NEW YORK, June 16, 2016 /PRNewswire/ -- Although the values and volumes of US mergers and acquisitions are unlikely to surpass 2015's figures, the deal drivers that fueled last year's record-high US M&A values remain in place heading into the second half of 2016, according to EY. Notably, M&A has stabilized as the midpoint of the year approaches, after a choppy first quarter during which dealmakers momentarily pressed pause as a result of hiccups in the debt markets and volatility in the equity markets. Through May 31st, deal values stand at $578.4 billion and volumes at 4,391. For the month of May alone, deal values reached record highs for the year ($182.9 billion).1
While this is trending behind 2015, it's on track to be the second best year since the 2007 high watermark and is ahead of comparable figures for 2014, 2013 and 2012. US Executives in the first quarter indicated that their intentions to do M&A remained high; with 66% reporting 2-3 deals in their company's pipeline and 83% saying that their companies will pursue a consistent number of deals.2
"After a bumpy first quarter, M&A is rounding back into top form. Equity and debt markets have settled down, credit is readily available, executive confidence is better, and the strong dollar is making the US more attractive for cross-border M&A," said Rich Jeanneret, EY Americas Vice Chair, Transaction Advisory Services. "You saw the strength of M&A in April and May with multi-billion dollar deals across life sciences, healthcare and agriculture. We are in for another strong year, likely the second best in the last five years trailing only 2015, which was historic."
Dealmaking activity in the second half of 2016 will likely outpace the first half and be driven by the following:
- Slowing global GDP putting pressure on growth
Slow economic growth continues to put pressure on companies' top lines. Companies are increasingly realizing that the most efficient way to grow is inorganically through M&A.
- China outbound to US
Chinese companies continue to look for US deal opportunities and have made $26.8 billion in acquisitions through May 31st, which is up a staggering 61% from 2015.3 "Chinese companies have helped and will continue to help prop up deal values. As they look to expand into new markets, the US remains attractive for its stable growth and currency," said Jeanneret.
- Activist fueled M&A
Activism continues to drive M&A as boards feel consistent pressure to drive short-term and long-term growth. Activist investors conducted 60 US campaigns in Q1 2016 with more than 78% of the campaigns targeting small and mid-cap companies.4 The top activist campaign objectives through March 31st were the sale of the target company and addressing operational issues.5
- Distressed asset sales
More than one-third of US executives (37%) expect distressed asset sales to become more prominent this year, particularly in the oil & gas sector.6 Low valuations could create a buying opportunity.
HP, AIG and Xerox were among notable divestitures in the first half of 2016. Activity is expected to remain high in the second half and beyond to mitigate regulatory and shareholder activism concerns. "Divestitures increasingly make strategic sense for companies looking to sharpen their focus, invest in their digital platform, or ease concerns from regulators," said Paul Hammes, EY Global Divestiture Advisory Services Leader. "Spin-offs are set to be a major driver for US M&A in 2016 as companies spin off non-core or underperforming business units, driven by the need to generate higher returns for shareholders."
- Hostile and unsolicited bids
US hostile and unsolicited bids are becoming more prevalent in 2016, with 8 unsolicited bids valued at $77.4 billion through May 31st, compared with just 2 valued at $4.5 billion during the same period last year.7 A fiercely competitive M&A landscape is expected to lead to more such bids in the near-term.
"US executives in the first quarter got hit with a triple whammy of uncertainty: with questions around growth, the price of oil, and the trajectory of interest rate hikes," added Jeanneret. "While those issues haven't been fully resolved yet, more clarity and generally positive news around the US economy is helping dealmaking confidence."
Market Conditions favorable for dealmaking as non-banks enter financing space
While the first quarter witnessed some tightening, credit market conditions remain accommodative, with plenty of capital for good deals. EY expects good capital formation in the second half to result in market conditions that are disciplined and total volume to be on par with last year, if not just slightly lower.
In addition, private capital formation has been brisk to start the year. Private equity firms, business development companies and traditional asset managers have all become more active and there have been large private equity sponsored LBOs getting financed entirely without traditional banks.
"Non-bank lending is becoming more prominent in the wake of increased regulations and scrutiny of US banks," said K.C. Brechnitz, Senior Managing Director, Head of US Debt Capital Markets, Ernst & Young Capital Advisors, LLC. "Traditional banks are still interested in putting capital to work but they are requiring more fee streams from their clients such as treasury services, foreign exchange and capital markets business."
From Megadeals to Megabusts
2016 has been notable for a number of high-profile deals that have been blocked or withdrawn, including Office Depot/Staples, Baker Hughes/Halliburton, and Pfizer/Allergan. Over US$450b worth of deals have been cut short through May 31st, the highest amount since 2007.8 "If 2015 was the year of the megadeal, you could characterize 2016 as the year of the megabust, but I think that's a misnomer. When you look at the US deal market collectively, only a small number of deals face concerns from regulators. As we see more megadeals announced, executives must have more realistic up front assessments of antitrust concerns and more aggressive plans for divestiture," said Jeanneret.
