US M&A market on a high
The US M&A market broke new ground in 2015. By the end of the third quarter, dealmaking had already surpassed the whole of 2014, coming in at US$1.44 trillion, and by the year’s end, deals for US companies were worth US$1.98 trillion. This has taken US M&A’s total share of global value to more than 46 percent—the highest share since 2001.
In many ways, 2015 built on the comeback witnessed in 2014. The US economy continued its stable growth, with S&P forecasting GDP growth of 2.5 percent. This is the sixth consecutive year since 2009 that output has expanded, according to World Bank data, laying a firm foundation for market confidence. Unemployment is at a seven-and-a-half-year low at 5 percent, according to the US Department of Labor. All of these signs of relative domestic strength helped to support business confidence and M&A activity.
Value vs volume The new M&A record was ultimately driven by megadeals, some of the biggest the market has ever seen. However, activity has not been spread evenly, rather it has been concentrated in sectors such as the pharmaceuticals, medical and biotechnology (PMB) and technology, media and telecommunications (TMT) sectors. Before the end of the year, Pfizer bid $184 billion for Allergan, forming the world’s biggest drug company and marking the third largest deal ever. Two other blockbuster transactions took place in the TMT sector—the US$77.8 billion acquisition of Time Warner Cable by Charter Communications and Dell’s US$63.3 billion bid for EMC Corporation.
While overall M&A value surged on the back of multibillion-dollar acquisitions, volume slowed. At the end of the year, the deal count stood at 4,819, down 8 percent from 2014 (5,237). This suggests that we are very much still in a sellers’ market as cash-rich corporates are having to pay more for assets. US targets worth more than US$1 billion are selling for a median multiple of 19 times EBITDA, which is forcing buyers to balance the need to analyze deals against sellers’ demands for speed and certainty more deeply before they act.
The outlook for 2016 remains positive—policymakers are optimistic about the macro environment in the United States and corporate confidence is still high. And while investors should remain wary of high prices, the recent interest rate rise could potentially prompt sellers to bring assets to market sooner than expected and at reduced cost.
Moreover, there is still appetite for M&A, many companies and private equity firms are looking for opportunities to invest their significant cash reserves, and debt for financing deals remains relatively inexpensive. Thus, there is good reason to expect M&A to remain robust through 2016.
With China’s growth slowing and the stock market volatility, Asian powerhouses feel that the US remains a safe haven. During the crisis, everybody was looking at emerging markets, but now the US is looking like a good place to put money, as the underlying economy looks pretty stable.
Companies tend to see their equity as undervalued by the market, and any recent falls in share price will magnify this view, creating a gap between what shareholders think their business is worth and how much buyers are willing to pay. But so far, US M&A markets have shown resilience to foreign macro shocks and even the resultant volatility in domestic equities.
US safe haven for Asia One of the major stories of 2015 was the prevalence of Asian players that have been showing a significant interest in US assets. Japan was the third most acquisitive country by volume after Canada and the United Kingdom, accounting for 69 deals this year, putting it just ahead of China.
“With China’s growth slowing and the heavy stock market volatility, Asian powerhouses feel that the US remains a safe haven,” says Reiss. “During the crisis, everybody was looking at emerging markets but now the US is looking like a good place to put money as underlying economy looks pretty stable.”
Japan has been flirting with recession even as Japanese companies sit on some US$2 trillion in reserves, nearly half the size of the nation’s economy. With poor prospects at home, Japanese companies have been looking to the United States for growth, particularly where brands have a strong foothold in the country. This was demonstrated by Japan Tobacco buying US$5 billion worth of assets from rival Reynolds American, including the Natural American Spirit brand.
There have also been strategic motives. Insurers have been some of the most active buyers as they diversify their geographical exposure to natural disasters. Tokyo Marine, the biggest name in Japan’s insurance sector, agreed to buy US firm HCC Insurance Holdings for US$7.5 billion, the biggest inbound deal from the country in 2015.
With China devaluing the yuan against the dollar in a bid to jumpstart its economy and US GDP holding up well, Chinese companies also looked to the States as a relatively safe haven. This revealed itself in inbound M&A figures, which surpassed 2014 in both value and volume terms at US$18.08 billion invested across 60 transactions.
Total value was bolstered by the US$3.3 billion sale of LED maker and patent owner Lumileds to Go Scales, a consortium comprising GSR Capital, Nanchang Industrial Group and Asia Pacific Resource Development. China is attracted to the United States because it can buy companies and introduce them to its higher-growth market.
In addition, the country is at pains to wean itself off coal and transition to cleaner fuel sources. This has meant manufacturers of energy-efficient technologies such as the LEDs made by Lumileds have become prime attractions.
