Deals year-end review and 2019 outlook

How abundant capital, not the economy, will shape M&A in 2019

The year 2018 was exceptional for M&A in many areas, characterized by megadeals in almost every industrial sector as companies aimed to create scale. Yet headwinds gathered steam, including continued changes to the regulatory environment, an uncertain political landscape and, most importantly, early indicators of an economic downturn.

Growing economic headwinds are starting to complicate the costs of doing business. After the US imposed new tariffs earlier this year, global trade tensions could endure or escalate, as it’s one area that the Trump administration can act independently of Congress. Tariffs have already disrupted some supply chains, and prices of intermediate goods have begun to rise. Meanwhile, wage growth is accelerating as demand for labor becomes more pronounced amid record-low unemployment. These factors have contributed to an inflation rate that is at its highest level in a decade.

The Federal Reserve has raised its benchmark rate three times in 2018 and will likely raise the rate once more before the end of the year. This move from an accommodative monetary policy to a more neutral stance will likely carry into 2019 as borrowing costs rise further.

These economic issues might normally curb M&A and other deals, but that’s unlikely to happen in the year ahead. Dealmakers are at the center of an unprecedented M&A cycle in which US investors, particularly private equity (PE) firms, have record access to capital. This enduring and unrivaled feature of the US deals market will help soften the blow of a downturn. More than that, access to capital will likely preempt many other variables in driving M&A deals so long as companies are ready and willing to compete in markets where scale increasingly matters and disruption has become the new norm.

The following is a closer look at some of the biggest drivers of deals today and where they’re likely headed in 2019.


Capital: US companies have funds to make bold investments

For many companies, 2018 has been a year of record investments across multiple spheres, including business investment, research and development, and M&A. This is partly driven by last year’s US tax reform law that allowed corporations to repatriate cash held overseas at a lower tax rate. Tech giants in particular have used the dramatic surge in capital to get ahead and position themselves to continue growing in technologically sophisticated markets.

During the first half of the year, business spending on R&D saw double-digit growth, according to US Bureau of Economic Analysis data. Capital spending also picked up significantly during the same period, largely driven by a handful of tech and energy giants that invested mostly in technology.

Meanwhile, deal values have soared to near-record highs, primarily due to the availability of capital. During the first nine months of 2018, values rose to more than $3 trillion globally and are on pace to surpass $4 trillion, largely reflecting a surge in megadeals valued at more than $5 billion. While 2018’s deal values may not beat 2015’s record $4.7 trillion, it could exceed levels we saw in 2007 just before the financial crisis. Looking ahead, deal values will likely stay elevated, as companies with a clear strategy for how they plan to grow will leverage their outsized funds and invest in a future that will be increasingly competitive and disruptive.

Scale: Buyers see growth potential within their sectors

Historically, the pursuit of scale has been the primary motivator behind most M&A deals. As companies look to expand and assert their footprint, scale drove the rise of megadeals in 2018 – mostly reflecting deals within the same industries, including in telecommunications, energy, consumer goods and services, and healthcare. In healthcare, two key megadeals are poised to change the broader industry: CVS Health’s $69 billion merger with Aetna and Cigna’s $52 billion acquisition of Express Scripts – both of which have won US regulatory approval.

The transactions, both vertical deals, come as hospitals and health systems continue to consolidate to better compete in the broader healthcare industry. PE firms also have become more active, completing more than 600 healthcare deals in 2016, or more than triple the number in 2009, according to a new report by PwC’s Health Research Institute.

The CVS-Aetna deal could encourage further consolidation in the years ahead, as the companies plan to transform CVS drugstores into walk-in clinics and add competition across the healthcare industry. But the quest to expand within sectors hasn’t been limited to large corporations. Smaller and mid-sized firms are also looking to scale up their businesses. For example, most pure-play cybersecurity firms today have a market capitalization that is only a fraction of tech giants. With cybersecurity continually evolving and becoming more sophisticated and in demand, these smaller firms may seek opportunities to gain scale.

How technology will guide deals

PwC Deals partners explain the different ways in which technological disruption can provide new opportunities at different stages of the M&A process.

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Other potential influences on deals

Technology and convergence: Emerging tech will drive more cross-sector deals

Technology continues to reshape many corners of business and drive companies to consider different markets, especially industrial firms that are accelerating efforts to reinvent their businesses. Cross-sector deals have made up well over one-third of corporate M&A in 2018 and reflected several industries, including power and utilities, consumer goods and services, and media and telecommunications.

These deals are largely concentrated in the middle market, and many outperform the overall market, according to a 2018 PwC analysis of global investments. Among companies that invested in emerging technologies – including artificial intelligence, blockchain and the Internet of Things – from 2013 to 2017, those that struck medium-sized transactions between $100 million and $1 billion saw their shares outperform all other companies that invested in M&A during the same period.

Increasingly, technology will also play a critical role in the formation of America’s biggest companies. How that manifests could depend on how government regulators and consumers perceive the rise of tech giants, as new privacy laws in the US and Europe have stoked questions over tech’s scale and influence over pricing and data. Longer-term, tech giants will need to consider how other regulations could influence the speed and scale of their growth aspirations.

