Despite 2013 being touted as the year for M&A and LBOs, barring a few large deals, the year is yet to witness a significant uptick.

Erin Lyons and Swati Verma of Citi Research feel despite 2013 witnessing some notable deals such as Verizon Communications Inc. (NYSE:VZ), H.J. Heinz Company (NYSE:HNZ) and Dell Inc. (NASDAQ:DELL), the year is yet to produce sufficient numbers to justify confidence.

Ticks all boxes to support enhanced M&A activity

Interestingly, Citi analysts point out that 2013 is conducive for all traditional factors to support enhanced M&A activity. The analysts feel despite the presence of the five traditional factors conducive for robust M&A activity, the year 2013 is yet to witness sufficient uptick.

With the 10-year Treasury rate 10 years forward still lower than historical averages for the next two years, Citi analysts feel financing is cheap and more debt can be financed. However, the analysts point out the recent Verizon deal had to be concluded with a significant concession to get the order book built.

Erin Lyons and Swati Verma of Citi Research feel with EBITDA multiples still trending below the pre-crisis averages, valuations are attractive. However, the analysts point out that overall the equity market has witnessed over 50 percent increase in price. Surprisingly, by comparing the deal size to constituents of the Russell 3000 (INDEXRUSSELL:RUA), analysts feel valuations are actually highest for the smallest companies.

A strong activity in equity markets should ideally support enhanced M&A activity. However, Citi analysts point out despite S&P 500 (INDEXSP:.INX) witnessing price increases, these are not translated into robust M&A deals, as the analysts feel CEOs might be choosing a less risky option of preferring buybacks over M&A.

Despite corporates having substantial cash on hand, Citi analysts point out corporates prefer to go in for buyback option as the spread between the cost of equity and cost of debt for S&P 500 (INDEXSP:.INX) companies reaching wides during the past few years.

Though managers are becoming more willing to lever up, the economic outlook in the U.S. and Europe is forcing CEOs to pause when considering major deals. Hence Citi analysts point out the CEOs choose the safer option of share buybacks or enhanced dividends to appease their shareholders, instead of turning their attention towards growth and earnings.

Potential releveraging Targets

Busting all the above five traditional factors that support robust M&A activity, Citi analysts have broadly identified candidates that are able to lever up. Some of the parameters considered for selection include generation of free cash flow, having EV/EBITDA valuations below 9x, leveraging and ratings supporting increased debt.

The following screen displays Erin Lyons and Swati Verma of Citi Research’s potential releveraging targets.

M&A Potential releveraing targets