The fundamentals that will drive M&A in the US and underpin US corporates’ appetite to acquire overseas in 2016 remain in place, despite the events of early January that have shown there are headwinds facing financial markets, resulting in significant volatility.
Headwinds: oil price and China
Recent oil price forecasts have contemplated $20 oil. Energy companies have been major issuers of leveraged loans and high yield securities, with over $275 billion outstanding. Over 15% of these securities are in significant distress; 30 such companies have already filed for bankruptcy. These developments have led to massive redemptions by investors, pressuring liquidity in the debt market and severely impacting trading levels across the board. With existing securities trading at deep discounts and investors withdrawing cash, the new issue market will slow significantly – impacting the ability (and cost) of financing new M&A activity.
The rout in Chinese markets, while disturbing, has little economic impact – Chinese imports are only 2.5% of US GDP. However, the slowdown of Chinese demand in a world that depends on the region to support revenue growth does impact the global economy, especially with regard to commodity prices. Further commodity price declines and a strengthening dollar would create significant pressure on other emerging economies as well.
Confidence in the US is high
While this volatility may cause distraction, the US economy continues to be fundamentally solid, growing (albeit slowly), the employment situation is improving, and margins remain near all-time highs. The December interest rate rise was a reflection of the Federal Reserve’s confidence in the economy – economic growth in 2015 was around 2.5% and is forecast to hit 3.0% this year.
Most companies have extended their debt maturities and/or deleveraged, with plenty of capacity to do acquisitions. The question of the year is whether the external volatility will temper this activity as large acquirers sometimes sit on the sidelines in times like these.
However, this won’t be the reaction of all market participants. In the US, private equity (PE) players have been aggressive sellers in recent years. PE exposure in the LP community has shrunk in absolute terms as a result; and with public equity moving higher in that time, allocations to the PE world are currently low. Capital raising has been occurring at a rapid rate to close this gap and the PE community is sitting on some $250 billion of dry powder. PE buyers are expected to increase as a percentage of overall activity, reversing the trend of the last two to three years.
Strong deal flow
The supply of transactions is expected to remain strong. Rather than the mega deals of 2015, this year will be characterised by high volumes of smaller deals. Some $5-$7 trillion of value is held in businesses owned by baby boomers looking to transition ownership and this is creating significant opportunities for acquirers, both domestic and cross-border.
Certain sectors are also powering ahead. M&A in healthcare, pharma and pharma services will continue to be strong. Healthy and sustainable products have unquestionably entered the mainstream and are being adopted by a widening and diversified consumer base. This $290 billion sector is disrupting established players and iconic brands, and is attracting both corporate buyers and PE. Innovation will also support deal activity. There is considerable momentum in areas such as industrial technology and the “internet of things”. And the technology sector in general continues to have strong momentum.
The corporate world remains fixated on one thing: revenue growth. US corporates will continue to look overseas for growth and the best opportunities. Outbound M&A volumes are at record highs and the UK is the most targeted nation with US companies making 244 acquisitions worth over $62 billion in 2015. Already this year, Acadia Healthcare has acquired mental healthcare specialist Priory Group for $1.9 billion. With the US and the UK furthest along in their recoveries, expect more activity between these markets as even M&A experiences a “flight to quality”.
Given the expected increase in market volatility, 2016 may be a bit uncomfortable at times but will represent a period of significant opportunity for buyers and investors.