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Deals 2018 mid-year review and outlook
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M&A momentum continues: Megadeals thrive in an increasingly complex landscape
We are in the midst of an unprecedented M&A cycle that’s about to get more complicated. The first half of 2018 has been marked by a spate of megadeals that began to take off at the end of last year, despite uncertainties over US tax reform and antitrust laws. The number of deals north of $5 billion is on pace to double last year’s total, and to date has driven overall deal value up by more than 50%, according to a PwC analysis of Thomson Reuters data. Deals are also getting bigger, with more announced deals of at least $30 billion so far in 2018 than in all of 2017.
As US economic growth remains steady, that momentum should continue and will likely accelerate as lingering questions around tax policy and big vertical deals have largely been answered. The number of US deals has flattened in recent quarters, but this doesn’t necessarily signal the end of the M&A cycle. Unlike previous cycles – such as the years following the 2000 dotcom bust, when deals rose consistently each year – this cycle has been quite uneven, and the pattern will likely endure in the months ahead.
Key themes
Reinvention and new paths to growth
Potential influences on the deals landscape
- Savings glut
- Higher oil prices
- US tax reform
- Antitrust ruling
What to expect for the rest of 2018
Reinvention and new paths to growth
From a strategic perspective, the age-old notion of using M&A to scale is alive and well in today’s market. At the same time, technological and demographic factors continue to be as important in defining companies’ inorganic growth. Firms are looking to reinvent old business models and shed assets that no longer fit as the pace of technological change accelerates. This has contributed to an increase in the value of divestitures by 60% compared to the first part of 2017, according to Thomson Reuters data.
From a buyer’s perspective, these same forces have companies looking beyond their own sectors to expand into new businesses and therefore broaden their customer base. Since the start of 2018, one-third of megadeals crossed sector lines, driven largely by an appetite for new technologies. That interest in tech hasn’t been limited to huge transactions, with smaller deals coming in retail, media and printing.
Potential influences on the deals landscape
Savings glut: Capitalize on a cushion that keeps on growing
One of the most enduring features of this M&A cycle is the glut of cash that US corporations and investors continue to hold. This trend has kept valuations elevated as the demand for deals exceeds the related supply.
Following the end of the Great Recession in 2009, access to capital became widely available amid ultra-low borrowing costs. Additionally, longer-term trends like an increase in global savings rates for certain demographic groups added to available capital. But the downturn significantly eroded the confidence of many US management teams. Even as the economy has fundamentally improved with unemployment approaching near-record lows, cash levels have continued to soar.
In other M&A cycles, valuations are tempered as the economy slows. We have seen some signs that the economy may soften in the medium term, giving some relief with respect to values. However, we still believe the most important feature of this M&A cycle is the record amount of available capital. It’s likely here to stay for the foreseeable future and will eclipse all other economic variables influencing deal values through the rest of 2018 and beyond.
Higher oil prices: A deterrent to dealmaking?
As companies aspire to stay competitive and reinvent old business models, deal values will likely keep rising while volumes recover. Dealmakers may face various economic challenges, but the rise in oil prices won’t necessarily deter M&A.
Prices have gained nearly 30% so far this year, briefly rising above $70 a barrel in May for the first time since 2014. If prices continue to rise in the months ahead, investors could interpret the rally as a positive sign that demand for goods and services are rising, and therefore the pace of economic growth is unlikely to slow down.
Separately, in terms of the gas and oil industry, $50 a barrel has historically been the point at which the sector has seen more deal activity, including public offerings and PE deals. That didn’t happen when prices hovered around that threshold for much of last year, but with the recent rally, we’re likely at the cusp of another uptick of deals through the rest of 2018.
Ultimately, the downside risk is if oil prices climb too quickly, reaching triple digits and therefore leaving the economy vulnerable to a downturn. This scenario could certainly play out and complicate the deals landscape, as oil shocks have preceded five of the past six recessions in the US.
US tax reform: An incentive to rethink old ways of investing
Since the passage of the Tax Cuts and Jobs Act of 2017, discussions around tax implications for dealmakers have become more important than ever. The law has prompted executives to re-evaluate their growth strategies, including how much to commit toward M&A versus other investment options like stock buybacks or increased dividends. Sellers may reconsider assets that were previously too tax-efficient or complex to spin off or sell, while buyers in search of particular assets can more efficiently acquire a company and sell parts that don’t fit.
The law has also further increased the availability of capital for companies and investors. While some expected the additional funds to translate to more M&A, access to capital hasn’t been a problem for investors in recent years, as we noted above. So they’re unlikely to consider a windfall of funds a motivating factor if a deal wasn’t already part of their broader strategy. And while the influx of repatriated cash may not drive an overall increase in deals, it could change the location of some deals. Cash that had been parked overseas and available only for acquisitions in those regions could now be used in the US.
The law ultimately includes important provisions likely to prompt investors to rethink old patterns of investing. These changes have already had some effect. At the start of 2018, spending among companies within the S&P 500 on equipment, buildings and other assets increased by 39% – the fastest rate in seven years. This trend will likely manifest in the post-deal environment and could potentially accelerate spending on capital-intensive integration plans.
Antitrust ruling: A hall pass for an M&A wave
Another surge of megadeals could hit the market now that AT&T’s plans to buy Time Warner have been cleared. The case was unique in that it addressed vertical mergers involving companies from industries that complement one another, which historically endured less scrutiny than horizontal deals involving direct competitors.
The ruling may encourage some companies to accelerate plans for substantial investments – if they haven’t already. Comcast has made an all-cash offer of approximately $65 billion for 21st Century Fox ’s assets, trailing Disney's new $71.3 billion cash and stock bid. And after previous attempts, T-Mobile in April agreed to acquire Sprint in an approximately $26.5 billion deal that’s awaiting regulatory clearance.
Other major vertical deals navigating antitrust regulations include CVS’s approximately $68 billion acquisition of Aetna and Cigna’s $67 billion bid for Express Scripts. If both win clearance, these deals could spur other healthcare mergers involving insurers, drug distributors and retailers.
What to expect for the rest of 2018
Dealmakers still face some unknowns. For instance, data privacy concerns have led some governments to consider regulations on major technology firms. This sentiment has emerged and will likely grow in states like California, where lawmakers continue to explore privacy legislation. Meanwhile, the European Union’s General Data Protection Regulation (GDPR), aimed to protect individual data and privacy, took effect in May and will likely affect US companies that do business in the region.
Between a still-healthy economy and an abundance of capital, companies and PE firms largely continue to be well positioned for pursuing new investments. Even with the Fed likely planning more interest rate increases this year, some concerns about the economy overheating remain. One risk is if the central bank becomes too confident in the economy and raises rates faster than markets are ready for.
Absent that, investors will need to weigh their existing and potential capital and balance rising valuations with their need to reinvent old business models, as the benefits and risks of new technologies evolve. Even as divestitures add possible acquisition targets, finding the right target at the right time and at the right price can be challenging. Companies and PE firms that re-evaluate their strategies in light of the above influences will have an advantage in the second half of 2018 and beyond.
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Bob Saada, US Deals Leader, and Curt Moldenhauer, US Deals Solutions Leader
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Q2 2018 Deals Day findings
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Bob Saada
Curt Moldenhauer
