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Key Trends in Mergers and Acquisitions: Q1 and Q2 2019

Many analysts were optimistic about M&A activity at the start of 2019. Despite recession fears rising during the year, mergers and acquisitions are currently well-positioned to weather an economic downturn, as well as to help companies clarify their core missions and goals through strategic purchases and divestitures.

 

As 2019 heads into its final quarter, here’s what investors, business leaders and other engaged parties need to know about this year’s M&A trends.

Early Expectations

2018 was a strong one for mergers and acquisitions within the U.S., leading some commentators to predict an equally strong 2019. The presence of significant liquidity, a lower-growth environment and a constructive debt market set the stage for elevated levels of M&A in the early part of the year, says Gerry O’Meara, head of M&A at SunTrust Robinson Humphrey.

Even when a Q3 2018 downturn disrupted M&A growth that year, 2018 registered the second highest value on record, with $2.72 trillion on the table across 13,575 deals, according to a Mergermarket report.

The fact that a downturn nevertheless landed with strong economic activity helped to boost confidence going into 2019. So did a number of financial reforms, including the reduction of the U.S. corporate tax rate to 21 percent and changing rules on the repatriation of overseas profits.

“We expect domestic M&A activity to remain strong in 2019 — despite the challenges in U.S. politics and the 2020 election in sight — partly as a result of companies looking to take advantage of the recent tax reform,” say Scott C. Hopkins and Adam Howard at Skadden, Arps, Slate, Meagher & Flom.

While 2019 has confirmed some early predictions, it has defied others. Overall, the pace of the deal count has slowed; companies are making fewer deals than in 2017 or 2018, say Stephen F. Arcano, Christopher M. Barlow and Allison R. Schneirov, partners at Skadden.

Despite this, the overall value of deals has remained high, as companies focus on making larger deals. For instance, seven deals valued at $10 billion or more were announced in the U.S. in the first quarter of 2019, compared to six such announcements in Q1 2018.

Valuations for private companies also dropped sharply in Q1 2019, an event that may be built into an upcoming economic slowdown, says Marc Emmer, president of Optimize, Inc. The good news for companies seeking to sell is that while valuations are dropping, so are the number of available businesses for purchase.

Liquidity Keeps Recession Fears in Check

Concerns about an economic recession beginning in late 2019 or in 2020 continue to make headlines and become part of the public consciousness.

For instance, in a survey by the National Association for Business Economics, 72 percent of economists predicted a recession by no later than the end of 2021. Of these, 38 said a recession would occur in 2020, say economists Megan Greene, Patrick Jankowski and Ken Simonson at NABE.

Currently, a number of factors point to an upcoming recession and influence investor behavior accordingly. For instance, an August 2019 inversion of the yield curve caused concern that led to a short-term drop in the U.S. stock market. Traditionally understood to be a strong indicator of an upcoming recession, the yield curve inversion caused many rates market participants to change their behaviors to protect themselves and their clients, says Charlie Ripley, assistant vice president at Allianz Investment Management.

An upcoming recession may be inevitable. Liquidity, however, is likely to help M&A weather a downturn. More cash began entering the picture in 2018 as companies increased spending on capital expenditures, research and development, and deals. In addition, private equity firms have more than $1 trillion in capital available for investment.

“When you factor in borrowing rates that are still historically low, there’s simply more than enough ammunition for investors to keep moving on acquisitions, particularly if company valuations start to moderate in a slowing economy,” says Bob Saada, managing partner at PwC and deputy leader of its Asia Pacific Americas Consulting division.

Capital Drives Decision-Making

Financial liquidity will also continue to drive decision-making within companies themselves, which in turn will affect the sort of integration or divestiture decisions made.

For instance, data from the U.S. Bureau of Economic Analysis revealed double-digit growth in business spending on research and development in the first half of 2019. Capital spending also increased during this period, driven by new investments in technology, say Colin Wittmer and Curt Moldenhauer at PwC.

While M&A has always been about scale, companies seeking to integrate in a capital-flush economy have opportunities to place other priorities on the table, as well, Wittmer and Moldenhauer say. For instance, the merger of CVS and Aetna provides an opportunity for innovations in healthcare provision, such as by turning CVS’s drugstore locations into walk-in clinics.

The unique combination of capital and innovation means companies are likely to think differently about integration and divestiture as 2019 draws to a close.

Companies Embrace Mission Realignment

A key element of M&A decision-making in 2019 is not only which businesses to acquire or divest, but why.

While large-scale strategic consolidations are likely to continue, 2019 and coming years will see an increased focus on aligning those deals with a single set of core values and goals, says Tom Miles, head of M&A for the Americas at Morgan Stanley.

“I expect large-cap companies to continue consolidating core businesses, but wouldn’t be surprised to see those actions more often followed by a spin-offs and divestitures of noncore businesses, as a way to refocus and provide greater corporate clarity for investors,” Miles says.

As interest in corporate clarity increases, companies are likely to refocus on cultural factors and organizational alignment as part of the M&A process. Currently, while leaders understand that attention to culture is necessary for a successful integration, fewer are spending the necessary time and energy on facilitating cultural transition, say Oliver Engert and fellow researchers at McKinsey and Company.

What will this look like? Expect a number of concerns to take center stage in the coming years, say Engert et al. These include a renewed interest in how work is done within the current culture, emphasis on setting priorities for cultural change and finding built-in ways to support necessary changes as the companies navigate integration.

 

 

What’s Ahead in M&A?

The increased interest in aligning mergers and acquisitions with a purchasing company’s core mission and values is likely to lead to an increase in due diligence, as purchasers strive to envision precisely how the company they’re acquiring will integrate with their existing portfolios.

Companies are also likely to increase their emphasis on due diligence because satisfaction with the process has been waning over the past few years. A 2019 Deloitte study found that 25 percent of business leaders believed that a merger or acquisition failed due to inadequate or faulty due diligence, up from 23 percent in 2018, say Deloitte researchers Russell Thompson, Susan Dettmar and Mark Garay.

Similarly, the need for liquidity in the face of a potential recession is also likely to play out as an increased emphasis on due diligence.

As a result, companies that focus on building robust and efficient due diligence practices are more likely to see mergers and acquisitions succeed in the coming months. Obtaining the necessary information and sharing it with the proper parties will be bolstered by software and other tools that provide the necessary data security and transparency to facilitate the process.

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