Contributed By Sirote & Permutt PC
The year 2016 saw record-breaking deal activity, particularly in the US, evidencing an increase in corporate confidence and a desire for seeking strategic transactions. Although overall economic growth was relatively slow, M&A transactions represented a genuine opportunity for businesses to increase top-line revenue. There was generally widespread shareholder support for those M&A transactions that could demonstrate significant synergies. The growth in corporate cash reserves and the availability of capital supported leverage and higher valuations that year.
During 2017 and the first half of 2018, M&A transactions continued to represent a means to enhance revenue. This 18-month period witnessed sector consolidation and transformational deals as companies sought value through M&A transactions. Many of these transactions continued to blur traditional industry lines through the convergence of companies in different but related industries (examples include CVS Health’s acquisition of Aetna, Cigna Corporation’s acquisition of Express Scripts Holding Company and Amazon’s acquisition of Whole Foods). Shareholder support for M&A transactions remained high during this period, with substantial corporate cash balances and investor capital available to fund deals. In general, the regulatory environment supported M&A transactions in the wake of deregulation under President Trump’s administration. However, concerns began to arise about antitrust enforcement actions by the Committee on Foreign Investment in the US (CFIUS).
When surveyed by Deloitte in September 2018, almost 79% of the more than 1,000 US corporate and domestic-based private equity firm executives (up from 70% in 2017) believed that M&A activity in 2019 would continue to be strong and could even surpass the 2018 level in terms of number and aggregate size of deals. However, the fourth quarter of 2018 revealed a slowdown in M&A transactions globally and in the US, due primarily to economic uncertainties, a potential increase in interest rates and the escalation of the trade dispute with China.
During the second half of 2018 the pace of M&A activity declined, but those M&A transactions that were completed during this time continued to effect sector consolidation and disruption. Although still generally supportive of M&A transactions, certain shareholder activists became more aggressive in moving to block deals. Investors began to closely monitor Federal Reserve policy in anticipation of interest rate increases.
Though waning towards the end of the year, overall 2018 was a great year for global M&A activity. According to Thompson Reuters, worldwide M&A activity in 2018 increased by 26% in value over 2017, though the number of transactions decreased by 9%. In the US, M&A activity increased by 48% in 2018 over 2017, while deal volume declined by approximately 10%. In the third quarter of 2018, M&A activity declined by 32% compared to the second quarter of 2018, reflecting growing global trade market instability and political uncertainty.
In the US, M&A activity reached USD1.67 trillion in 2018, an increase of 28% over 2017. The leading industries in M&A activity by overall value were energy and power (22% of the total value of M&A deals), technology (19%), telecom and media (8%), real estate and healthcare (7% each).
M&A Trends for 2019
Going into 2019, corporate cash reserves and investor capital remain high, which executives and experts predict will be utilised to fund M&A activity. Some uncertainty exists in relation to the volatility of the capital markets, particularly in light of the performance of the US stock markets in November and December of 2018. Possible challenges facing M&A activity in 2019 include increasing concerns about rising interest rates, the Trump administration’s trade policy and a possible economic slowdown.
There were four interest rate increases in 2018 and the Federal Reserve initially indicated that there could be two additional increases in 2019, although it has since backed off from this position. Higher interest rates could serve as a headwind to potentially slow M&A activity, but without other negative factors in the marketplace coming into play, most experts and corporate executives expect to see a vibrant M&A market continuing in 2019. According to Deloitte, corporations have increased cash reserves (due in part to tax reform) and private equity investors have a substantial amount of cash available for investment. M&A transactions remain a primary focus for the use of such funds.
Further global trade disputes, especially between China and the US, could adversely impact M&A activity in 2019 as supply chains and overseas investment are disrupted. The US has placed tariffs on steel and aluminium and has imposed tariffs on numerous Chinese goods, which has triggered retaliation by China on almost all US goods. These actions have caused the cost of manufacturing and the cost of goods to rise. Some US companies have moved manufacturing from China to elsewhere in south-east Asia. Chinese manufacturing and consumer spending were both down in the fourth quarter of 2018 compared to the same period in 2017. The impact of these trade disputes could create uncertainty in the market and uncertainty in the market inversely affects M&A activity. In 2018, M&A transactions outbound to China were only USD19.2 billion, less than outbound transactions to the UK, India, Canada and Spain. China did not even place in the top five countries for inbound transactions in 2018.
Although the overall economic environment continues to be relatively stable in the US, there are some signs that an economic slowdown could occur in 2019 or 2020. A tightening of the monetary policy by the US Federal Reserve Board tends to reduce inflationary expectations, which will likely reduce the difference between long-term and short-term yields and could even result in an inverted yield curve. Each post-WWII recession has been preceded by an inverted yield curve. In addition, the US is now in the second-longest recovery period in its history, and if this continues through mid-2019 it will become the longest recovery. All recoveries eventually end, and if the current recovery ends, followed by an economic downturn or recession, there could be a slowdown in M&A activity in the second half of 2019.
The government shutdown in the US was disruptive, with over 800,000 federal employees going unpaid, but most experts do not believe that the shutdown will have an adverse long-term impact on US or global M&A activity. It could, however, slow the pace of M&A activity as a result of regulatory delays at the Securities and Exchange Commission and the Federal Trade Commission.
Expectations for 2019 Remain High
Despite the volatility in the stock market for much of 2018, especially in the fourth quarter, and concerns over rising interest rates, most corporate executives and potential investors expect M&A activity to continue to be strong in 2019. In the absence of major economic or financial market disruption, most experts expect an increase in both the volume and size of M&A transactions in 2019 compared with 2018.
Although the split in party control of Congress makes a second round of tax cuts highly unlikely, it also makes dramatic regulatory changes by Congress very difficult (including attempts to reverse changes implemented in the past two years). The Trump administration is expected to continue to implement deregulation, and President Trump is expected to continue to use his executive power to block potential transactions. The CFIUS is expected to continue to be active in blocking transactions.
Slight Shift in M&A Focus in 2019
While technology acquisitions are expected to remain robust, they may not have the same level of importance in 2019 as they had in 2017 and 2018. The focus on M&A activity in 2019 is expected to shift toward preservation and expansion of customer bases in both existing and new markets. Acquiring technology is still important, but as its cost continues to rise it has become more expensive for some companies relative to other M&A factors, such as expanding and diversifying products and services, enhancing top-line revenue and acquiring talent.
Industry and sector convergence are expected to continue to drive M&A transactions in 2019. The industries most likely to experience convergence in 2019 are banking and securities, energy and resources, asset management and technology. Companies primarily in banking and securities are expected to converge with companies in construction and manufacturing. Companies primarily in asset management are expected to converge with companies in banking and technology, and companies primarily in technology are expected to converge with companies in manufacturing and telecommunications.