It’s a year of mixed feelings when it comes to mergers and acquisitions. The market hit record volume in the first half of this year before caution settled in after a wave of uncertainties — tariffs, regulatory changes, Brexit. It won’t be long before investment banks, law firms, consultancies, and data providers churn out end-of-year reports to make sense of this year’s global M&A market. But there is already plenty of evidence showing that 2018 is on track to beat 2017’s deal volume — and at least one survey indicating that robust M&A appetite could continue into 2019.
2018: Record M&A activity turned cautious
Reports proclaimed that the M&A market in the first six months hit an 11-year high, a level not seen since before the global financial crisis. The trend was driven by mega-deals — those valued $5 billion or higher. Notable deals include Takeda Pharmaceutical’s announced acquisition of Shire at $62 billion, Comcast’s acquisition of Sky television network at $40 billion, and IBM’s recently announced purchase of open-source software provider Red Hat for $34 billion.
However, global deals volume in this year’s third quarter fell 5% compared to the third quarter in 2017, mostly because of a downturn in deals targeted at Asia-Pacific and Europe, Middle East, and Africa (EMEA). It was a telltale sign of buyers’ dampening appetite and a more cautious outlook. But even with a slower third quarter, data from Dealogic shows that the total deals volume in the first nine months is still a significant 32% increase from last year, suggesting a high possibility that 2018 will close with a higher M&A volume than 2017. As of the publishing date of this article, total value of deals for 2018 stands at $3.4 trillion, compared to $2.9 trillion at this point last year.
But uncertainties remain. At the forefront are the ongoing US–China trade dispute and Brexit. JPMorgan Chase recently said that large cross-border deals behind the M&A boom over the past five years will become more difficult because of the prolonged trade war and bigger regulatory hurdles. Following the 1 December meeting between US President Donald Trump and China’s President Xi Jinping at the G20 summit, both sides agreed not to escalate the tariff amount, but current tariffs remain. The Brexit cloud looms over the UK as politicians try to negotiate a favourable deal.
What does this mean for 2019? A survey by EY suggests that M&A activity will be slower next year, but corporate takeovers are still on the agenda.
Slower but still active M&A expected in 2019
In the semiannual Global Capital Confidence Barometer, 90% of executives predict that the M&A environment will improve or remain stable in the next 12 months, and 96% say their M&A pipeline will increase or remain the same. But looking beyond the surface, the optimistic outlook shrouds a cautious undertone. Of the 2,600 executives in 45 countries surveyed, only 46% of executives plan to actively pursue an acquisition in the next year, the lowest in four years.
That said, companies are not moving away from dealmaking but merely taking a breather, argues Steve Krouskos, co-author of the report and EY global vice-chair of Transaction Advisory Services. He gives two reasons: Companies want to assess risks in the market because of regulations, tariffs, and Brexit before they continue M&A, and companies need a break to integrate past deals to maximise value.
Technology has created a tidal wave of disruption impacting all sectors, and Krouskos said that corporate takeovers and divestitures are still sound strategies to stay ahead of competition.
“The speed of change is relentless and M&A has proven to be an effective means to move quickly to gain competitive advantage or defend against future disruptors,” wrote Krouskos in the report. “This still holds true.”
Even in Asia-Pacific, where number of deals declined in the third quarter, significant M&A activity will continue into 2019, said Harsha Basnayake, the managing partner of EY’s Asia-Pacific Transaction Advisory Services, in an interview. For Asia’s emerging markets, M&A is a solution to the region’s slowing growth.
Organic growth falls short
“The emerging markets are increasingly settling into a low-growth trajectory. Gone are the days where our markets used to grow double digit. It’s not going to happen,” Basnayake said. “So that’s the market environment that we’ve been on … for CEOs to find growth, organic growth alone is not going to do the magic.”
A World Bank projection forecast GDP growth in emerging and developing markets at 4.7% in 2019 and 2020. If the projections are right, inorganic growth through M&A will be a consistent theme in the emerging markets.
The EY report provides more perspective on what C-level executives are looking for in these deals. The top three reasons for pursuing M&A were to gain access to new markets (26%), to respond to changing customer behaviour (21%), and to acquire talent (19%), according to the report. Other motivations include securing supply chain and acquiring technology, production capabilities, or innovative startups.