Market fundamentals to outweigh US presidential election, Brexit, Fed concerns
US Executives will be watching the presidential election and the Federal Reserve closely, as well as the UK's Referendum on EU membership. "Brexit is a concern for companies and where the Fed goes could have a bit of impact. As for the election, you might see the pedal come off the gas just beforehand, but dealmakers won't dramatically alter their strategies if the right deal is on the table. There's no discernable pattern based on previous election years. The overall market fundamentals will have a greater impact," said Jeanneret.
Private equity and sector outlooks
Private Equity – ready for liftoff with abundant dry powder available
The number of US private equity (PE) deals done from the start of 2016 to the end of May dipped by 22%, going from 327 invested deals in 2015 to 254 in 2016, while deal value increased 17%, hitting $48.1 billion at the end of May.9
As we noted in our year-end update for 2015, we were concerned about how the debt markets would impact 2016. Private equity firms faced challenging debt markets in Q1, which dampened deal activity. At the start of April, the tide changed with a resurgence of transactions in the pipeline, setting up a bright outlook for the rest of the year.
"Deals were done at a breakneck speed in 2015. Combine that with a challenging debt market in Q1 2016, and it is understandable that private equity activity dipped in the first quarter of 2016. The improvement in the debt markets should help lift deal volumes over the remainder of 2016," said Bill Stoffel, Private Equity Leader, Ernst & Young LLP
From a sector perspective, oil & gas remains intriguing for PE executives, although many continue to wait on the sidelines. "PE is eager to jump into the oil & gas industry. While we haven't seen a tremendous amount of deals in the space, major players are raising sidecar energy funds from investors, so clearly the industry is doubling down. PE deal values in the sector are up more than 100% from this time last year, as firms slowly begin to put assets to work in the space," said Stoffel. "Utilities saw a handful of large deals in the power generation space. That may continue and you'll see interest in technology and also healthcare, given the shifting demographics as baby boomers get older."
Furthermore, a subdued fundraising environment will have minimal impact on deal appetite as dry powder continues to grow. Dry powder for US buyout firms grew by 12% in the first half of 2016, to $290.8 billion, a record level, exceeding December's US$260.4b.10 "2014 and 2015 were record years for exits. We expect to see a buying spree in the second half of 2016 as firms look to spend," Stoffel said.
With regards to IPOs, the number of US PE-backed IPOs dropped a staggering 55% in the first half of 2016.11 "In the last two months, we have seen a slight uptick in IPOs, but it's likely that the number of issuances won't rebound until 2017 after the presidential election concludes," said Stoffel.
Life Sciences – the sector to watch
Life sciences bolstered the wider US M&A activity in the first half of the year. The two largest US deals through May 31st involved life science companies: Shire's acquisition of Baxalta, and Abbott's acquisition of St Jude Medical, not to mention other notable deals such as the Quintiles/IMS merger and Mylan's offer for Meda. The momentum is likely to continue as many sub-sectors consolidate and the drive for strategic focus sparks both acquisitions and divestitures.
Year-to-date deal values have passed the $100 billion mark, down 21% from the same time period last year.12 Deal values in April and May have increased by 77% compared to the same time period in 2015.13 The number of deals being done is holding steady, with 327 deals announced in the first half of 2016.14 Many of these deals are spurred by the need to improve shareholder value.
"We continue to see big pharma narrowing its strategic focus, which has been driving deal activity on both sides of the Atlantic for several years," said Jeff Greene, EY Global Life Sciences Transaction Advisory Services Leader. "Product pricing pressures are also exacerbating the perpetual quest for growth, triggering deals. One trend to look for in the second half is more contingent M&A. More acquirers will provide targets with only part of the total consideration upfront. Then they make further payouts later if pre-defined clinical and commercial milestones are reached."
In spite of a US Treasury Ruling that many feared would curtail activity in the sector, US life sciences CEOs remain upbeat about M&A. "With the recent declines of equity indices, especially in biotech, valuations have become much more compelling across the sector. Bolt-on deals in targeted therapeutic areas with future top-line growth have become a greater priority than immediate bottom line performance. There's more to the 2016 M&A story in life sciences than inversions," concluded Greene.
Technology: mobility, security and big data to keep sector strong
Technology sector deal values through the first half of 2016 fell 20.9% to $103.6 billion; down from $130.98 billion in the first half of 2015, while volumes fell 5.9% to 1,205 deals.15 Nonetheless, activity in the sector remains robust, with Microsoft's acquisition of LinkedIn as a case in point that deal activity is strong, whereas the seemingly large declines can be attributed to several massive semiconductor megadeals that took place in the first half of 2015.
