This year’s headline-grabbing flow of M&A transactions is expected to remain strong through the rest of the year, according to a Deloitte poll conducted in May. Almost four in 10 respondents expect deal flow involving U.S. companies to increase, and nearly half say they do not believe the US dollar had peaked yet.
FEI Daily spoke with Kevan Flanigan, national managing director, Deloitte Corporate Finance LLC, about M&A trends and today’s transaction landscape.
FEI Daily: Can you describe what the survey indicated about M&A expectations for this year?
Kevan Flanigan: In early 2014, the macro trends were all encouraging, although we had bit of a pullback during the rough winter. Then as the calendar year ’14 progressed, things started getting progressively more heated in terms of both volume of M&A, and competition for deals. Underlying that was growing confidence that the economy was starting to get some legs to it and people were feeling better about their own prospects, and therefore, looking at inorganic growth more aggressively. And that trend has continued nearly unabated throughout ‘15 year to date.
Despite a pretty hectic and aggressive first-half following an increasingly strong ’14, people still feel strongly that we’re likely to see an increase in the back half of ’15.
We think that shows a couple things. One, folks are feeling better about their own prospects and they’re either sitting on stronger balance sheets or can acquire large amounts of capital. In addition, cash is plentiful and cheap by any historical measure, and that’s driving a lot of activity.
FEI Daily: Are you seeing more activity that’s strategic or financially driven?
Flanigan: It’s a bit of a perfect storm, in a good way. The liquidity that’s available, including both the amount of private equity overhang and cash on corporate balance sheets, is driving part of this activity. There is a lot of cheap money, and the U.S. is benefiting from concerns around global instability and is seen as a relative growth market. Even at a 2 to 2.5 percent GDP growth, which is not something you do back-flips over historically, the U.S. is considered a safe bet for a lot of domestic and foreign investors.
We’re also coming out of a long, painful recovery. Most corporations have done significant amounts of cost cutting, cleaning up their balance sheets and honing their growth strategies, and now they’re getting pressed by the analysts and their boards to accelerate their growth. And so, you’ve got the strategic view that says, “We’ve got access to cheap capital and/or a strong balance sheet. Let’s put some of our cash to work and grow the top line faster.” You also have financial engineering that’s driving M&A, and those two are competing for those same deals.
FEI Daily: Do you see any potential obstacles on the horizon?
Flanigan: There are some. Interest rates can’t stay this low forever, and I think we’re already well beyond what people had expected in terms low inflation and low interest rates. If there were meaningful upticks in inflationary pressure that led to aggressive rate increases, I think that could cause some jitters across the capital markets. And there is always the risk of a geo-political event that catches people by surprise and undermines confidence. Barring that, at least over the next couple of quarters, people seem to be pretty confident, both about their own prospects and the general safety and security of the US market.
FEI Daily: How much is private equity playing a role in this boom?
Flanigan: Private equity is an aggressive seller and buyer in this market. Private equity as an asset class has been around for a long time now, but in terms of the volume and share of overall M&A, it peaked with the debt-fueled binge in the ’06-’07 timeframe. And then they sat on a lot of those businesses and worked on improving them or restructuring them during the downturn. Private equity knows a good market, they’ve been a net seller for a period of time, and are also fundraising again after a period of fairly protracted, inward focus.
Generally, we still tell clients that when a motivated strategic and a motivated private equity buyer want the same asset, usually the strategic bidder will win. But the reality is that the line has blurred because private equity has been around so long now and has so many holdings, very often private equity is a strategic bidder, because they’ve got a platform company that’s looking at a deal, and has the same, or many of the same, strategic benefits that a corporate buyer would have — in addition to a deep-pocketed financial parent that’s sponsoring the deal.
FEI Daily: Geographically, are we seeing more cross-border interest in deals?
Flanigan: No question. As I said, there’s a flight to safety. We see a lot of activity from Europe, as well as Southeast Asia, and Japan in particular. China continues to be an active, or at least interested, party. And South America as well.
There have been two challenges for that. One has been the strong dollar. An active U.S. M&A market means not only are prices reasonably high by historical comparison, but when you adjust them into whatever currency the foreign buyer is leveraging, the prices look even more frothy. So, I think that’s had a little bit of a cooling effect. But the other, probably the more significant impact, has been the competitive nature of the domestic market, meaning that deals are moving pretty quickly.
In this market, bankers are able to run an aggressive sale process, and to shorten the timeframe between when initial bids are due, when letters of intent are due, and when final bids and closing is done. That tends to be a very difficult thing for foreign buyers to compete with. It’s one thing to get there on price, but it’s another thing to be as decisive and run as quickly as they need to for decision-making, and assertive as they need to be to win a competitive process.
FEI Daily: Similarly, are you seeing U.S. firms looking to buy overseas?
Flanigan: We are, and I think that’s the more interesting trend right now, with the stronger dollar. Many US corporates have cleaned up their strategy, their balance sheet, and are sitting on very strong cash positions. There are also healthy companies with cash trapped in foreign jurisdictions, where it would be expensive to try to repatriate it given current tax regimes. If you have cash trapped in a geography that you’d like to grow strategically, inorganic growth can be a pretty strong driver, especially when you’ve got a strong dollar that’s making some of these foreign opportunities look a little cheaper.
FEI Daily: Given the competition for deals, are sellers’ expectations about valuation realistic?
Flanigan: Sellers’ expectations tend to outpace the market even in a strong market. At the same time, I think educated sellers are smart enough to remember where their particular business was during the downturn. If they don’t remember, I’m sure if they have qualified advisors reminding them what things looked like in 2009, and I think that tends to create a little bit of a reality check.
Sellers are realizing, “Hey, we got several bids from motivated parties, often both financial and strategic. They’ve come in within this sort of range, let’s pick the group we think we’re most comfortable with and that best meets our objectives.”
FEI Daily: We’ve also seen a lot of announcements about spin-offs. What’s driving that?
Flanigan: Many of these spin-offs are driven by a refocusing around businesses that boards, executives and analysts believe can be better managed in more focused fashion. It’s either that a company has disparate businesses that are either hard to run together, or, frankly, that the market values very differently. We’re seeing a lot of that in technology, where there can be such a value differential between a faster-growing business that’s riding a hot wave, like cyber, cloud, or big data versus a legacy business that may be an absolute cash cow, but that’s a much slower-growth, mature business. It’s hard to run those together and get full credit by the market, and, frankly, to manage them both from a talent strategy and market awareness lens.
So, I think it’s a reflection of a good M&A market, and investor expectations that management teams will continue to drive yield and will continue to drive shareholder value. And I think it’s a trend that, while this strongly valued equity market continues, for the right situations, you’ll continue to see a desire to focus on the core businesses, separate the faster-growing businesses from some of the cash cows, and let management teams focus on those disparate businesses to drive shareholder value post-spin.
FEI Daily: How does today’s M&A environment affect CFOs and their career prospects?
Flanigan: The number of CFO slots of the largest companies tends to be very rarefied air, and as those large mega-mergers come together, those positions do tend to decrease. But I think that’s offset by very significant growth opportunities. They may be in private equity backed, rapidly consolidating businesses, or high-growth technology companies where CFOs can find significant opportunity to grow and develop, and maybe position themselves for a significant second act down the line.
My advice would be to continue to build your network very strategically. Things can happen very quickly in terms of deals coming together, as we’ve seen in this market. Keep your network fresh and current, such that you’re seeing opportunities and people are aware of you, so should there be an immediate change of circumstance such as your parent company merging away, you are well positioned to find another home quickly.•