February 22, 2016    9 minute read

The 2015 US M&A Review

   February 22, 2016    9 minute read

The 2015 US M&A Review

Mergers and Acquisition is a combination of words that is usually taken as a major sign of how an economy is performing: if M&A activity is relatively high as compared to historical deal levels, that means more capital was allocated (invested) in the markets and therefore, more value was created and productivity raised the economic outlook. Therefore, high M&A activity is generally taken as a good augur sign. However, too much M&A can damage the stability of financial markets. For example, the bid wars that goes on between companies can lead to overvaluations of the targeted businesses or in the case of mergers, the lack of synergy integration within the newly formed corporate entity can result to a collapse of the entire organisation as conflicts of interest rig the ‘fresh’ company. Alternatively, low levels of M&A activity is taken as a red flag that indicates poor economic performance, slow GDP growth, sluggish outlook and so forth.

Globally, the year of 2015 was a year dominated by mega-deals involving names such as Pfizer, Kraft and Time Warner Cable. The professional services giant Deloitte reported that the value of M&A deals in 2015 reached over a stellar $4tn, the highest since 2007. At the same time, synergy costs (costs that are incurred as a result of combining the business operations of the M&A parties) are assessed to be around 3-4% of the transaction value mentioned above.

M&A global 2015

(Sources: Mergermarket, Merrill Corporation and Deloitte)

M&A activity across all sectors

The US drove the $4tn of global M&A activity, accounting for 46% of this number and with its own deal value rising to records high. Most importantly, valuations jumped across all sectors, with the most aggressive buyers paying as much as 24.3x EBITDA for technology companies and 18.8x EBITDA for pharma, medical and biotech firms. Data from Mergermarket underlines this below.

M&A US 2015 general 1

(Sources: Mergermarket, Merrill Corporation and Deloitte)

The M&A dealmakers use EV to EBITDA as a core measure for valuing their targets. Enterprise Value (EV) is more accurate than market capitalisation because it accounts for both debt and equity of a company, whereas the market capitalisation metric only looks at the equity. Therefore, these relatively high valuations, when compared to the ones made in the prior years after 2007, may suggest either overconfidence or confidence in the financial health of these corporations. Let’s hope that it is just confidence. However, the start of 2016 seems to suggest a slower progress on the M&A picture as equity markets went downwards: January 2016 is the first month at the beginning of a year, since 2011, that has not seen an IPO in the US.

M&A US 2015 general 2

(Sources: Mergermarket, Merrill Corporation and Deloitte)

You can see that the M&A value across North America has been rising, with its ups and downs, since Q1 2009 and skyrocketed since Q1 2014 to historically high levels. At the same time, the volume (number) of deals has increased also but at a steadier pace. This can underlying that the markets are overvalued or simply that industries are consolidating themselves. In order to evaluate this wave of M&A deals accurately, we need to look at how these deals were funded? Was there more credit used than cash and shares? Who backs up the lenders that financed some of the deals? What are the regulatory measures triggered by some of these big deals? These are some of the questions we need to answer in order to read the above data realistically.

Finally, some of the major drives that played a significant role in 2015 and that are likely to impact the M&A stage across the American States in 2016 include the amounts of cash held by corporates and privet equity firms, around $3.2tn which can fuel further deals, the technology sector will likely be the most colourful in terms of development as investors focus on new developments in the Big Data and Cloud technologies sectors and tax benefits. At the same time, the positives from low oil prices are likely to be balanced out by insecure emerging markets and a dodgy financial system in China and a slow start for IPOs.

M&A in the Financial Sector in the US

For the past 5 years, the financial services industry, especially in the US, but also across the world, has been transforming at a beautiful and fast pace: new competition from the tech industry (the rise of Fintech companies), an increasingly digitalised business environment based on Big Data Analysis and Cloud Technologies, a possible revolution of currency systems from the likes of Bitcoin and the rise of shadow-banks across the global markets are only a few of the elements that are blowing the wind of change over ‘traditional finance’.

The year of 2015 has seen the activity of M&A deals in the financial sector bounce up and down, peaking in the Q3 and then falling back to reality in Q4.

