PHILADELPHIA (Reuters) - The U.S. merger market could drop by as much as 20 percent in 2008, while Europe may see a 5 percent to 10 percent decline in volume, as lending markets remain tight and investment banks absorb the fallout from mortgage losses, investment bankers said on Thursday.
The market may see several small leverage buyout deals of about $1 billion to $3 billion in size, but it may take several quarters before private equity buyers return to buyouts of more than $10 billion, experts said.
"There are two general views. The first view is that there's going to be a slowdown in the economy, but no recession. In that case, we should have a reasonable, healthy M&A market next year," said Stefan Selig, global head of mergers and acquisitions at Banc of America Securities.
"However, if that (view) turns out to be optimistic, then we'll have a more precipitous decline in M&A activity," said Selig, who forecast 2008 global merger volume to mirror activity seen in 2005.
About $2.9 trillion in deals were announced worldwide in 2005, while $3.9 trillion were done in 2006, according to research firm Dealogic.
With every merger expert, however, comes a slightly different forecast. The one thing upon which bankers do agree, though, is that 2008 will see a slowdown from this year's record.
So far this year, almost $4.3 trillion in deals have been announced globally, with about $1.4 trillion announced in the United States, according to Dealogic.
"This year we'll see over $4 trillion in M&A, It could have been $5 trillion if the credit markets hadn't seized up. But $4 trillion -- north of that -- will be a terrific year," said Dennis Hersch, JP Morgan's global chairman of mergers and acquisitions.
Hersch said he expects the U.S merger market to decline about 10 percent in 2008, with the decline in Europe to be slighter.
The slowdown that began with the summer credit clampdown had peaked in September, which showed the lowest monthly deal volume in more than two years, Dealogic said.
"What has left the market, of course, is large sponsor deals. We certainly don't expect the large ones to come back any time soon. We could well go through the first half of next year without seeing any of the sort-of mega-sized deals the sponsors were generating in '05 and '06," Hersch said.
Credit markets will remain cool as the losses from the subprime mortgage market ripple through the financial markets and the balance sheets of investment banks.
Morgan Stanley (MS.N), became the latest bank to detail its problems, saying on Wednesday it suffered a $3.7 billion hit stemming from its U.S. subprime mortgage exposure. Citigroup Inc. (C.N) and Merrill Lynch & Co. MER.N also reported large write-downs from exposure to lower-quality debt.
As a result, there will be tougher scrutiny when borrowers seek money to fund acquisitions through at least mid-2008, experts said.
Private equity firms, which accounted for about 20 percent of the volume this year, are not expected to sponsor as much activity next year.
One Citigroup banker, who declined to be named, said the investment bank expects U.S. merger volume in 2008 to drop by about 20 percent, and mergers in Europe, Middle East and Africa to show a decline in the range of 7 percent to 9 percent.
The private equity market might not agree, but billionaire investor Wilbur Ross said he thought the credit markets' tightening might help investors over the long term since valuations will decline.
"Deal prices were getting a little on the generous side, with multiples up around eight-times EBITDA. I'm much more comfortable at five-, and six-, and six-and-a-half-times (EBITDA)," Ross said in an interview on CNBC.
"To the degree that the net effect of the credit crunch is that lower entry prices are made -- that eventually has to work out to better rates-of-return for the equity investors in the deal," Ross said in the Wednesday appearance.
Some expect the decline in the merger market to be cushioned by public companies returning to dealmaking even as private equity retreats. Public companies may offer more stock as currency in deals instead of competing against all-cash offers.
"Corporates aren't concerned nearly as much about the ability of competing against the private equity community, which was getting a huge advantage with the low cost of debt the past few years," said Hersch.
Corporate deals grabbed headlines on Thursday as Australia's BHP Billiton (BHP.AX) made a $140 billion offer to acquire UK mining rival Rio Tinto (RIO.L) (RIO.AX). The offer, which would have been the second-biggest takeover mobile phone giant Vodafone's purchase of Mannesmann in 2000, was rejected by Rio Tinto.
Yet, the return of corporate deals has been slower than some had predicted.
"There hasn't been enough time yet for seller's valuation expectations to moderate sufficiently to spur deal activity. There's also sufficient uncertainty about the markets and the economy that is keeping companies on the sideline," Selig said