Tech disruption is another major theme impacting companies’ competitive advantage. “Naturally, digital disruption is also causing a lot of companies to rethink their positioning, capabilities, [and] new market channels so people will look at doing an inorganic acquisition in some cases to give them the necessary capabilities and channels that they have not had in the past,” Basnayake said.
In the EY survey, 31% of executives cite “disruptive forces” as the greatest near-term risk to the growth of their core businesses, and many of these disruptions are related to new technologies. For these companies, getting ahead of the digital game is a defensive measure as well as an opportunity, Basnayake said.
Record levels of dry powder
Another driver of M&A in the coming year is healthy liquidity in the market. A combination of historically low interest rates and cheap financing is driving buyouts globally. In this environment, the private equity market is playing an increasingly bigger role in M&A, where dry powder — money raised in the private market that’s yet to be invested — surpassed $1.1 trillion for the first time this year, according to a Mergermarket report.
This means two things: Private equity firms are hungry for good deals, and there is heightened competition for assets. In fact, in the EY survey, 68% of executives expect increased competition for assets in the coming year and 46% see competition coming from private equity and other funds such as sovereign wealth funds or hybrid funds like Softbank’s Vision Fund.
In Hong Kong, Alexander Que, an adviser of public and private M&A at law firm Deacons, sees a similar two-pronged trend — some buyers taking a pause and some going ahead with pipeline deals, especially in the technology sector. He said buyers are taking a pause due to uncertainties in the macro environment. They’re thinking about “whether they are able to buy things cheaper if they just wait a bit longer”. The boom in M&A market the past five years has driven prices to a historic high. Sellers who fear missing out on a good cash out if they wait longer may agree to lower valuations, to the advantage of buyers.
“I think generally there may be a bit of a slowdown,” Que said. “But … in some sectors, in technology and new economy, from what we see our clients are planning, they seem to be still very, very aggressive.”
Chinese state-owned enterprise is another group of buyers that will continue M&A activity into 2019 to gain market access, Que said. “State-owned enterprises [with] strong financing, sufficient funding, or strong balance sheet offshore, it seems [like] they’re still planning a lot of [M&A] activities,” Que said.
Weigh market and political noise
Emerging markets’ slower economic growth, technology disruption, changing consumer behaviour, and record levels of dry powder will drive companies to get into the M&A market, and these are fundamentals that nobody can brush aside just because of market or political noise, Basnayake said. “Political noise has to be weighed in its context, instead of imagining the world has come to an end,” he said, referring to media reports on regulatory barriers and tariffs and remarks by politicians.
“We do believe that there will some degree of volatility in terms of volumes, but overall, in the medium-term, deal activity should prevail,” he said.
Looking into 2019, there are a few things that executives can evaluate before jumping into a deal:
- Understand where your current business is. Basnayake said that companies should know their current standing in their own market and other sectors that may affect their business. “If I’m a CEO of a business, one of the first questions I need to ask myself is: What are the themes affecting my business, and [is] my business affected because of the political noise out there?” he said. If the answer to the second part is no, perhaps there isn’t a need for a shift in focus through M&A. However, if the answer is “yes”, then companies need to analyse the value chain, identify what is affected, and figure out a solution to that. The solution may be in gaining capacity in a different geographical market or shifting the supply chain.
- Decide if you have the capacity for M&A. Companies need to evaluate their financial standing and decide how much debt they can take on to determine whether they have the capacity to aim for inorganic growth. “Just because there’s cheap money doesn’t mean that you should borrow at a level that’s unhealthy. You’re going to fall into trouble at some stage,” he said. An M&A deal puts excessive pressure on a company and could disrupt current businesses, Basnayake said. Another area is management capacity — whether there is leadership to lead the M&A and to integrate the partner company or the acquired company, he said.
- What’s the best value for money? Firm valuations have skyrocketed over the years. According to an estimate by Boston Consulting Group, targets today are more expensive than they were in 1999, during the dot-com boom, and in 2008, before the fall of Lehman Brothers. To judge how much you’re willing to fork out for a company, it’s imperative to understand potential gains, whether it’s market access or talent and technology acquisition, to allow you to operate in the long term much more cleverly, Basnayake said.
— Alexis See Tho (Alexis.SeeTho@aicpa-cima.com) is an FM magazine associate editor.