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.
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.
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.
PwC Deals partners explain the different ways in which technological disruption can provide new opportunities at different stages of the M&A process.
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:
US Deals Leader, PwC US
Partner, US Deals Solutions Leader, PwC US