At a Glance
- Following a weaker second quarter for overall volume, in which just over 2,600 M&A transactions were completed in the U.S. and Canada, preliminary data suggests transaction volume increased modestly in the third quarter.
- Equity markets experienced a strong third quarter, as the majority of companies in the S&P 500 continue to outperform earnings expectations and GDP data remains robust.
- Despite significant equity market volatility at the beginning of the fourth quarter, the outlook for M&A remains positive heading into 2019.
M&A Volumes: Strong and Steady
The M&A market environment remained relatively unchanged throughout the third quarter of 2018, and preliminary observations indicate that M&A transaction volume in the U.S. and Canada increased slightly quarter over quarter (Figure 1).
Figure 1: North American M&A Volume Increased Slightly in Third Quarter
Source: Thomson Financial
Many transaction launches slated for late 2017 and early 2018 were delayed, as some shareholders waited for a vote on tax reform and for uncertainty surrounding trade policy to subside. This dynamic likely had a negative impact on both second- and third-quarter volume, which defied the broader momentum and characteristics of the current market.
Nonetheless, James Clark, a managing director in the Harris Williams Healthcare & Life Sciences Group, expects to see strong M&A volume well into 2019. “Across sectors it is a very active M&A environment. The M&A volume we are seeing is as strong as it has ever been in the past 20-plus years.”
Derek Lewis, a managing director in the Harris Williams Business Services Group, concurs. “After such a long period of growth, it’s natural for investors to wonder about a slowdown,” he notes. “Yet strong market fundamentals are still in place, and that’s unlikely to change in the near term.”
In particular, Lewis explains, economic indicators remain solid, cash positions among public companies continue to be strong, and private equity dry powder remains at peak levels, which all indicate another strong quarter of M&A activity. We take a closer look at these factors and their impact on M&A below.
Broad Economic Indicators: Economy Remains in Good Shape
In September, the Federal Open Market Committee once again raised the federal funds rate by a quarter of a percentage point. Many policymakers believe this third increase for the year places the fed funds rate close to, if not at, the “neutral” rate where monetary policy neither adds to nor subtracts from growth.
After hitting record highs in early September, U.S. stock market indices fell in October. Stock price volatility has also increased, although only to historically normal levels. Unemployment remains at all-time lows, and labor availability continues to be top of mind for executives.
While tariffs and global trade are top discussion topics, these and other geopolitical headlines do not appear to be significantly influencing investor or business decisions to date. In fact, according to the PNC Economic Outlook, a semiannual telephone survey of small- and middle-market business owners and executives, four out of 10 business leaders described their outlook for the national economy as optimistic, the second-highest rating in the 15-year survey.
“There is certainly some turbulence in the public markets caused by rising interest rates and geopolitical and global trade uncertainty,” says Michael Wilkins, a managing director in Harris Williams’ Technology, Media & Telecom Group. “The economy is inherently cyclical and that means there may be a downturn at some point. However, based on the data we have now, the economy is very solid, as is the strength of the M&A market.”
U.S. Capital Markets: Abundance of Deployable Capital
S&P 500 aggregate cash positions (excluding financial companies) have hovered near $1.5 trillion over the past few years (Figure 2). As such, the pressure to supplement organic growth via acquisitions continues to be top-of-mind for boards and shareholders.
Figure 2: Cash Positions Hovering Near $1.5 Trillion
S&P 500 – Aggregate Corporate Cash Balances1
($ in billions)
Excluding financial companies.
Likewise, as shown in Figure 3, North American and European private equity firms possess record levels of dry powder, standing at approximately $850 billion of deployable capital to invest.
Figure 3: Private Equity Overhang at Record Levels
North American and European PE Capital
($ in billions)
Both strategic buyers and private equity investors continue to demonstrate an eagerness to put that capital to work, particularly in companies with a proven track record through economic cycles. Wilkins sees some changes in how sponsors are approaching deals, given the unprecedented amount of capital in the market. “In order to compete more effectively, many sponsors are looking for new angles, such as working closely with highly qualified operating partners to bring ideas they may not have thought of on their own.”
Clark sees strong competition as well. “Sponsors want to put their money to work, and they need to find high-quality companies and good management teams to do so,” he says. “When they find an asset they like, they are investing early in the process to best position themselves to win. We are seeing faster diligence and a frontloading of effort—particularly when multiple firms like an asset.”
Clark has also seen some investors exploring sale options sooner than originally planned. “With transactions trading at such high multiples,” he explains, “some business owners who may have been positioning to sell in the next couple of years are getting ready now.”
While the current strength of the market is spurring plenty of buying and selling, prospects are good for the longer term as well, says Lewis: “Forward-looking investors aren’t worrying about a 12- to 18-month recession, and are not timing their investments out of fear for what might happen in the macro economic environment in the short term. They have a multi-year horizon.”
Record-high levels of available capital paired with healthy multiples are sustaining a very active deal environment, with both buyers and sellers actively looking to transact. And while short-term market dynamics may accelerate some deals, solid fundamentals provide the groundwork for a promising long-term environment as well. Overall, the M&A marketplace is poised for a strong finish to 2018.
Published November 2018
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