US Financial Sector M&A Activity 2015

(Sources: Mergermarket, Merrill Corporation and Deloitte)

However, the volume levels are paining a different picture: they have moderately increased and decreased, almost in line with the past 5 years. Some might read the picture as a suggestion that the financial services deals were overvalued. Nevertheless, we must look at the deals individually and their methods of settling transactions in order to draw such conclusions.

For 2016, Mergermarket forecasts strong M&A activity within the financial services sector across the United States. Most likely, as need for flexible credit will continue to persist through 2016 and the role of banks as financers becomes under fire by newcomers from the FinTech sector, smaller banks, who are facing increasing regulatory costs as well, are likely to be the acquired targets for the months to come.

M&A in the Technology Sector in the US

The technology industry is probably the most exciting one to view in terms of R&D development and company valuations. Acronyms such as IoT, AI, HFT and P2P are defining concepts and technologies that impact the global economy.

Robert Townsend, co-chair of Morrison & Foerster’s LLP global M&A practice group, stated that for 2016, he expects software companies and semiconductor producers to engage in M&A and tech investments during the year. I think that we all are to follow the development of the US technology sector, especially the digitalised side. For example, look at this almost unknown company, Humai, that conducts medical research based on AI algorithms to advance brain data uploads on a machine – as crazy at this may sound, this is a perfect example of how fast and forward-thinking the technology ‘guys’ are.

The M&A background in this sector is at least to say unconventional. Technology firms tend to be a bit unorthodox as they are well-known for pushing the boundaries of R&D and investing in moon-shots projects – think of Google (now called Alphabet) for example. Also, as they breach into more and more industries, to value them accordingly will be difficult. At the World Economic Forum, held in Davos in January 2016, the some of the world’s brightest and most influential minds considered very seriously the digital impact and the quality of innovation of technology as an incentive or hurdle for economic growth.

As the New Economy presented in their special report, Our Digital Planet, development in this sector has far-reaching implications across all areas of socio-economic dimensions of our society. Therefore, when putting a price on a tech company, one should not only value the capacity to make profit and upgrade or sustain that capacity for years to come but also account for qualitative factors more than one would do if one would analyse more conventional businesses, say oil producers, supermarket chains or hotels.

Early stage businesses are still a ‘hot’ target for technology behemoths and 2016 looks to move the chart lines even higher for M&A activity in this sector. Below is the US M&A activity and deal size for 2015.

US Tech M&A Activity 2015

(Sources: Mergermarket, Merrill Corporation and Deloitte)

M&A in the Energy Sector in the US

Finally, we take a look at the energy sector. It is no news that the oil prices are at historic lows and continue to scare investors and have put on hold many oil production projects. As the FT has reported on 14 February 2016, major oil companies, including Chevron, ExxonMobil and Royal Dutch Shell, have been putting the majority of their projects on hold. Morgan Stanley suggests that just nine large projects, out of 230, are deemed as realistic for approval during 2016.

Therefore, it is no surprise that 2015 was a year when M&A in the energy industry has gone downwards following the commodities’ prices. For example, the US and international crude began 2015 around $50 per barrel and ended to around $30 at the beginning of 2016, with a few dips under $30. Additionally, Iran is coming into the oil production and export markets. As a result, it is no surprise that the M&A activity has slowed.

US Energy M&A Activity 2015

(Sources: Mergermarket, Merrill Corporation and Deloitte)

However, Asian companies, despite the Chinese economic shenanigans, are still hungry for resources and look towards completing deals in the US and Canada. At this moment in the industry’s financial health, foreign investors and private equity houses are the most likely buyers of energy companies, as they look to profit from what is nothing but a business cycle that will, at some point, in the future re-bounce back and with it the M&A deals will be dragged up.

We have looked at the M&A activity in the US throughout 2015. As I see it, M&A deals are not as much a sign of economic performance as of business cycles – they reflect what the trends are and what are the ‘darlings’ in the eyes of investors. Take the data sceptically and look behind the columns of activity in order to see that the EV/EBITDA multiples and gain a historical perspective on the valuation of financial markets.

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