John Reiss, Global Head of M&A, White & Case
In addition, US oil assets have become attractive to Chinese buyers in the face of competition from China’s state-owned operators. In October, investment firm Yantai Xinchao agreed to pay US$1.3 billion for oil assets in the western Texas Permian Basin from Tall City Exploration and Plymouth Petroleum.
Interest from Asian buyers may soften in 2016. Owing to its economic robustness and in anticipation of an imminent rate rise, the US dollar has appreciated as Japan’s yen weakened and China’s central bank unpegged the yuan from the dollar to prop up growth. This foreign exchange pressure will make US companies relatively less attractive in 2016 and could slow activity.
However, White & Case partner Reiss feels there are more deals to come from Asia. “I don’t see that the situation in China and Asia is going to make Asian investors less interested in the US. In fact, it seems quite the opposite.”
▪ US deal values at a record annual high ▪ Deal values up 41 percent compared with 2014 ▪ US M&A accounts for nearly half of total global M&A value ▪ Megadeals continue to bolster the market ▪ Consolidation, convergence, low interest rates and comparative economics and political stability are the foundations for the thriving M&A climate
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The five Cs of M&A As with 2014, to a lesser or greater degree, the market is still being driven by what we are calling the five Cs of M&A: confidence, consolidation, convergence, cash supply and cheap debt.
Confidence can be seen in the continued ascendancy of the megadeal—2015 saw the Pfizer/Allergan deal among a slew of others including Royal Dutch Shell’s US$70 billion purchase of the BG Group in February. In addition, the appetite for inorganic growth appears to be as high as ever. A survey of more than 1,600 senior executives by professional services firm EY shows that 59 percent of companies are actively looking to pursue acquisitions in the next nine months—the biggest appetite for M&A in six years.
“Potential buyers have generally been interested in acting because of all the cash and the reasonably favorable financing markets and interest rate environment,” says John Reiss, a partner at White & Case. “High valuations have helped get the sellers to the table and from a corporate perspective, there’s a high level of confidence that combinations are going to result in substantial value, and I don’t see that changing right now.”
Meanwhile, we have seen growing consolidation in a number of sectors including TMT and financial services. However, nowhere was this more prevalent than in the PMB arena, where headlines were made on an almost weekly basis as the sector got smaller but the deals got bigger.
The trend toward convergence across sectors is also accelerating, particularly as companies in the TMT and entertainment sectors scale up to become ever larger conglomerates. One such example is Google’s acquisition of Softcard in February, which would bolster the company’s Google Wallet offering as it competes with Apple Pay in the fintech (financial technology) space.
“Technology convergence is no longer seen as a “disrupting” trend—but rather, it’s a competitive necessity,” says Arlene Arin Hahn, a partner at White & Case. “In order to remain nimble and viable in today’s market, it is unlikely that a company can rely solely on organic growth. The fastest, and often most reliable, way to jumpstart a company’s technology and talent is through M&A.”
And the trend is likely to continue into 2016, with convergence spreading from fintech, PMB and digital heathcare to the automotive and consumer products sectors. “The next frontier in the automotive industry is the driverless car, and the fully connected car is the first step towards that goal,” says Hahn. “Similarly, the potential diagnostic and analytic capabilities of the Internet of Things (IoT) will likely result in traditional consumer goods manufacturers investing in third party technology solutions to revamp and update their products.”
And record cash supply will only keep momentum running high. Non-financial US companies have collectively tockpiled US$1.4 trillion, and shareholders want them to put that cash to use. This has been evidenced by pressure from activist shareholders, as was the case with diversified chemicals major DuPont. After narrowly facing down calls to streamline from hedge fund Trian Fund Management in May, the company ultimately merged with Dow Chemicals in a US$77 billion deal that will see the two companies combine their agriculture, specialty chemicals and commodity chemicals business before splitting them, fulfilling Trian’s initial demands.
Meanwhile, PE firms have US$1.3 trillion in “dry powder” ready to invest, according to research firm Preqin.
Dealmaking has also been stoked by continued low interest rates, which for the most part have made for cheap debt. Low borrowing costs, driven down by the Fed’s quantitative easing program and ultra-low base rate, have provided an opportunity to deliver returns to shareholders via debt-financed M&A.
A volatile mix Credit markets have become more volatile in recent months as investors have begun to show an aversion to risk and are thinking twice before buying debt. This is exemplified in the financing for Carlyle Group’s takeover of Veritas. It was touted as the biggest buyout of the year but banks were unable to sell the US$5.5 billion worth of loans and bonds. This was put down to a lack of investor interest, even after underwriters reportedly offered rates of 11.5 percent to 12.5 percent on a $1.8 billion tranche of the debt—one of the highest yields of the year. The Veritas buyout left the software company with debt of 6.5 times EBITDA, an indication that investors are wary of more aggressively leveraged private equity deals.
