The energy, finance, technology and healthcare industries are expected to be the hottest areas in a dealmaking market that in 2010 is likely to expand gradually from this year's depressed levels.

This week's move by Exxon Mobil Corp to buy XTO Energy Inc for $30 billion in stock may be a harbinger of activity to come in 2010 as companies flex their stronger share prices and release pent-up deal demand.

The XTO takeover followed other corporate mega-deals, such as the $26 billion cash-and-stock deal for Burlington Northern Santa Fe by Warren Buffett's Berkshire Hathaway, and Comcast Corp's $30 billion planned purchase of NBC Universal.

We're encouraged by the current activity. The pipeline for the early part of 2010 is improving -- 10 to 15 percent growth for the year is possible. Both engines of activity -- private equity and corporates -- are now active, said Jeffrey Kaplan, global head of mergers, acquisitions, financial sponsors and corporate finance at Bank of America Merrill Lynch.

You need a sustainable economic recovery, he said. You cannot expect the M&A market to flourish without favorable economic conditions. The best deals often are done at the beginning of a recovery. Post-bubbles create opportunities to get great values but are not always the best times for sustained M&A activity.

M&A totals $1.968 trillion so far in 2009, down 32 percent from full-year 2008 and down 53 percent from the record high in 2007, according to data from Thomson Reuters.

The United States, which suffered a six-year low in mergers and acquisitions, still squeaked ahead of Europe for the first time in three years.

Bankers expect flat-to-modest growth for 2010.

We're expecting $2 trillion for M&A for 2009. If you look deeper into 2009 and you back out rescue financings, which were counted as M&A transactions, we're closer to $1.6 trillion in traditional M&A. So much of this year has been nontraditional M&A and a few mega healthcare deals, said Paul Parker, head of global M&A at Barclays Capital.

We expect $2.1 trillion in 2010, but with more traditional M&A playing a larger role, he said. The numbers may look flat on paper, but when you take out a lot of the noise of this year, it really indicates more traditional merger transactions and a healthier market,

Lee LeBrun, co-head of Americas M&A at Swiss bank UBS, said, There are a number of factors which create a tailwind for M&A volumes to rebound: CEO confidence is high, capital markets are accommodative, balance sheets are stronger with high levels of cash. And given the interest rate environment, cash hasn't ever had a lower opportunity cost.

But he added, One potential headwind is the regulatory environment. How the regulatory risk is shared between parties and reverse break fees will become more important discussions in merger negotiations.

Joseph Frumkin, a partner with law firm Sullivan & Cromwell, said the market remains quite cautious, with deals taking months to assemble, rather than mere weeks for some deals during the M&A peak.

MORGAN STANLEY TOPS CHARTS

Morgan Stanley topped the global M&A league table in 2009 for the first time since 1996, benefiting from working on each of the five largest deals this year.

Morgan Stanley's win is a big upset for Goldman Sachs, which until this year held the No. 1 ranking on the list of announced M&A deals for the last 12 years without interruption.

Advisory fees generated by M&A deals totaled $18.9 billion, down 46 percent from 2008 -- the worst annual level since 2003. For the first time in six years, M&A was not the main source of fees for investment banks, representing just 27 percent of all fees earned this year, according to Thomson Reuters.

The energy and power sectors generated the most fees of all industries, followed by financials. Still, the biggest deal of the year was in the pharmaceuticals sector: Pfizer Inc's $64.6 billion acquisition of Wyeth.

Energy and healthcare were the only two industries that showed gains in deal volume this year. The worst performing sectors were consumer staples and consumer products and services, according to Thomson Reuters.

Energy and raw materials, as well as industrials, financial institutions, healthcare services and technology will likely take the spotlight next year, bankers said.

M&A activity in 2010 will be driven by strategic buyers who have access to capital and the strategic vision to capitalize on some of the best values we have seen in recent times, said Bob Filek, a partner with PricewaterhouseCoopers Transaction Services.

Companies have taken aggressive actions on costs; the low hanging fruit is gone, and to drive further efficiency they will look to combine with similar players to drive scale and enhance productivity. The 'merger of productivity' will be a driving force in 2010 as companies look to drive revenue growth and enhance margins, Filek said.

PRIVATE EQUITY HITS SEVEN-YEAR LOW

Global buyside financial sponsor activity dropped 45 percent in 2009, hitting a seven-year low of $130 billion. There were only two financial sponsor deal over $5 billion this year -- the takeover of Delphi Corp by creditors, and the acquisition of IMS Health Inc by TPG Capital and the Canada Pension Plan.

Private equity is sitting on $400 billion in dry powder, or cash, while Fortune 1000 companies have more than $1.8 trillion of cash on hand, an increase of $271 billion over last year, according to Ernst & Young's Transaction Advisory Services.

As debt markets become more open, with banks willing to lend money for deals with higher leverage, private equity firms and corporations will begin to compete again on deals.

Cash on balance sheets is at its highest level since 1951. At current rates, holding cash is very dilutive. If companies don't start using it, activists will say return it to shareholders. We have a lot of well capitalized companies. And financial sponsors are coming back meaningfully, as well, Parker said.

The percentage of deals using a mix of cash and stock more than tripled this year to 19 percent, while the percentage of pure cash and pure stock deals dropped, according to Thomson Reuters.

We're seeing a marked shift toward mixed cash-and-stock and all-stock deals. It bridges the gap between sellers and buyers by allowing for upside participation from combination synergies and continued economic and market improvements, Parker said.

HOSTILE DEALS TO INCREASE

Extra cash on balance sheets, buoyed stock prices and rising corporate boardroom confidence points to an increase in hostile deal activity over the next year, bankers said.

In a corporate governance environment with fewer staggered boards and poison pills, hostile activity continues to be relatively robust. However, despite a number of high-profile bids, completion rates remain low, LeBrun said.
Kraft Foods Inc's $16 billion hostile offer for British confectioner Cadbury is typical of the move toward hostile deals, according to data from Thomson Reuters.

Hostile bids represented only 0.9 percent of the M&A market this year, but that was still the highest rate of the past five years, the data showed.

When you have a disconnect between market valuations and sellers' expectations, that tends to make buyers go hostile. It's exactly this kind of environment that is ripe for hostiles, though it's somewhat constrained by bank lending. With hostiles, there is no chance to do due diligence, and banks tend to be risk averse, Frumkin said.

You need both CEO and board confidence to pursue M&A in general and hostiles in particular, Kaplan said. You tend not to see a large number of hostiles. Typically, it's not what we advise companies to do -- only as a last resort.

(Reporting by Jessica Hall; Editing by John Wallace)

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