April 25, 2018
Q1 2018 Deals Day findings
As the latest PwC Deals Industry Insights shows, US M&A is once again a big-ticket production. Even with a couple of new policy issues raising concerns – which I’ll discuss below – companies have shown a stronger enthusiasm for megadeals. And this is happening across the industry spectrum: The top six megadeals covered six different sectors, and one-third of megadeals crossed sector lines.*
With US deal value up almost 50% from Q1 2017 and the pace of megadeals threatening to leave last year in the dust, it’s easy to overlook deal volume – namely the 12% decline from a year ago. That’s the first increase in value and decrease in volume in the same quarter in more than two years. To understand why it has happened in 2018, you have to take a closer look at 2017 and even the end of 2016, as politics and the regulatory environment influenced M&A:
- After M&A volume was mostly flat for 2016 – in part because of uncertainty around the US presidential election – the end of the year brought an upswing that was even more pronounced in Q1 2017. With the Trump administration taking office, the number of deals hit a high, topping 4,100 in the quarter.
- That pace didn’t continue, however, with volume declining each of the next three quarters – even as total 2017 volume continued to outpace 2016. One possibility is the heavy debate in Washington over such issues as healthcare legislation and tax reform but limited new regulations that could help drive deals. Another is that we saw some bunching as delayed and accelerated deals converged.
- It wasn’t until the end of 2017 that the president and Congress passed tax overhaul. And now, in the first full quarter since that approval, we’ve seen a 6% increase in deal volume over the previous quarter.
- Meanwhile, deal value was modest to start 2017 – middle market M&A carried much of the water – but then increased with each quarter. That’s one reason why we’re optimistic value will be higher overall this year.
In short, while Q1 deal volume is down year-over-year, that’s simply a case of not matching the extraordinary confluence from a year ago. Q1 2018 US deal volumes were higher than any other quarter from 2012 through 2016. The reality is that both volume and value are on the rise as 2018 marches on, and deals likely will be a primary lever to drive strategic growth and competitive positioning.
Looking across sectors – and at deals that cross sectors
Consolidation within industries remains a substantial part of M&A. We’re seeing it in technology, pharmaceuticals, life sciences, media and other areas. But for some companies, the path to customer growth is leading them into other sectors.
Consider General Mills’ $8 billion bid for Blue Buffalo Pet Products. It’s the well-known food company’s first investment in pet food, but it’s understandable given the huge amount of money people spend on their pets today and the margins in the category. It also begs the question of other subsectors where oligopolies dominate their markets, such as the beverage industry. How much more can a leader grow in its own space? Or should it explore another avenue that brings deeper penetration with existing customers or a whole new group of customers?
Cross-sector deals also can bring different capabilities in-house. Technology is perhaps the most common example, where it can be easier for companies in other industries to buy a tech upstart instead of trying to build the tech-enabled capabilities themselves. One potential issue, though, is growing concerns about security and data privacy. The increased scrutiny of tech deals and companies’ business models and proposed acquisitions could ultimately trickle down, with non-tech companies more closely assessing the risks – both cyber and reputational – of a potential tech acquisition.
Dealing with a trade war
One of the biggest Q1 developments was the new tariffs announced on certain products, which could lead to a trade war if tensions remain high – particularly between the US and China. An extended trade war could jeopardize the availability and pricing of goods in the US and Chinese supply chains; think of how many core consumer products aren’t made in the US.
The tariffs and broader trade policy could affect deals in a couple of ways. Foreign companies may look at acquisitions or other investment in the US, moving production into the market. How easily they can accomplish that in this political environment is to be determined. Meanwhile, US companies could become more competitive in M&A in the short term, seeking to take advantage of fewer non-US bidders.
All this comes as Chinese investors remain interested in the US. Bob Saada, PwC’s US Deals Leader, heard this firsthand during his recent visit to China. We also see it in certain sectors here in the US. What’s less clear is how a Chinese company’s bid for, say, an oil and gas asset would be received by the Trump administration – especially as oil and gas have become much more tech-centric, yet still geopolitical.
Meanwhile, the potential for changes to NAFTA lingers and could affect some US industries. Automotive companies are doing scenario planning around their supply chains to determine if any parts will need to be redirected. Oil and gas companies are similarly assessing the situation, given most US oil imports come from Canada. Hiccups in moving things across the border could lead some companies to explore acquisitions closer to home and revamping the supply chain.
What will drive deal opportunities
It’s an interesting time. Geopolitical risks are high and could increase even more, yet the overall global economy remains relatively strong. That disconnect might be cause for concern if there weren’t multiple things working in favor of a strong deals environment.
The current economic expansion is one of the longest in history, with few signs of an imminent end. True, labor costs are rising – yet still lagging in real dollar terms to inflation – and consumer spending is beginning to moderate. But business investment is starting to increase, which should have both a positive impact on GDP and eventually help with the recent low labor productivity. The Fed rate remains extremely low by historical standards, with recent increases a sign of confidence that the economy is growing stronger, with low unemployment and rising wages.
Tax reform and cash repatriation can provide additional funding for M&A, though capital hasn’t been a primary constraint to deal activity. To date, we’ve mostly seen companies announce stocks buybacks and dividends, employee bonuses and wage increases, and other investment across different sectors. But between lower tax rates and other provisions, such as cost recovery and immediate expensing, many companies will explore new acquisition opportunities. The hurdle rate, and ability to generate sufficient returns on those investments, will be the key threshold.
There’s a chance lower taxes and higher government spending could cause the economy to overheat. But a downturn might not necessarily curb the appetite for and ability to make deals. The current amount of available capital is staggering; private equity and venture capital funds have raised more than $1 trillion globally. That surplus has exceeded the supply of deals for some time, and it could come into play if a recession brings lower valuations for M&A targets.
Until then, valuations likely will remain high, and the big prices for M&A should continue elevating overall value. As companies and PE firms funnel more dollars into deals in Q2, we’ll keep an eye on the antitrust and trade issues outlined above, as well as other trends that could affect M&A activity, such as corporate debt levels. Dealmakers will need to adapt to any significant developments in these areas if the current uptick is going to continue.
* All figures from Thomson Reuters with PwC analysis, unless noted.