Since the recession started in 2007, expectations of market behavior have been constantly revised, perhaps improvised. The mergers and acquisitions market is not unique in that respect. Debt market activity is stridently hitting new heights, yet M&A deal values are at an all time low. Despite the laundry list of reasons that explains its current state—wary lenders, lower cash flows, lack of investor confidence, macro data—uncertainty pervades the M&A market.

That sentiment may be starting to change. September was a busy month for dealmakers, including announcements that Abbott Labs was buying a unit of Solvay in Belgium for $6.6 billion and that Xerox agreed to buy Affiliated Computer Services for $6.4 billion.

Yet some potential buyers are opting to remain on the sidelines. Although profitability is returning, there are doubts regarding revenue growth in most industries. These doubts are holding back lenders and holding down values of companies trying to sell.

The second quarter of 2009 consisted of 1,870 deals done at a total value of $131 billion, down from 2,416 deals worth $426 billion during the same
period in 2008.

“With a few exceptions, value has declined, and it is not a propitious time to sell a business,” says investment banker Hugh Taylor of NewburyPiret.

“For buyers, the challenge is getting expected cash flow,” says Bob Filek, partner at PriceWaterhouseCoopers Transaction Services, “and gaining visibility in reliability of cash flows.” Indeterminate cash flows deter both buyers and lenders. Lenders determine the amount of debt they will issue as a portion of expected cash flows of the target company. Before the recession, if a company was bought at 10 times EBITDA, 80 percent of the purchase could be financed with debt. Today, that amount is closer to 20 percent.

Mergers continue to occur for public companies, but at lower values. “There have been a lot of small acquisitions in pharma and healthcare,” says Matt Toole, an analyst at Thomson Reuters.
For the M&A market to return, there is unanimous consensus of what needs to come first: normality. A return to normal business conditions all but guarantees more M&A deals. Business fundamentals, not the stock price, are running the show.