Indicators Point to 2010 Recovery for Automation and Control Sector

Global economic decline, market volatility and heavy losses characterized 2009.

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In what was the most serious recession since the Great Depression, consumers and businesses slashed spending in the first quarter of the year at a historically furious pace. Unemployment reached new highs and markets were plagued by the uncertain economic impact of government policy changes worldwide. With the weakening of the dollar, ever-increasing value of gold and burgeoning federal debt, it’s not surprising to find some questioning the signals of a sustainable recovery in the new year.

While manufacturing capacity remains at or around trough levels, there had been three consecutive months of manufacturing expansion through October, according to the Institute for Supply Management. Real discussions between buyers and sellers required to fill the deal pipeline have been increasing since August. Available capital, earnings visibility and improving equity valuations have emerged as the critical elements of a more robust mergers-and-acquisitions (M&A) market in 2010.

The equity and debt capital markets were essentially nonexistent to issuers in the first half of 2009, but we’ve seen encouraging signs since August that point to a more robust 2010. In the high-yield bond market, investors have successfully absorbed relatively heavy new issue volume. According to Dealogic, approximately $123 billion in high-yield bonds have been issued through October 2009 as compared to $48 billion in all of 2008.

Companies that have avoided bankruptcy are tapping the debt capital markets to refinance new debt, push out maturities or execute debt exchanges. Managing Director Tad Flynn in Houlihan Lokey’s Financing Group says: “We’re seeing our clients, both public and private, take advantage of this window of demand for equity and debt securities in order to position their balance sheet for the next growth cycle. We believe the traditional loan markets will recover slowly throughout 2010, but expect that both equity and mezzanine investors are really going to compete for event-driven opportunities in order to put capital to work in the new year.”

Earnings growth?

Aside from available capital, some form of earnings visibility is a necessary dimension for returning confidence to the market. The question, “How much will it grow?” always brings more investors to the table than, “How far will it decline?” Industry bellwether, Rockwell Automation, in its third quarter earnings release, announced sequential quarterly growth in revenue and earnings and set expectations for 2010 growth. Berkshire Hathaway’s recent $34 billion acquisition of Burlington Northern Santa Fe Corp., the nation’s second-largest railroad, may be one of the best indicators to date of optimism for the country’s economic health going forward.

Given the aforementioned factors, it’s no surprise that the Houlihan Lokey Industrial Automation and Control Index is up 25.3 percent year-to-date, and up 80.7 percent since the most recent market bottom on March 9, 2009. Comparatively, the S&P 500 is up 19.1 percent and 64 percent over the same periods. Equity valuations continue to improve and outperform in the industrial automation and control sector, and these relative values represent a more normalized level than seen throughout the first half of 2009. Stable valuations in the public markets are another essential component to buyers and sellers as they negotiate the terms of a possible transaction.

The long-term prospects of equity and debt capital markets are beginning to look attractive once again, and issuers are finding capital available for investments in both organic and M&A growth opportunities. Barring an exogenous event (such as a dramatic change in government policy), we’re optimistic for a tangible recovery in 2010.

Jim Lavelle, jlavelle@hl.com, is a Managing Director in the Industrial Technologies practice, and Eugene Bazemore, ebazemore@hl.com, is Senior Vice President in the Industrial Technologies practice of Houlihan Lokey, an international investment bank (www.hl.com).

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