 pandemic. An investment banking industry official hinted, "The M&A market in the first quarter of this year is the lowest in over a decade."
Facility investments by domestic companies have also sharply declined. Although Korean exports continue to break record highs, companies have been reducing facility investments since the second half of last year. Exports in the first quarter increased by 4.1% compared to the previous quarter, but facility investments decreased by 2.4%. Kim Hyo-jin, a researcher at KB Securities, analyzed, "Korean companies have chosen a strategy to reduce investments in anticipation of future demand slowdown even if exports increase currently. After the US-China conflict emerged in 2018, total facility investments shrank by 13% over two years. Although supply disruptions of materials related to facility investments due to bottlenecks should be considered, it is judged that companies are preparing for future demand slowdown."
Investment recovery does not seem easy going forward. Researcher Kim said, "Korean exports are continuously breaking record highs, but when divided into unit price and volume, export unit prices have surged, but volumes have stagnated and have not recovered to pre-2018 US-China conflict levels. Considering volume stagnation and the possibility of expanded lockdowns in China, corporate investments are expected to decrease further, which will also act as downward pressure on the economy despite service sector recovery."
Focus on Investments by Cash-Generating Companies
However, the securities industry is focusing on companies with excellent cash-generating capabilities. It means attention should be paid to companies that can utilize this period. Lee Jae-man, a researcher at Hana Financial Investment, said, "When interest rates rise, it becomes difficult for corporate valuations (PER) to increase, but considering that acquisition price premiums follow a similar trend to PER, this can be interpreted as a period when good companies can be acquired at reasonable prices. Since the global M&A market is already cooling, it is necessary to consider the possibility that M&A may be revitalized from a contrarian perspective."
Due to rising interest rates, the cost of capital for companies is likely to increase, so investments or M&A will likely require companies to have ample cash reserves. The KOSPI WACC (weighted average cost of capital) has steadily risen from a low of 6.4% in 2019 to 7.6% in 2021. This means that aggressive investments need to be carried out through the cash companies hold. The researcher emphasized, "Among domestic companies, attention should be paid to those with steady sales growth → relatively good cash-generating ability and cash accumulation → relatively low debt ratios → companies that have not been able to invest aggressively as before."
The KOSPI free cash flow (FCF) ratio to sales rose from 3.3% in 2019 to 3.8% in 2021. Representative companies with steady sales growth, relatively good cash-generating ability, and low debt ratios include Samsung Electronics. Samsung Electronics’ free cash flow ratio to sales is recorded at 6.4%. DB HiTek (21.4%), Lotte Fine Chemical (11.0%), CJ ENM (17.1%), S-1 Corporation (7.7%), LG Household & Health Care (8.2%), Pan Ocean (9.4%), and SM Entertainment (14.3%) are also considered companies with excellent cash-generating capabilities.
Meanwhile, according to the '2021 Financial Flow' data recently released by the Bank of Korea, domestic companies held 885 trillion KRW in cash (including deposits) assets at the end of last year. This is an increase of 125 trillion KRW, the largest ever, compared to the end of 2020. The cash held by the representative companies of the five major groups?Samsung Electronics, Hyundai Motor, SK Hynix, LG Electronics, and Lotte Shopping?amounted to 65.3353 trillion KRW, an increase of 15.305 trillion KRW (31%) in one year.
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