July 16, 2018
Bulging corporate balance sheets and the move toward transformation have led to high-dollar M&A across many sectors so far in 2018. But rising valuations also may be a factor in deal volume being somewhat muted in the first half of the year. And deal-disrupting concerns such as cybersecurity are demanding new thinking and investment by companies in a variety of industries.
In the PwC Deals 2018 mid-year review and outlook, we discuss overall deal activity and notable influences on the deals environment, including tax reform. A recent PwC survey sheds more light on the potential impact of tax reform, and it reinforces the reality that tax reform is just one element that dealmakers must consider in the months ahead.
Tax reform: Important, but won’t drive deals by itself
In a survey of more than 400 US C-suite executives, PwC asked what their companies planned to do with savings from the US Tax Cuts and Jobs Act passed in late 2017. About four out of five executives said tax reform will have either major or minor impact, and they also said tax reform savings will allow them to make strategic investments that weren’t previously possible.
M&A is one investment option, but as of now it’s not a leading one. Among companies that already have made investments as a result of tax reform savings, more money went to debt payments, research and development, share buybacks, a range of employee actions – training, hiring, raises, bonuses and benefits – and other areas than was used for M&A. Deals hold a similar spot when looking at the next 12 months, ranking last among 16 options for spending tax savings.
These findings back up what we’ve been saying ever since the prospect of tax reform entered the horizon: While provisions of the law could provide more capital for deals, it’s unlikely to be the sole driver in a transaction. Corporate buyers and PE firms already have healthy cash balances and access to capital. Tax savings could tip a deal decision here or there, especially if you factor in other provisions such as certain investment deductions. But on the whole, dealmakers can’t consider tax reform by itself, but rather as part of a complex landscape that pushes and pulls on deal activity:
- Continued low US unemployment could increase the cost of labor.
- Inflation – now at its highest point in six years – could drive up interest expenses and other costs.
- A prolonged trade war between the US and multiple nations could boost the cost of materials for US companies.
In short, looking at the broader geopolitical environment reveals potential costs that could offset some savings from tax reform. To ensure they don’t misfire on the projected value of a deal, dealmakers should revisit their current models – something many may not have done in several years. Tax reform gives them an opportunity to pull together the tax team and corporate development team on growth strategy, so they can look at an integrated approach to M&A instead of the typical deal-by-deal dialogue. Look for these models to evolve in the months and years ahead.
Cybersecurity: Protection, not just privacy
Another area where buyers and sellers can improve their prospects of gaining value in deals is cybersecurity. There have been a lot of headlines on data privacy, which is crucial. But cyber goes beyond that, and many companies still don’t understand how to protect themselves from threats that can affect a transaction. In our recent tax reform survey, for example, cybersecurity was just as low as M&A for percentage of tax savings spent – to date and expected in the year ahead.
Cyber due diligence is only going to get more difficult as technology continues to advance and countries and companies become more connected. And it’s not just M&A that’s affected. Alliances, joint ventures and other strategic partnerships are linking companies within and across sectors, providing other opportunities for data sharing – and risks.
In some cases, the decision to invest in better privacy infrastructure will be made for companies. The European Union’s General Data Protection Regulation (GDPR) went into effect in May and applies to companies that do business in the region. In the US, states have responded to breaches by considering privacy-related legislation. But companies contemplating inorganic growth shouldn’t take a reactive posture. By including the privacy and protection conversation in deals due diligence, acquirers and targets can improve safeguards not only for customers but for their employees, intellectual property, supply chains and other key assets.
Looking ahead: The price has to be right
Corporate and private acquirers have plenty of variables to ponder as they evaluate deal opportunities the rest of this year and into 2019, especially with valuations not expected to plummet anytime soon. Potential buyers are spread across the industry spectrum, many focused on transformation, often through technology. Then there’s the potential for lower tax rates to make US assets more attractive to foreign investors, although some of those deals may have to navigate heightened government scrutiny.
While it may be a sellers’ market, I expect corporate buyers to be cautious about overpaying for acquisitions. They might have more money because of tax reform, but the bigger the premium, the bigger the risk of shareholder angst over M&A. Better to reassess your valuation models for tax reform and the other factors I mentioned above and avoid the temptation to pay an inflated price that can jeopardize your return.
Instead, we could see more appetite for bold deals. Usually, when a company makes a big bid for another business, their stock prices go in opposite directions: The acquirer’s drops, often because of the premium being paid, and the target’s rises. Now we’re actually seeing some transactions in which both companies’ shares go up. That’s an indication that the market is rewarding inorganic growth. I think that’s going to keep values strong, and it’s going to keep competition for M&A strong as we continue moving toward and into 2019.