October 9, 2018
With 2019 fast approaching, one big question in the M&A landscape is if the megadeals that have defined 2018 deals activity are approaching a tipping point or if the pursuit of large transactions will continue into next year. With the US economy still humming, corporate and private buyers have made substantial investments to increase scale; most of this year’s megadeals involve businesses within the same industry.
In addition to a few clouds on the economic horizon, the November US elections loom large, with the potential for change in the political balance of power in federal government. Turnover among state governors and legislatures also could be a prelude to rule changes that affect businesses and their investment decisions.
However, policy and regulatory changes haven’t yet had a significant effect on deals for the most part. We’ve seen the late 2017 federal tax overhaul spur some modifications of business structures, such as asset management firms converting from partnerships to corporations. But overall, the potential impact on M&A and other transactions has remained muted, with other factors having more influence on deals.
Three stories of Q3
Various developments helped define deals activity last quarter. Here are three of note:
- Looking upstream, M&A has mirrored VC investment: While overall 2018 M&A value has far outpaced last year – fed by megadeals – the number of deals has lagged. That trend is similar in venture capital investing, according to data from the latest PwC/CB Insights MoneyTree Report. After peaking in mid-2015, the number of VC deals dipped and has leveled off, with Q3 deals down about 20% from their high. Meanwhile, the amount being invested has climbed significantly in the past several quarters, powered by mega-round activity – any deal valued at $100 million or more. This is worth noting because today’s VC-backed businesses can become tomorrow’s potential acquisitions or IPOs, and big early-stage investments could shape the expected returns when those businesses exit the VC space. On the flip side, earlier buyouts by strategic investors is also harvesting mid-stage investments to fuel innovation and capability-building.
- With a persistent sellers market, divestitures demand attention: The third quarter supported our view that divested businesses will increasingly attract interest from corporate and private equity acquirers. Iconic companies such as Campbell’s are exploring divestitures as they refocus their business strategies. In other cases, such as the CVS-Aetna and United Technologies-Rockwell Collins deals, companies agreed to divestitures as part of regulatory reviews of planned acquisitions. More acquisition targets in the market could benefit both sellers looking to take advantage of generally high valuations and buyers – US and foreign – who are eager to tap a healthy trove of capital and fuel their own growth.
- Sticking to what they know, buyers boost scale: While we’re still seeing bold cross-sector deals, that’s not holding up deals that represent more traditional expansion. Coca-Cola is expanding its beverage portfolio with deals for a UK-based coffee chain and Australian kombucha maker. A semiconductor supplier announced a more than $1 billion acquisition aimed to improve its market position. And there continue to be straight-up consolidation plays in such sectors as restaurants and medical practices. For some companies, opportunities remain within their industries or close by, even as larger transformational deals grab headlines.
Three things to watch in Q4 and beyond
While deal activity has been mostly consistent this year, a few situations could help shape intentions in the coming months:
- Trade war and investment restrictions: The debate around NAFTA appears to be settled for now. But multiple major companies have said tariffs by the US and China are having an impact on their businesses. There are short-term costs, or “damages,” for some US businesses as a result, as various Cabinet members have acknowledged. There also are benefits, and the calculus on the foreign operations and markets is more complex – yet all is factored into M&A and capital investment decisions. Even as the US negotiates bilateral agreements with other nations, China’s size and influence is such that companies and investors will need to consider possible adjustments. In the past, that meant more foreign investment in the US, but recent legislation added more teeth to deals reviewed by the Committee on Foreign Investment in the United States. That may curb the ways Chinese companies can engage in certain US sectors.
- As tech proliferates, privacy looms larger: Recent regulations such as the European Union’s General Data Protection Regulation (GDPR) and the California Consumer Privacy Act likely are a prelude to other regulations around data privacy concerns. As other nations and US states consider new laws regarding the collection and use of personal data, companies engaged in deals in certain sectors – especially those related to consumer activities – will need to adjust their deal processes. Some industries, such as healthcare, have been highly focused on managing customer privacy. But more comprehensive sets of rules could increase compliance and regulatory costs for other businesses. Those that haven’t been heavily involved in handling – and securing – customer data will need more guidance navigating a higher-scrutiny environment.
- Potential gridlock at the federal level, while states stake out positions: The November elections could bring changes in the balance of US legislative power. Issues such as tariffs and antitrust typically fall under the executive branch, but how much will the Trump administration be able to accomplish if engaged in partisan combat? This could heighten the risk of the regulatory environment becoming more of a patchwork as states take positions on various issues – not only privacy but also such matters as the environment, wages and healthcare.
Monitoring dynamics and taking action
The enduring economic expansion and abundance of capital remain big stories, and valuations have shown little sign of ebbing. But dealmakers will need to monitor potential shifts, opportunities and risks in the coming months – including a possible recession after one of the longest periods of sustained growth in US history.
Big swings in the economy always can influence corporate growth strategies, including deals, although companies and PE firms are generally in stronger positions than in recent years. Today’s valuations have translated to higher multiples for targets that buyers could have bought one or two years ago for a fraction of the price. But until an economic correction comes, those who want to put capital to work have settled in and accepted higher prices.
The key in this environment is picking and choosing the right spot to invest. Companies could consider:
- Scale plays similar to those in recent quarters, which could provide a bigger market presence that helps weather a downturn.
- Tech investments to help add innovation, boost capabilities or improve efficiency.
- Diversification into another sector – possibly one with customer overlap, and through alliances as well as acquisitions.
- Taking a hard look at your current portfolio and determining if divesting a business could yield capital for a strategic acquisition or other investments.
Different companies will make different choices. But the simple fact is the current climate remains ripe for investments that could both provide near-term gains while setting businesses up to navigate a less certain future.