New Deal Frontier: M&A is the new trade

James Marshall Deals Research and Insights Leader, PwC US 04 April, 2017

Pundits are ringing the death knell for globalization. The Economist magazine was blunt in a January cover story: “The biggest business idea of the past three decades is in deep trouble.” To which we say: Not so fast.

In the first blog of our series New Deal Frontier, we discussed how cross-border M&A continues to be robust in the face of the new nationalism rising in many countries. In fact, cross-border M&A is defying the push to erect border walls. In this blog, we explore the underlying reasons behind the ongoing wave of cross-border M&A – and why these drivers will continue to drive global M&A even in the face of the new nationalism.

Ultimately, any decision to grow inorganically is made at the firm level. A firm may adopt a market-seeking strategy in order to grow revenue in new locations or an efficiency-seeking strategy to achieve economies of scale and cost advantages against its competitors. The state of economic recovery and capital markets as well as regulatory changes and competitors in one’s industry also influence cross-border investment decisions.

While these are some common considerations behind cross-border M&A, the underlying motivations of dealmakers have been changing over time.

Economists have identified at least seven waves of cross-border investment. This current wave of M&A, we argue, is quite distinctive. As illustrated in the chart below, M&A has grown since 2013 while trade has languished.

For another, it is being driven by markedly different forces than those that fueled the previous waves in which companies pursued market-and efficiency-seeking strategies. The third M&A wave, for example, started after World War II and continued over two decades of growth and prosperity in the US and Europe. Businesses pursued horizontal diversification and became big conglomerates. In the fifth M&A wave of the 1990s, an Asian deals market emerged along with trade liberalization of the region’s economies.

The current boom in cross-border M&A is different because it’s happening in a world that is flatter and more fractious at the same time. Here we explore the drivers of this wave – and why they will endure in the face of new nationalism.

Every business has become a tech business: Nationalist or not, all businesses today face essentially the same question: how to unlock value from the next generation of digital technologies? And the answer often points them in new directions. Like Chile, which has positioned itself the start-up capital of Latin America. Investors in Start-Up Chile include PayPal, which acquired the payment processing network Multicaja, and Microsoft, which has partnered with the government to open an innovation center for entrepreneurs. Even more telling are deals driving convergence between tech and non-tech sectors. In the US tech sector, for example, non-digital buyers accounted for more $80-billion of deals value two years in a row. The $100-billion Vision Fund, which aspires to be the world’s biggest tech fund, has as its main investors the Japanese conglomerate Softbank and a Saudi Arabian sovereign wealth fund.

Emerging markets have emerged: Thanks to years of trade and globalization, emerging-market businesses have amassed experience – and surpluses – to confidently pursue global investment opportunities. This is changing cross-border M&A patterns. Investment flows among developing countries will continue to increase, particularly regionally. According to the UNCTAD, more than a third of Indian outbound investments are in Asia and half of South African outbound investments are in Asia and Africa. But these investors are also flocking to mature markets. Here, their motivations are varied but broadly fall in three categories: to take technology and other IP back to their home markets, to own well-known developed-market brands, and to access new markets (interestingly, this last reason is less important to those with large home markets like China and India). Cross-border flows will go in new directions, as new economies take center stage. PwC projections show that by 2050, Indonesia and Mexico could be larger than Japan, Germany, the UK or France, while Turkey could overtake Italy.

Economic power is dispersed: Emerging markets have arrived at a time when popular sentiment has turned against globalization in many mature economies. As a result, the world economy is being shaped by a complex and continuously shifting set of economic relationships. Globalization is no longer defined by US-led institutions. You need only consider how the Chinese development agencies are now funding more energy projects worldwide than Washington DC-based IMF and World Bank to understand the magnitude of this shift. In this environment, cross-border investments offer stability and the opportunity to directly build trust with local communities.

Think this is a brave new world? There are historical precedents. In medieval times, Asian, Arab, North African and European powers traded with one another along the Spice Route and Silk Road. As late as the 17th century, trade and commerce thrived in a world in which economic and cultural power was much more diffused.

Cities are more connected than ever: More than a third of the world population will be made up of urban dwellers by 2050. Megacities with large constituent populations have power to rival that of national governments. For global investors this raises not only economic, but broader cultural implications. Megacities need megaprojects to address the infrastructure, health and education needs of the citizens. At the same time, concentrated populations have greater access to information and varied cultural influences. Some cities already punch above their weight. The 2016 DHL Global Connectedness Index has identified Singapore, Manama, Hong Kong, Dubai, Amsterdam, and Tallinn as global hotspots, where the intensity of international flows (of capital, people and information) is very high relative to internal economic activity. Global dealmakers will make the most of such hotspots that are magnets for talent and gateways to bigger markets.

Barriers to information have fallen: In this wave of cross-border M&A, investors are reaching into the hinterlands of countries, often through middle-market acquisitions or directly via greenfield projects. A growing share of China’s outbound investments, for example, are going to the US rust belt. Take Fuyao Glass’ $450 million-refurbishment of a former General Motors plant in Moraine, Ohio with the potential to employ 2,000 people. We expect the ongoing democratization of information to further boost such deals. A recent study by Stanford Graduate School of Business scholars looked at the impact of greater media coverage (via algorithm-generated quarterly earnings news reports) on smaller firms. It found that their trading volume and liquidity went up, suggesting that investors are now finding it easier to track and monitor such firms.

It’s interesting to think about the relationship between trade and M&A. A World Bank econometric model investigated the determinants, including trade, of outbound M&A activity of 10,000 emerging-economy companies between 1997 and 2010. It found that when barriers to trade are low, these companies are less likely to pursue acquisitions. Conversely, they tend to establish direct operational presence in markets where barriers to trade are high. In other words, the study suggests that when trade protectionism increases, so does cross-border M&A. Since 2008, G20 economies have introduced more than 1,500 trade restrictions. So it stands to reason that cross-border M&A has become the key route to global opportunities.

In our next blog, we will continue our discussion by focusing on what makes the US, in particular, a desirable market for global investment. Where do you think the hot spots for cross-border deals will be in 2017?