China’s slowing economy and falling stock market were contagious, rattling investors’ nerves in both the equity and debt markets in the US. And in the weeks leading up to the Federal Reserve’s recent decision to lift interest rates, it seemed that investors began to hold back, re-evaluating what they considered to be acceptable yields on corporate and leveraged debt, forcing some issuers to re-price loans and bonds and the Wall Street banks that acted as underwriters to hold paper they intended to sell.
Stock markets were not immune to this anxiety either, with the S&P 500 sinking more than 10 percent at the end of August before making a recovery. The index finished the year where it started in 2015, after plummeting in January. Uncertainty could hinder M&A going forward if the bid/ask spread between buyers and sellers widens, particularly where acquirers are using their own stock as purchasing currency.
“I feel what we’re going through right now, with turbulent trading in China and that spilling over into the US markets, might be even more volatile and longer term than what we saw in August 2015,” says Reiss. “That said, there is still some good economic data out there, particularly in the US.”
Antitrust: Eyes on the prize
As M&A hits new record levels, antitrust regulators across the globe are scrutinizing more deals—and not just the blockbusters The prevalence of multibillion-dollar deals between market leaders has inevitably put the issue of antitrust high on the corporate agenda in 2015. When two big players look to merge, there is a greater likelihood that anti-competitive problems will arise. Indeed, a number of high-profile deals have fallen foul of regulators this year, including the proposed deal between appliance makers GE and Electrolux.
However, White & Case partner Rebecca Farrington says that regulators are keeping their eyes wide open and not just focusing their attention on the giant deals that have been making the headlines.
“Antitrust agencies around the world have been very active in investigating deals of all sizes, so it’s not just the megadeals. Smaller, local transactions can have just as much—or more—effect on consumers. In addition, some sectors such as healthcare and pharmaceuticals continue to see heightened scrutiny,” she says. “And it is not only the transactions that have to be affirmatively reported to the Federal Trade Commission and Department of Justice before closing—there have been an increasing number of investigations into deals that fall below the reporting thresholds.”
Any corporate pursuing a deal should have an antitrust strategy in place before they make a bid. This becomes even more crucial when exploring cross-border targets. A clear indication of this comes from China. In October, the country’s Ministry of Commerce stated that the number of antitrust investigations had risen by 43.5 percent in the first nine months of 2015.
It is vital not only to understand the competitive dynamics in foreign markets but also the nature of how those markets are regulated.
“Every jurisdiction has its own reporting thresholds and rules,” says Farrington. “Companies should be very smart about how they approach a transaction by looking at where they have to file and thoroughly analyzing markets to see where there are serious competitive concerns or where there are longer waiting periods. All of those considerations should be built into the closing timetable.”
This preparation is not simply a matter of abiding by rules—there are financial implications to consider. Companies need to carefully analyze all of their business lines and assets for any potential competitive concerns and be prepared to sell where necessary.
“Antitrust should always be part of M&A due diligence to understand how big the competitive risks could be. If the concerns are high enough in particular overlapping business areas, then the divestiture possibilities should be considered from the start,” says Farrington. “You need to be aware of the potential financial impact, as it can affect the overall economics of the deal. Divestiture assets are often sold at ‘fire sale’ prices; it’s always pennies on the dollar.”
US outbound The value statistics for US outbound dealmaking reflect a changing M&A landscape. The steep fall of investment into Ireland in the first nine months of the year may be due in part to measures taken by the US Treasury to close loopholes related to tax inversion deals, which involved US firms buying companies in the low-tax jurisdiction in order to re-domicile to lock in lower tax rates.
However, a single deal—Pfizer’s US$184 billion acquisition of Dublin’s Allergan—made Ireland a significant destination once again in value terms, even if volume has remained low. The reverse takeover, which reflects Allergan’s tax domicile in Ireland, shows how US companies will look to other countries opportunistically.
In terms of emerging markets, India has seen an increase in both the overall value and volume of deals coming from the United States. This comes at a time when the country has replaced China as the fastest–growing major economy in the world, with GDP expansion of about seven percent, and as the government makes efforts to streamline the country’s complex tax system and reform labor rules to promote business. These positive signs appear to be attracting US capital. In the first nine months of 2015, investment into India had already surpassed 2014. One of the year’s most notable deals saw American Tower Corporation buy a 51 percent stake in Viom Networks for US$1.9 billion.
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