Three sectors dominated the US M&A charts this year. The pharmaceutical, medical and biotechnology (PMB) sector was way ahead of the field in terms of deal value, where a series of megadeals took its value haul to record levels.
The PMB sector accounted for almost US$300 billion worth of deals in 2015. This was followed by the energy, mining and utilities (EMU)sector, which saw an aggregate of US$274.78 billion worth of transactions over the same period. In both, there was a gap between value and volume, as megadeals led activity.
Transactions such as Pfizer’s US$184 billion move for Allergan have distorted the figures to a degree. Indeed, there were only 536 deals in the PMB sector in the year, just creeping over 2014’s 520 deals.
In volume terms, technology and industrials were well ahead of other industries. In the case of technology, and unlike PMB, activity was not so heavily weighted toward a few mammoth deals. Certainly, there were heavy-hitters such as the US$77.8 billion acquisition of Time Warner Cable by Charter Communications and Dell’s US$63.3 billion bid for EMC Corporation. But with 781 transactions recorded in 2015, technology was less skewed toward the upper end of the market compared with other industries.
▪ Technology and industrials drive deal volume with almost 800 deals each ▪ PMB sectors continue to drive deal value with a record total of US$296.8 billion ▪ Energy, mining and utilities sector sees large rise in value but steep drop in volume ▪ Convergence between sectors and consolidation within sectors is on the rise
The next big thing
Mammoth purchases may be hitting the headlines, but some of the biggest players are still picking off smaller deals as they restore their product pipelines. In August, a lesser-known manufacturer called Sprout Pharmaceuticals received approval from the Food and Drug Administration for Addyi, a pill that boosts the female libido. The following day it was acquired by Valeant Pharmaceuticals for US$1 billion in cash.
“The majors are always looking for the next blockbuster drug,” says Pierce. “We’ve seen some deals where a company has developed a product that has the potential to be huge. If you’re not looking at the very biggest megadeals, like the Pfizer/Allergan deal, there’s a lot of activity in companies that are developing drugs that have the potential to be blockbusters.”
Energy—high value, low volume In the energy, mining and utilities (EMU) sector, deal value was not far behind PMB, with US$274.78 billion-worth of deals. Two major deals that buoyed the sector’s value in Q3 included Energy Transfer Equity’s US$55.9 billion takeover of Williams Companies, and MPLX’s US$19.6 billion acquisition of MarkWest Energy Partners.
However, volume in the sector sat at 356 in 2015 compared with 495 for the whole of 2014, a marked decline. There is pressure for companies to consolidate to shore up their revenues and maintain dividend as commodities prices continue to fall.
Prices look attractive for investors looking to gain value on a future market rebound, but unless they absolutely need to secure weak balance sheets, companies would rather wait for an upturn than sell cheaply. Greater certainty and a convergence in buyers’ and sellers’ expectations is needed before M&A volume in the sector picks up.
“There’s a lot of uncertainty around commodity pricing at this point, so that’s really been the biggest inhibitor to M&A. Who knows when commodity pricing will bottom out? I don’t think people expected oil to fall to below US$40 a barrel,” says White & Case partner Greg Pryor. “The energy sector is like other sectors in that M&A activity dips when the economic cycle turns down.”
A new wired world Technology is one of the major driving forces behind the M&A revival—both for those within the sector and outside it.
The M&A revival has been driven by a number of factors such as cash supply, cheap debt and consolidation. However, the role of technology has perhaps been underplayed, not just as a sector in itself but also as a facilitator of deals across all sectors.
In the deal market, tech companies have been looking outside native sub-sectors to provide more integrated solutions to their customers. Meanwhile, older generation technology companies are making acquisitions to stay relevant (for example, hard drive manufacturer Western Digital’s US$19 billion acquisition of flash drive company SanDisk in October).
Meanwhile, non-tech companies need the solutions offered by those in the digital sphere, whether in mobile, online payment, IoT, security or big data, to bring their business offerings in line with the digital age and meet changing customer demands and behaviors.
This has meant that valuations have sky-rocketed. “The best technology-enabled companies offer their buyers a gateway into the future, in terms of product offerings, customer solutions, company culture and vision,” says White & Case partner William Choe. “And a premium is being placed on this gateway. This coupled with ready cash, inexpensive financing and a need to ‘stay relevant or fade away’ are the factors that have been driving up technology company valuations.”