US midterm elections: A divided US Congress will lead to a slower pace of regulatory change

Interestingly, the near-term outlook for US regulations appears more certain since Democrats won control of the House and Republicans retained the Senate in the midterm elections. As compared with 2017-2018, dealmakers likely can expect fewer major regulatory changes in financial services and healthcare during the next two years. Democrats and Republicans generally hold significantly different views on legislation in those areas, and the Trump administration and previously Republican-controlled Congress already have made related policy and regulatory changes. Overall, dealmakers considering investments can execute or revise growth strategies with fewer uncertainties than during the first two years of the Trump administration.

Privacy is one area where new federal legislation is gaining momentum, following the implementation of the General Data Protection Regulation in Europe and the approval of the California Consumer Privacy Act in 2018. Bipartisan bills on data privacy have been proposed in the past, and legislators in both parties have expressed interest in progressing from hearing testimony from tech executives to possibly enacting protections for consumers.

While a divided Congress could mean few significant changes in Washington, turnover in state legislatures and governors’ offices could open the door for new regulations at the state level. Dealmakers will need to factor that possibility into such aspects as targeting and valuation, particularly when it comes to data privacy, wages and healthcare.

Europe: What Brexit Day will mean for US-UK deals

Britain is expected to officially leave the European Union on March 29 in what has been a long-anticipated exit from the 28-member trading bloc. While the lingering uncertainties of an exit plan have left the British pound vulnerable to volatility, a surge in inbound M&A into the UK suggests it hasn’t discouraged dealmakers. The rise dates back to 2016 following the UK’s referendum vote. Buyers overseas saw it as an opportunity to invest in UK companies, partly due to the sliding value of the British pound that effectively made UK assets more attractive.

At the start of 2018, M&A activity involving British companies increased to $275 billion, the highest value this century. US buyers have been particularly drawn to the UK’s technology sector, as Britain remains the leading European destination for international tech investors. This suggests that corporates and PE investors are looking beyond the short-term uncertainties of Brexit Day and instead taking a medium to long-term view.

To be sure, negotiations between UK and EU officials over a trade plan could break down, as talks thus far have faced setbacks. While the lack of a deal could damage Britain’s economy, hurt its international trade competitiveness and unnerve investors, UK assets should remain attractive to foreign buyers in 2019. Since the UK has a robust tech sector that has drawn US dealmakers, there are opportunities for more coordination – specifically, tech and finance hubs between London, New York and California.

China: A complex market could offer different opportunities

After a record year in 2016, the pace of outbound M&A by Chinese firms into the US dropped sharply in 2017. The downward spiral continued through 2018, as US regulators approved stiffer reviews of foreign deals by widening the purview of the Committee on Foreign Investment in the United States (CFIUS). This comes as Washington also levied new tariffs against China. From the first half of 2017 to the first half of 2018, Chinese investment into the US fell more than 90% – its lowest level in seven years, according to Rhodium Group. Even though the US and China have publicly pledged to work out a trade deal, large-scale and tech-related deals between the two nations will likely remain soft in 2019.

Earlier in 2018, China began easing restrictions on foreign investment across a broad swath of industries, including banking, agriculture and automotive. China’s auto industry, in particular, is expected to start easing decades-old restrictions that limited foreign vehicle manufacturers from owning more than 50% of joint ventures (JVs) with Chinese partners. The relaxed rules theoretically could give foreign companies greater control in the world’s largest auto market, while also boosting overall margins. There also has been a noticeable rise in US JVs in China in general.

Despite the regulatory climate, private Chinese companies in recent months have been looking at investing in the US again, partly due to the rising strength of the US dollar and the long-held view that America remains a relatively stable market for investment. Ultimately, interest in the US among Chinese investors remains high, and we could see increased activity in middle-market transactions and deals in sectors that typically don’t invite high regulatory scrutiny, such as the paper industry.

What to expect in 2019

Trade wars and a growing consensus that the US economy could soon slip into a recession will likely make investors more cautious in the year ahead. These reasons and others could lead some to take a more bearish outlook for 2019, but it would also be short-sighted to overlook key drivers of deals activity:

  • Corporate and private equity investors will continue enjoying record access to capital as they plan for growth. This will keep valuations high and cushion investors from economic pressures on the horizon.
  • Scale drove megadeals in 2018. This trend will likely continue, and it will extend to smaller and mid-sized firms looking to expand their businesses.
  • Digital disruption has driven many companies to look beyond their immediate industries for growth opportunities. In 2018, cross-sector deals made up well over one-third of corporate M&A, and convergence will likely continue driving mid-sized deals between $100 million and $1 billion.
  • Expect a slowdown in the pace of regulatory change following the US midterm elections. But dealmakers in the year ahead will also need to factor in the possibility that a turnover in state legislatures and governors’ offices could clear the path for new regulations at the state level, particularly as it relates to privacy laws.
  • UK assets, particularly within the tech sector, should remain attractive to foreign buyers in 2019, even as the UK prepares to officially leave the European Union in March.
  • Despite more oversight in the US on foreign deals, Chinese investors continue to view America as an attractive place to invest. Expect to see more middle-market deals across industries that will typically draw little, if any, regulatory scrutiny.

Contact us

Bob Saada

US Deals Leader, PwC US

Curt Moldenhauer

Partner, US Deals Solutions Leader, PwC US

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