"The mega deals that dominated the 2015 tech M&A deal volumes are likely not to be repeated in 2016. Tech executives are still keen to pursue M&A in 2016, but they are more focused on doing the right strategic deal to propel innovation-driven growth and profitability," said David Hedley, Senior Managing Director and Group Head of US Technology Sector Lead Advisory, Ernst & Young Capital Advisors, LLC. "That said, the sector has the highest amount of deal activity in the first half. There are cross-sector tech deals and alliances taking place across nearly every industry, from farming all the way to the latest powerhouse automotive tech alliance."
The volume of "industrial mashups" -- technology alliances with non-tech companies -- continues to climb in areas such as automotive, healthcare and financial services. Non-tech companies are apt to strike alliances rather than commit to billion-dollar consolidations, due to unfamiliarity with the tech space and risks integrating the technology.
"As we look ahead to the second half of 2016, expect more deals around mobility in payments and solutions, security, and big data analytics. You will continue to hear about exciting emerging developments in such areas as virtual reality, but tech M&A will continue to be focused on these three big areas," said Hedley.
Power and Utilities - off the sidelines
Power & Utilities has been the surprise sector of 2016 thus far, with US deal values skyrocketing up 255.7% through May 31st.16
There are several trends that are encouraging power companies to merge. Canadian utilities are seeking inorganic growth in the US, while US electric companies are acquiring gas utilities as a means to diversify their businesses, add earnings stability, gain a competitive advantage and capture growth.
"Lower margins and lower demand for electricity, partly due to advancements in energy efficiency, have been driving consolidations. Since these dynamics are not changing, the M&A boom will continue into the second half of 2016, but likely not at the same pace as we've seen. We are running at four to five megadeals every six months, which is historically very high," said Joseph Fontana, EY Global Utilities Leader, Transaction Advisory Services.
Oil and Gas: bankruptcy coupled with healthy M&A
The first half of 2016 featured a better deal market in the oil and gas sector. Through the end of May, overall US transaction value increased by 21.6 percent – from $44.6 billion in 2015 to $54.2 billion in 2016.17 When comparing 2015 to 2016, deal volume stayed flat with 172 and 173 deals completed respectively.18
"While M&A values have risen, executives at distressed companies have surprisingly chosen bankruptcy over M&A," Vance Scott, EY Americas Transaction Advisory Services Oil & Gas Leader explains. "Executives' belief in the underlying value of these natural resources remains steadfast. Determined not to sell at the bottom, bankruptcy appears to be management's preferred alternative to mergers or asset sales. Plus, the recent run-up in oil price allowed many stressed players with good underlying assets to enter the capital markets as a mechanism to migrate through the cycle bottom."
For the second half, low oil prices will curtail exploration and drilling capital, but large projects with associated major volumes will continue. "Expect significant projects, such as the Deep Water Gulf of Mexico and the shale development in North America, to continue at a strong pace. However, the longer-term supply pressure and country-level gearing will slow major production increases in stressed national oil companies. Without fiscal regime transformation, these companies will struggle to access capital," said Scott.
Healthcare: from Wall Street to Main Street in dealmaking
Deal activity in the healthcare sector took a slight breather in the first half of 2016, with US values dipping by 37.2 percent to $8.2 billion in 2016 from $13 billion in 2015.19 Likewise, deal volumes fell by 5.7 percent, with 197 deals compared to 209 last year.20
From a macro standpoint, US deal activity in the sector is still strong. Gregory Park, US Healthcare Sector Leader for Ernst & Young Capital Advisors, LLC, expects 2016 to be a top 5 year for M&A in healthcare. "We are in the midst of a tectonic shift in patient care, delivery and payments and from a big-picture perspective, the deal boom is far from over," Park said. "The fundamental drivers of portfolio pruning and divestitures are still there."
While still robust and expected to finish strong, the first half of 2016 marked a continued transition in deal origination – spreading from Wall Street to Main Street. Companies are consolidating very actively on a local basis, creating a significant middle market. "Expect reinforcement of the strength of the middle market in healthcare M&A, which will continue as companies combat shrinking reimbursement, cut costs and ultimately pass those savings down to the consumer," Park said.
Conclusion and outlook for the second half of 2016
"US M&A is showing remarkable resilience in the first half of 2016 and we think the spigot is open for more deals with life sciences and technology leading the way," said Jeanneret. "The uncertainty that plagued the first half has faded, and while the UK's Referendum on EU membership and the US presidential election could impact financial markets, we don't think they will materially curtail US M&A momentum. As the search for growth continues, executives realize that standing still is going backwards and they have abundant capital to do deals. At the same time, they are making prudent dealmaking decisions, and showing a willingness to walk away from deals that don't fulfil their investment criteria. This points to a level of sustainability that wasn't present during previous M&A booms. It's a healthy M&A environment and the acceleration of industry transformation and new technology across all sectors will continue to power it further."
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