And in the coming year, M&A in the sector could grow even further. There is no shortage of startups taking their crack at “disrupting” old-line industries—taxi services (Uber, Lyft), lodgings (Airbnb), pet lodgings (DogVacay) and even the neighborhood laundry service (Washio) have become significant online properties. Whether or not the disruptive companies get acquired by their old-line counterparts, acquire them or replace them outright remains to be seen.
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Life sciences strategy In 2014, M&A in the PMB sector was spurred by US companies buying foreign competitors to drive down tax bills by relocating their headquarters to countries with lower corporate rates. The US Treasury took measures to try and curb so-called inversions. Pfizer demonstrated that with the correct structuring legitimate business objectives can still be achieved. Pfizer opted for a reverse takeover that involved Dublin-based Allergan, the smaller of the two companies, buying New York–based Pfizer.
“You didn’t see as many inversion deals this year. I don’t know if that’s because of the Treasury’s efforts or not, but the Pfizer deal shows that companies can accomplish an inversion deal if they really want to,” says White & Case partner Mort Pierce. “Technically, it wasn’t structured as an inversion, but it achieves the goal of moving the company outside of the US.”
However, this is not the primary motivator for corporate M&A in the sector, according to Pierce. Like those in any other sector, PMB companies are eager to grow more quickly than they can organically. However, there is additional pressure in the industry due to its high capex demands.
“Drug companies have a significant embedded cost structure because of their R&D, so there is an incentive to become larger and spread that cost over a larger revenue base,” he says. “As the competition gets bigger, there is also a sense of having to keep up.”
CFIUS: Near the mark
Before bidding in the United States, foreign investors must give careful thought to whether any proposed deal is likely to draw the attention of the Committee on Foreign Investment in the United States (CFIUS). One major concern is a US business’s close proximity to facilities or areas considered sensitive by the US government.
A US business’s close proximity to sensitive US government sites can cause major issues for a deal. So just how close is too close?
The most high-profile case that highlights close proximity issues related to CFIUS began with the March 2012 acquisition by the Chinese-owned Ralls Corporation of four Oregon wind farm projects. After the transaction closed, the Committee flagged the deal because it thought the assets were located too close to a US Navy training range, and the President ultimately ordered that the wind farms be sold within 90 days. Following three years of litigation, the matter has finally been settled, but not without significant cost.
“Given the stakes, it is essential that overseas acquirers understand how CFIUS factors proximity into its determination of whether a deal threatens US national security,” says White & Case partner Farhad Jalinous.
Any deal in which the target business owns physical assets near military bases or training grounds may raise concerns. However, there is no strict rule on what constitutes close proximity, and not all military assets are equally sensitive. It may pay to look at airspace restrictions in a location, but this will only give an indication of the likelihood that proximity is an issue. In the case of Ralls, its wind farms were not near or adjacent to the naval air base that was at the center of the proximity concerns.
“Another point to consider is the immediate area surrounding the target assets,” says Jalinous. Urban areas could warrant less attention from CFIUS since the proximity of any military training grounds or other US government activities to densely populated areas will have already been considered.
It is not just proximity to buildings that raises red flags. Concerns are often raised where the target business is involved in digging under ground or under water, or operates towers or elevated structures, which was one of the issues with the wind turbines owned by Ralls Corporation. While it has not been explicitly stated, the inference is that such access could open up the potential for surveillance. This is liable to impact deals in sectors such as mining, upstream oil and gas, and energy.
It’s important for companies and investors to conduct in-depth due diligence to ascertain whether there are likely to be any proximity-related obstacles to getting CFIUS approval for a deal. Even if there are, mitigation measures tend to focus on specific assets of concern rather than whole businesses. This means that such deals might still be viable, so long as a particular facility is divested or retained by the vendor.
Until now, all deals that have been publicly blocked due to proximity issues involved Chinese investors. However, one could deduce that any buyer from a country that is considered to be a military adversary to the United States or even an ally to an adversary is at risk of having deals rejected.
In principle, Chinese investors are very welcome in the United States. Numerous Chinese acquisitions of US businesses succeed each year. Moreover, during President Xi Jinping’s state visit in September, both the United States and China committed to limiting the scope of reviews of foreign direct investment to national security alone, ruling out economic or public interest issues for reasons to scrutinize and block deals. America’s door is open. But investors must be mindful of how to work the locks.
The majors are always looking for the next blockbuster drug. We’ve seen deals where a company has developed a product that has the potential to be huge. If you’re not looking at the biggest megadeals, there’s a lot of activity in companies that are developing drugs that have the potential to be blockbusters.
Mort Pierce, Partner, White & Case