January 24, 2018
Full-year 2017 Deals Day findings
After a year in which companies faced many questions yet were undaunted in completing deals, 2018 should bring some clarity for dealmakers, who will be in a strong position to navigate the playing field. This will include increased cross-sector investment, a potential uptick in sellers, shifts in cross-border deal flow and additional capital poured on top of our already healthy pile of dry powder. At least we know what the new tax rules are now; how they will affect each company’s and each industry’s investment and capital allocation decisions will be key.
Today’s dealscape presents companies with different changes that will shape decisions on acquisitions, divestitures, alliances and other deals. There have been immediate impacts, such as the potentially dramatic effect of the recent federal tax overhaul. And there are more subtle disruptions, such as shifting demographics that are influencing customers and workforces, which are testing businesses – and, by extension, deals. For instance, the aging population drives much of the health services industry, and the evolving impact of technology on treatments, cost reduction and care delivery is resulting in various transactions. Even without these shifts, the importance of a company’s digital IQ in strategy and competitive viability will influence deals activity.
Between these developments and historical patterns, we see the coming months bringing more deals and larger transactions, with deal volume continuing its ascent and deal values outpacing 2017, with multiples continuing to rise. PwC’s latest CEO Survey supports this optimism, with 69% of US CEOs planning to pursue growth through new M&A in 2018. That’s up from 55% a year ago and well ahead of this year’s global response of only 42%. As companies face a new deal frontier, conditions appear to be in place for the successful execution of their growth strategies.
Deal volume still on the rise
Last year’s nearly 15,000 US deals were the most this century, continuing several years of annual increases and exceeding the levels before the financial crisis*. While M&A volume was up 11%, average deal size was lower for the second straight year. Corporate deal numbers largely matched the overall changes from 2016, while private equity posted a slightly bigger increase in volume and a slightly smaller dip in average value.
Contributing to the 16% overall decrease in value was a decline in megadeals – transactions with a value of more than $5 billion – which were down in both volume and value by more than 25%, representing the worst year since 2013. Energy and industrial products experienced the most megadeal activity, and there were other high-profile bids in industries such as health care and media and telecommunications. But even with ample cash on hand and access to other capital, some would-be dealmakers decided to wait and see with large-scale transactions or couldn’t win the competitive battle for assets that traded in 2017.
The drop in average value wasn’t universal. Health services saw a significant increase from 2016, even without including the year’s largest transaction, CVS Health’s bid for Aetna. Automotive deal value was buoyed by two megadeals after none in 2016, with many of highest-value deals targeting component suppliers. And aerospace and defense posted a record year for value, as commercial aviation remains strong and increasing competition and pressure on profit margins have resulted in some of the largest acquisitions in industry history.
In addition, the broader economic climate is bustling. As PwC’s latest annual US Capital Markets Watch explains, all three major US stock market indices had a record-breaking 2017, with market volatility at a 24-year low. GDP growth has been robust, unemployment and interest rates are low, and consumer confidence and corporate earnings growth are high.
IPO volume and value exceeded the previous year, reversing two years of decline. Even with a quiet summer, 2017 saw 181 total IPOs that raised more than $44 billion, with a wide diversification of industries.
Strong interest in the middle market
The decline of overall average deal value is driven by the residual strength of middle market activity. Along with an 11% rise in volume, the total value of middle market deals – those with a value of less than $1 billion – increased 7%. That’s the second straight year of higher values, with a bigger jump than in 2016.
Middle market M&A activity extended across the industry spectrum. The power and utilities sector saw smaller asset deals in 2017 after much larger deals for new platforms in 2016. The insurance industry has seen significant consolidation in the broker area. Financial service M&A has moved away from giant deals, with the next wave of M&A expected to involve mostly regional banks.
Divesting to focus on the core
Helping fuel the supply of M&A targets is divestitures, which were up in 2017 for the second straight year and at their highest level in more than a decade. That could continue in 2018 as conglomerates and large corporates re-evaluate their core business and consider breakups, spinoffs and sales.
Industrial products saw the most divestitures last year – many large companies have announced the strategic realignment of their portfolios – followed by consumer goods, real estate and technology. But more than a third of total divestiture value came from two other sectors, energy and media and telecom. Divestitures have helped drive deal activity in the oil and gas industry, with the sale of non-core assets providing capital to expand core operations – including through acquisitions. Going forward, the need to pay down debt and respond to activist shareholders could keep the pace of divestitures brisk. Continued portfolio assessment, as well as potential reshuffling under the new tax law calculus, could spur further movement.
One positive note for companies considering divestitures is that, along with volume, the overall value was up in 2017 after a dip the previous year. Given the capital available to potential buyers, companies that are scaling back before the current economic cycle ends may be able to command favorable prices for their assets. In pharmaceuticals and life sciences, for example, private equity buyers seem primed to acquire many anticipated carve-outs, particularly in medical devices.
Solid flow across borders
Despite increased nationalist and protectionist rhetoric in various markets, cross-border deal flow hasn’t diminished. Although values were down substantially, the number of transactions into and from the US were up 7%, with technology topping both inbound and outbound volumes.
Bids by US companies for foreign firms didn’t change much, but prices were higher on average. Acquisitions of US companies by foreign buyers increased 15%, with total inbound volume continuing to close the gap with outbound. But those inbound deals on the whole have been smaller, with total value down more than 50% from 2016.
Real estate is one sector that has seen significant cross-border M&A. In addition to traditional markets such as China, capital is flowing from such nations as India, Israel, Japan and parts of Latin America.
Looking beyond industry lines
The activity within each sector tells only part of the story, as deals between different industries continue to bloom. In particular, recent years have seen a growing slice of tech company acquisitions going to buyers in non-tech industries.
Automotive companies are investing in connectivity, electrification, ride-sharing and the software, sensors and other components that support these trends; auto technology deal value increased more than fivefold from 2016 to 2017. Defense industry investments include such technologies as autonomy, artificial intelligence (AI), robotics and cybersecurity. Internet advertisers also are exploring how to harness AI to track ads across platforms and create personalized targeting.
Traditional-to-tech deals can bring different challenges – from valuations on the front end to integration on the back, and potential cybersecurity concerns throughout. That may lead some companies to take a more tentative approach in some cases. We’ve seen airlines make minority investments in security technology, forming a partnership instead of seeking total control of a specific capability. Or consider the oil and gas industry, where some oil field services companies are looking to set up venture funds to provide seed capital for startups.
Beyond technology, other cross-sector deals include retailers acquiring local delivery businesses. But in a growing number of cases, companies aren’t jumping across verticals simply to expand into a market. Instead, they’re playing a longer game of collecting platforms that provide more entry points for customers, who then can be offered a broader range of services and products.
Plenty of money available
As industry lines continue to blur, companies should have the money to explore new types of deals. Corporate balance sheets largely remain flush, interest rates are still low and capital is available not only from but insurance companies and private equity firms.
Then there are funds from overseas accounts, with the recent tax overhaul allowing the repatriation of foreign cash to the US. The technology and pharmaceuticals industries have significant amounts of cash overseas that – if not used to pay down debt or buy back shares – could set M&A dominoes in motion.
That possibility is just one of a confluence of circumstances that suggest the steady deal volume of 2017 will continue, with values rebounding in the form of larger deals. Companies that are agile and creative should be able to thrive as many industries prosper in a healthy M&A environment.
* All figures from Thomson Reuters with PwC analysis, unless noted.
For more information, please visit PwC Deals Industry Insights.