The amount and diversity of capital available for business investment may be unprecedented. It’s certainly extraordinary. Corporate cash. Private equity dry powder. Bond issuances. Borrowing capacity, especially at historically low rates in the US and other large economies.
Structural changes in the economy and business behavior have helped drive capital growth. Saving rates remain high a decade after the last recession – well past the point when they might be expected to fall, based on past cycles. The transition of the US economy from manufacturing to services has resulted in less tangible investment. Companies that may be struggling with an “ideas deficit” aren’t confident in what they should pursue next, leaving cash largely untouched.
Private investors also are exerting more influence, shifting the capital mix. Private equity firms accounted for less than 10% of total US deal volume in the 1990s and about 20% of volume 10 years ago, a PwC analysis of Refinitiv data found. In 2018, that share surged to nearly 40%. At the same time, more firms are considering longer holding periods that allow more time to create value and generate higher returns.
At some point, this abundance of capital likely will decline, influenced by short-term economic uncertainties but also longer-term forces. Some of the “savings glut,” for instance, could dwindle as baby boomers who stashed away cash for decades start to spend more in retirement. Yet plenty of funding still could be available for deals by corporate and private investors in a downturn.
"Using equity as a currency is going to be very challenging. However, there’s just this unprecedented level of liquidity."
S&P 1500 companies held about $2.2 trillion in cash and equivalents in 2018 – about three times the amount in 2000. And that doesn’t count cash that companies have invested in longer-term securities, which aren’t included as cash and equivalents on corporate balance sheets. Companies have generated more cash from operations over the last several years, PwC’s analysis of cash flow statements found, and the cash they’ve spent on acquisitions has more than doubled during the latest M&A wave. As a result, cash has more closely tracked with deals than in previous cycles.
This cash isn’t evenly distributed among companies. Eight of the top 10 non-financial companies with the most cash are in the technology industry, our analysis found, and big tech companies are estimated to hold about one-third of corporate cash overall. In addition, lower tax rates after the late 2017 tax overhaul and repatriation of overseas cash have kept balance sheets flush, although some companies have used cash for share buybacks.
The capital held by US private equity (PE) firms but not yet invested has grown, more than doubling in the last seven years, according to data from Preqin. Private investors, including pension funds, family offices, high net worth individuals and others, continue to seek higher returns not afforded in more traditional investment vehicles. They also see benefits to diversification in investments, and are willing to deploy capital to explore it.
As PE firms’ share of total M&A has increased, so has the PE industry. The attraction of PE as an asset class, both in terms of the private nature of the capital and past success, has created momentum behind “mega” PE firms, which are leveraging their scale and resources to capture an increasing share of fundraising. About 45% of PE capital raised in North America between 2016 and 2018 was for just a handful of funds, according to Pitchbook.
Some PE firms have attracted other investment partners, such as sovereign wealth funds, that add to the capital supply. At the same time, they’ve diversified their tactics – inserting themselves into different parts of the capital structure – and the tools at their disposal to generate value have become more sophisticated.
With historically low central bank rates since the last recession, debt has been plentiful for companies. Lower interest rates after a downturn, especially a historic one, are understandable. But those rates typically rebound in an improving economy. Instead, the slow recovery from the Great Recession and other factors have kept rates well below historical levels.
As it has in past M&A cycles, the various sources of capital available for deals probably will shift as new circumstances unfold.
If businesses have the appetite for M&A, the above sources of capital will provide the means. Before the economy worsens, however, corporate and private acquirers need to ensure they’re not simply relying on a big bankroll to execute deals. The next part of Succeeding through M&A in uncertain economic times outlines what businesses should do now and be prepared to do later to capitalize on M&A possibilities.
Deals Leader, PwC US
John D. Potter
Deals Clients and Sectors Leader, PwC US