At a Glance
- Following a strong first quarter in which nearly 3,400 M&A transactions were consummated in the U.S. and Canada, preliminary data suggests transaction volume dipped in the second quarter. This begins a similar pattern to what transpired in 2017, but it does not appear to indicate any slowing in the broader M&A market.
- Equity market volatility subsided relative to the first quarter, as Federal Reserve actions have come as expected and underlying economic growth continues to appear strong with 78% of S&P 500 companies outperforming quarterly expectations.
- The outlook for the second half of 2018 is positive. While M&A transaction volume for the year may not reach 2017 levels, market fundamentals remain unchanged.
M&A volumes: A strong year continues
The M&A market environment remained steady throughout the second quarter of 2018, although preliminary observations indicate that M&A transaction volume in the U.S. and Canada dipped when compared to the first quarter.
However, Brent Spiller, a managing director in the Harris Williams Consumer Group, doesn’t believe the quarter-over-quarter volume drop indicates a trend. “We haven’t seen or experienced any signs of a slowdown. To the extent that quarterly volumes for the broader market are down, we suspect it is more of a timing dynamic versus a shifting tide. For example, growth companies may be waiting until mid-year to demonstrate their forward earnings base. From our perspective, all indicators point to a strong second half.”
With solid economic indicators, continued strong cash positions among public companies, private equity dry powder at peak levels, and robust investor confidence levels, Harris Williams anticipates another strong quarter of M&A activity. We take a closer look at these factors and their impact on M&A below.
North American M&A Volume1
Includes transactions with a target located in the U.S. or Canada | Source: Thompson Financial
Broad economic indicators: Investor confidence remains strong
Tariffs and trade wars are top discussion topics among executives. However, these and other geopolitical headlines do not appear to be significantly influencing investor decisions to date, as focus remains on the fundamentals. Indeed, equity market volatility subsided relative to the first quarter. Federal Reserve actions have come as expected, and underlying economic growth continues to appear strong. More than three-fourths of S&P 500 companies outperformed their quarterly expectations.
Looking forward, executives are keeping a watchful eye on trade war possibilities, but also thinking about labor availability. According to Frank Mountcastle, a managing director in the Harris Williams Transportation and Logistics Group, “Since we are essentially running at full employment, qualified labor is hard to come by in some industries. That can handicap growth and drive wage inflation in the future. It’s an issue we hear frequently about from our clients.”
U.S. capital markets: Abundant cash and capital to invest
S&P 500 aggregate cash positions (excluding financial companies) have hovered near $1.5 trillion over the past few years, which has led to increased scrutiny around balance sheet management and utilization. The pressure to supplement organic growth via acquisitions continues to be top of mind for boards and shareholders.
“With the tailwind of a strong economy and earnings environment, you would expect cash balances to rise,” notes Mountcastle.
“Strategic buyers are looking to deploy cash,” adds Drew Spitzer, a managing director in the Harris Williams Energy, Power and Infrastructure Group. “But it can be a challenge to deploy it at the rate they would like because the current environment is very competitive for high-quality assets.”
S&P 500 - Aggregate Corporate Cash Balances1
Excluding financial companies | Source: FactSet
While strategic buyers are in a robust cash position, North American and European private equity firms also possess record levels of dry powder, standing at approximately $850 billion of deployable capital to invest. These firms are demonstrating an eagerness to put capital to work, particularly in companies with a proven track record through economic cycles.
Spiller continues to see growth in both the number of private equity firms and the amount of funds they can raise. “There are long-standing funds and new groups popping up all the time,” he says. “I don’t see any slowdown in that trend. It’s very representative of what we see every day across the private equity universe.”
Mountcastle agrees: “Over time, private equity has shown very strong returns, and there are more investment dollars continuing to enter into this asset class as a result.”
However, Spiller notes the tension created by this dynamic. “With more money chasing fewer deals, there can be a tendency to reduce discipline, which can lower returns. There’s a threshold that investors need to maintain despite the pressure to invest.”
North American and European PE Capital
Deal multiples: A blip, not a trend
Healthy deal multiples for middle market companies reflect the competition to deploy capital within the asset class, and the overall strength of the M&A market. As debt multiples have remained largely constant over the past few years, investors continue to be willing to deploy significant equity toward opportunities with strong underlying growth rates.
While average purchase prices were down in aggregate quarter-over-quarter, there’s no indication of a concerning trend. “There’s averaging at play here, and many things can drive a shift in numbers on a quarterly basis,” says Mountcastle. “This does not signal the market is declining. Some pockets will outshine others, but the financing market is steady and valuations remain strong. At some point it may slow, but from all indications, the foreseeable future will feature double-digit EBITDA multiples.”
Spitzer adds, “The best of the best are still setting the market benchmarks within their sectors because of the fundamentals that are in place. Others may be hoping to take advantage of current valuation levels we’re seeing. Nonetheless, purchase prices remain solid.”
Average Purchase Price Breakdown by Sponsors
Deals less than $50 million of EBITDA | Source: Standard & Poor's
Harris Williams professionals are keeping a close watch on leading indicators of a market shift. At this time, our professionals see no signs of an imminent change. Business sentiment is positive. Strategic buyers and PE firms continue to have substantial capital to invest, and deal flow is healthy. Whether M&A volumes surpass or lag 2017 levels, market fundamentals remain strong, and 2018 promises to be another strong year for M&A.
Published August 2018
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