January 10, 2018
In our recently released PwC Deals year-end review and 2018 outlook, we noted that 2017 was a year when dealmakers had to navigate various disruptions. Considering how M&A and other deals not only continued but increased last year, I’m optimistic about even healthier activity in the year ahead. After a 2017 defined by adaptation amid uncertainty, 2018 will see that uncertainty continue … and require even more agility and creativity from dealmakers.
Make no mistake: The deals environment is more complex than anything we’ve seen in the past several years. Despite debate over trade policy, regulatory changes and tax reform over the past year, the nation’s current economic expansion endured and is now the third-longest in the last century and a half. Cross-border deals continue to happen despite an increasingly populist climate. And companies from a wide range of sectors are ramping up investments in technology – to the point that most acquisitions of tech companies are by non-tech buyers. Clearly the industry lines have blurred.
Our year-end review and 2018 outlook has more details and data, but I think the defining theme for year ahead will be the return of high-value deals – something we already started seeing in the second half of 2017. Here are a couple of key reasons why megadeals should rebound and even larger “gigadeals” – transactions from $50 billion to as large as $100 billion – will emerge.
Corporate strategy and capital availability
With many companies shifting their corporate strategy to focus on core businesses, divestitures should increase, providing more acquisition targets. And those targets should attract interest, as corporate acquirers and private equity (PE) firms both are sitting on significant amounts of capital.
Between favorable regulations and a pursuit of scale over the last several years, large corporations have been created in almost every part of the US economy. Yet this mindset of bigger-is-better is fading as executives adapt to the pace of technological change and global market dynamics, as well as anticipate or respond to demands from activist shareholders. Those factors, plus concerns about when the current economic cycle will end, could not only drive more corporate restructuring and divestitures but also result in more acquisitions as companies strengthen their core capabilities.
If corporate buyers don’t leverage their healthy balance sheets to make more acquisitions, PE firms certainly could. PE fundraising surged to record levels in 2017, with firms raising some of the largest funds in history as investors chased yield in a low-rate environment. High prices could lead some PE firms to hold back a little while longer, but that could change as more assets come on the market, especially if low interest rates persist.
Capital may cost more for some companies based on the interest expense limitations that are part of the tax changes recently approved by Congress. But on the whole, the new tax laws could help spur deals in a few ways in 2018.
First, the lower corporate income tax rate could lead some previously-hesitant companies to move ahead with divesting non-essential assets. Under existing rules, those assets often were spun off, which made sense tax-wise but usually was more difficult than a sale. Now companies may not be limited to the spin-off option when deciding whether to divest.
The cost recovery provisions, which would enable businesses to immediately deduct the cost of certain property, also could spur M&A activity. That, combined with the lower tax rate, would make the US a more favorable jurisdiction for investors, although it also raises concerns in some sectors about how trading partners will react.
The big question is how much of a role corporate cash now sitting in overseas accounts will play in deals. The last substantial repatriation, in 2004, was cited as a factor in some deals, but much of that cash also went to shareholders and executive compensation. Most of the untaxed foreign cash today sits in two sectors, technology and healthcare, limiting its potential as a deals catalyst across the industry spectrum.
That said, tech and healthcare already have been active sectors for megadeals. Having access to repatriated cash could make it easier for those companies to explore additional high-value transactions. Given today’s high valuations, however, acquirers will need to be even more vigilant about capturing value in deals. In other words, you can spend big, but still spend wisely.
Disruptions to watch
In addition to releasing our 2018 outlook, PwC Deals recently hosted a webcast in which I sat down with other partners to discuss dynamics that will influence deals in the year ahead.
Todson Page, a technology Deals partner, explained how the current wave of M&A in that sector has been defined by the faster speed of technology adoption today and the sheer amount of money going into start-ups and growth capital companies. Corporate buyers and PE firms are doubling down on emerging technologies such as artificial intelligence and the internet of things in an attempt to bring them to market quicker. In many cases, Todson said, companies that historically would have been an IPO candidate or the target of an acquisition are actually becoming acquirers themselves.
Todson and Carrie Duarte, a human resources transaction services partner, also discussed how the rising gig economy – in which independent contractors and temporary, flexible jobs are more common – is causing dealmakers to evaluate transactions differently. Some of these contractors can be paid much more than full-time equivalent employees, might contribute valuable intellectual property and may not want a permanent position, Carrie said. That can add a new dimension to due diligence and risk assessment in a potential acquisition, especially if traditional methods of retaining employees don’t work.
Among other risks facing dealmakers is the complex regulatory policy environment. David Sapin, PwC’s US Advisory Risk and Regulatory Leader, and Alison Kutler, PwC’s Strategic Policy Leader, noted that transactions not only must navigate changing federal legislation and agencies that are still refining their approach from the previous administration. They also must consider state and local regulations. Some regulations and requirements may pose challenges, they said, but the fragmented environment also is creating good opportunities for acquirers.
My view of 2018
“Opportunities in a fragmented environment” may be the most accurate forecast for the year ahead. I’m confident deals will continue at a steady pace, with values higher than in 2017. Potential headwinds that could slow deal flow – such as a rapid rise in interest rates, a decline in equity markets or an overall slowdown in economic growth due to some exogenous event – all seem less likely at this point.
Even without those obstacles, the current landscape remains complex, and dealmakers shouldn’t underestimate the disruptions that can change the dynamics of M&A, alliances and other transactions. Instead, they likely will show the agility and creativity that should make 2018 a strong year for deals.