October 15, 2019
By John Potter, US Deals Sector Leader
The third quarter of 2019 brought with it a milestone: the longest US economic expansion in history. In the more than 160 years the federal government has kept records on the economy – dating back to before the Civil War – we’ve never seen such a positive run between recessions. While most forecasts have this growth continuing into 2020, talk of the next downturn remains persistent. As PwC’s analysts have noted, expansions don’t simply die of old age. But various indicators have led many economists to predict the economy will slow down eventually, possibly within the next year.
While downturns historically have seen a steep decline in deals, the next one could be different. As the new PwC series Winning through M&A in the next recession explains, historic levels of capital could allow opportunistic investors to pursue acquisitions at greater levels than in past slowdowns. The latest part of the series details how the current M&A wave is different from previous ones, and how companies that pursue deals in a downturn could see better returns than industry peers who don’t do deals.
The capital cushion isn’t uniform across all industries. Some uncertainty in the energy sector has translated to higher hurdles for bank financing. Manufacturing is struggling and may already be in a recession; September was the worst month for U.S. manufacturing in more than a decade, according to the Institute for Supply Management’s manufacturing index.
As they continue watching the economy in the months ahead, companies across the industry spectrum will need to navigate other forces that can reshape deal strategies. This includes a volatile policy climate, the shifting dynamic between federal and state regulations, and an increased demand for a better customer experience.
Agility in an active policy climate
Dueling tariffs and the trade war with China remain one of the biggest issues affecting many types of US companies. Those aren’t the only tariffs with disruptive potential; the US is planning new tariffs this month on many European goods, including aircraft, Irish and Scotch whiskies, certain tools and machinery, and various foods. But the ties that US industries have formed with China are front and center for many companies and are being re-examined, with potential ramifications for deals.
Depending on their end market, a company may need to consider divesting of assets in China, or it could go in the other direction and invest more in the country, using acquisitions to offset trade challenges. Tech companies in particular are trying to figure out how they position themselves in China going forward. The country is a big market for many businesses, but US government pressure around keeping technology secure has increased. Firms that feel compelled to choose a side could be looking at making divestitures or holding off on acquisitions in one nation or the other.
Within the US, other regulatory issues could affect deal decisions. The popularity of e-cigarettes has driven plenty of investment in “vaping,” but the federal government last month announced a ban on thousands of flavors used in the devices, responding to increased underage vaping. Tobacco giants Philip Morris and Altria earlier this year discussed a huge merger that would have reunited the companies after their 2008 split, but those talks ended in September. Altria previously made a $12.8 billion investment in e-cigarette company Juul in December 2018.
Healthcare is another area of potential change – possibly drastic. On one end, you have a lawsuit by several states seeking to declare the Affordable Care Act unconstitutional; the suit is supported by the Trump administration and making its way through the court system now. On the other end, most Democratic candidates for president support a healthcare system that provides coverage for more people. Whether it’s a US Supreme Court ruling or a change in the White House, potential shifts in the next year or two could lead some healthcare companies to look at investments now that help them get ahead of those changes. Already in 2019, payer-related healthcare deal volume is up from last year, our deals leader for that sector said.
Elsewhere in the medical arena, pharmaceutical companies continue to invest in research and development as they pursue new treatments for disease. That investment is usually significant, yet consumer and government concerns about the prices of drugs could result in legislation that affects current business models. More than one-fourth of 2019 US megadeals – transactions of at least $5 billion in value – through the end of August were in the pharma sector. Going forward, though, companies should ensure their deal strategies account for potentially substantial regulatory shifts.
Anticipating more state-level initiatives
Dealmakers increasingly have to account for regulatory changes at the state level as well. In real estate, for instance, rent-control measures that have been or could be passed in multiple states have contributed to investment in traditional multi-family housing shifting from some of the largest US cities to secondary markets. There also has been a move toward more niche housing and away from traditional apartment communities.
In other cases, state regulations are addressing areas where the federal government has pulled back. California formed a deal with four automakers to produce fuel-efficient cars and passed new vehicle emissions rules, only to have the Trump administration revoke states’ authority to do so, prompting a lawsuit by California and other states. Such measures might technically apply to the state in question, but for companies that do business nationally, it could impact their finances, products, facilities and labor more broadly.
One challenge for companies is making sure regulations don’t stifle innovation in their industries. Businesses that start small but bring something that’s truly new to the table can become big brands, but also invite closer scrutiny. We’re seeing that play out in the ridesharing industry. Those apps didn’t even exist a decade ago. Now the companies likely will have to adapt to a new California law that requires workers to be considered employees instead of independent contractors.
Experience is everything
At PwC’s Deals West event last week in California, I was part of a panel discussion on customer experience and M&A. Including this topic on the agenda was an easy call: As companies across all sectors are increasingly recognizing the value in delivering a better experience for their end customers, deals are playing a pivotal role – from the benefits they can bring to those customers to how, if not managed well, they can damage a relationship.
As our CX in M&A report illustrates, consumers care about deals and how they affect them in a range of industries – from healthcare to manufacturing to banking to technology. It can be difficult to put a dollar value on customer experience, but failing to maintain it during a transaction and improve it afterward can jeopardize the return on the deal. Consider this: While 33% of survey respondents said they did more business with a company after an acquisition, another 17% said they did less. And 45% said if a business they were a customer of combined with one they didn’t trust, they wouldn’t be a customer anymore. So the stakes are high, and companies of all types need to account for those end customers in deals.
Some sectors immediately jump out as ripe for boosting customer experience through deals. Technology certainly has been leveraged by various sectors to meet consumers’ greater expectations for both personalization and speed of service. This isn’t just something as obvious as shopping online. Last quarter saw McDonald’s acquire another artificial intelligence company to better serve drive-thru customers, a nod to how demographic shifts have influenced their overall customer mix.
In other sectors, investments recognize the demand for a high-quality on-site experience that many consumers still value in this digital age. Going back to real estate, we’ve seen more deal activity with assets focused on things that consumers want to buy or enjoy in person instead of online. Whether it’s entertainment, retail, hospitality or a combination, these developments or redevelopments are increasingly part of strategies that bet on hard real estate still having value as a destination for people who don’t want to look at their phones 24/7.
For more details on Q3 2019 deals activity, including individual sector reports, visit PwC Deals Industry Insights.