Alvarez and Marsal

Making M&A Great Again

http://pipeline.thedeal.com/article/13976632/index.dl

With Donald Trump now inaugurated as the 45th President of the United States, and the U.S. equity market’s reaction to the election results still generally positive, CEOs and transaction leaders are finding renewed confidence for deal-making.

They’re moving full steam ahead to capitalize on an encouraging landscape for mergers and acquisitions – one in which corporates remain flush with cash and the private equity market is still seeking to deploy a record amount of capital. They’re watching high levels of M&A activity in industries like technology and healthcare – action spurred by the ongoing forces of disruption as well as Trump’s promise to re-reform healthcare and loosen regulations, not to mention the needs of our country’s aging population. Corporates continuing to divest themselves of non-core assets will create many attractive targets in the market that will be fought over by the ever-growing number of private equity investors around the world. Even the energy space, where deal flow has recently slowed, has shown to be on the rebound with cash-rich players waiting for the right moment to jump in. This is all happening despite Trump’s indication that he would block certain deals deemed detrimental to competition and the consumer.

With these fundamentals, my read for 2017 is to buy growth now, based on four key reasons:

1: The Potential for U.S. GDP Growth

While the election results created plenty of uncertainty for the market, which would typically suppress deal activity, these forces are being offset by confidence-boosting plans of the Trump administration, which seeks to double gross domestic product growth from 2 to 4 percent – a welcome change after eight years of anemic growth. This focus on job creation, hiring/buying American and jumpstarting the economy have the potential to spur true, organic growth vs growth through M&A, as well as the rise of stock prices and overall management confidence. Still flush with cash, corporates will continue to transact, especially in a continued low interest rate environment where leverage is inexpensive by historical standards. When comparing the interest cost to borrow to the cost to do a deal (or the opportunity cost of using cash on hand to transact) to what the economic benefits are of buying a business, it doesn’t take much to make a deal work.

Despite some turbulence right before the inauguration, the dollar remains stronger relative to almost every other global currency, which will help drive up the price of our goods as those from other countries become less expensive here. Similarly, in an M&A environment, currency fluctuations can drive the direction of cross-border deal activity as the valuation of deals outside of the U.S. look more attractive to U.S. firms and vice versa. For example, in Brazil the value of the Real has dropped significantly over the last year, alongside valuations of businesses, all while interest in cross-border deals have heightened from all over the world, such as from Chinese entities which have demonstrated an almost insatiable desire to transaction in the global marketplace.

2: Interest Rates, Still at Historical Lows

While interest rates on debt to fund deal activity are inching up, they remain at historical lows so aren’t likely to soon dampen the M&A market. Further, it is anticipated that rates will remain low for some time, eventually rising but gradually and over an extended period of time as the Federal Reserve tries to avoid shocking the system. Only several years of small to moderate interest rate hikes will materially impact borrowing costs and deal activity – a time frame that is still on the horizon. Additionally, with mega deals of past years long gone, most activity is taking place in the upper middle market with less leverage being utilized in general. Further, dealmakers anticipating potential interest rate increases may show more willingness to execute in the short term.

When interest rates do reach a point where they start to impact M&A activity, asset valuations will adjust accordingly and the market will adapt to what will ultimately become the new normal. There is far too much capital to deploy – both on corporate balance sheets and in private equity – to slow deal activity as long as leverage is available.

3: A Potential Tax Law Overhaul

Dealmakers are under additional pressure to transact quickly as the market braces for the tax law changes Trump has signaled he’ll enact, particularly related to carried interest and personal income tax rates. Even mere hints of an increase on carried interest or the elimination of it altogether will create a flurry of M&A activity, just as we saw in late 2012, although ultimately no changes materialized.

On the flip side, if Trump signals that the personal income tax rate for individuals will decrease, private equity investors will be incentivized to wait and see if they can benefit from these changes by postponing M&A activity.

It wouldn’t be surprising to see investors start considering incorporating into purchase and sale agreements some type of provision for future refunds / payments based on any benefit or detriment arising from future tax law changes in order to get a deal done.

4: Less Regulation

 

Beyond driving M&A activity, Trump’s stated intentions to relax the regulatory environment will potentially stimulate significantly more initial public offering (IPO) activity, a more attractive option with less regulation. In particular, specialty pharmaceutical, biotech and device companies will benefit from such a change, which is likely to bring about improved valuations and related activity.

Beyond these key reasons, other economic factors, such as oil prices and the repatriation of U.S. corporate cash trapped overseas, will unquestionably impact the breadth and depth of deal activity in 2017. Although these are still somewhat volatile, signs are increasingly pointing toward favorable deal activity. Further, this market volatility will spur hedge fund trading activity and greater risk-taking in the financial markets as firms look to drive alpha.

Trump is by nature a dealmaker. Ultimately, I expect that the actions of his administration and a Republican-controlled government will favor M&A deal-making in the near future and over the next four years. For companies considering options and opportunities, now might very well be the very best time to act.

Paul Aversano is a Managing Director in Alvarez & Marsal’s Private Equity Services practice and the Global Practice Leader of the firm’s Transaction Advisory Group, and was named “Service Professional of The Year” in 2015 by The M&A Advisor. With over 20 years of experience, he specializes in buy-side and sell-side financial accounting, due diligence projects for complex public and private company transactions, as well as transactions in the capital markets.

 

SOURCE: ALM VANGUARD: TRANSACTIONS - ACQUISITIONS CONSULTING JUNE 2019 REPORT

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