By: James D. Rosener and Cagatay “Ty” Akkoyun, Pepper Hamilton LLP
The 19 percent increase in the dollar volume of deal activity during the first half of 2019 was the strongest six-month opening for U.S. dealmaking since 1980, according to data from Thomson Reuters. The US$1.1 trillion of completed transactions for U.S. targets reflects the rise in large deals that offset a significant decline (13 percent) in U.S. middle market transactions (up to $500 million), compared to the first half of 2018. In terms of number of deals, the decline in the U.S. middle market was sharper, with a total number of announced deals with U.S. mid-market targets of 4,977 in the first half of 2019, compared to a total of 6,471 in the first half of 2018 — a 23 percent decrease. Contributing to the decline was the government shutdown from December 22, 2018 to January 25, 2019, which caused delays in regulatory applications (antitrust, CFIUS or bank regulatory) and filing of registration or proxy statements.
The decline in U.S. middle market activity between the first half of 2018 and the first half 2019, follows a relatively stable period between 2017 and 2018, with transactions for U.S. middle market targets totaling US$175 billion during 2018, compared to US$174 billion for 2017. While it is too early to tell, it may be possible for the second half of 2019 to offset the decline in the first half.
In general, mega deals influenced the aggregate value of M&A activity significantly, and transactions below US$1 billion constituted only 28 percent and 22 percent of the aggregate value of M&A activity in 2017 and in 2018, respectively. But, in terms of deal number, transactions below US$1 billion accounted for 94 percent and 93 percent of the total number of transactions in 2017 and in 2018, respectively. While transaction multiples decreased slightly in 2018 relative to 2017, from 12.9x to 12.3x, they remained well above the 10-year median of 10.9x. The amount of uncalled capital of private equity funds portends a positive outlook for transactions, especially if dark clouds begin to form in the economic skies causing sellers to stop waiting for prices to continue to rise.
For M&A deals valued up to US$500 million in 2018, buyers were most active in the consumer discretionary sector (18 percent), followed by the industrials (14 percent), information technology (13 percent) and health care (13 percent) sectors, according to data from S&P Capital IQ. Due to the influence of large transactions, 2018 saw a slightly different breakdown for the general U.S. M&A market, with information technology as the leading sector. The first half of 2019 showed similar trends for the U.S. M&A middle market, but the portion of transactions in the health care sector among all middle market transactions grew to 18 percent.
Sponsor-backed U.S. M&A activity increased in 2018 but there is strong competition to deploy cash reserves among private equity firms due to the scarcity of quality assets. In addition, a potential trade war is concerning private equity investors.
Going forward, we can expect inbound investment, especially by Chinese buyers, to be impacted by growing scrutiny under the U.S. Foreign Investment Risk Review Modernization Act (FIRRMA), which took effect on August 13, 2018. It reformed and expanded the authority of CFIUS. Mandatory declarations to CFIUS are required for any investments in U.S. businesses related to critical technologies if the specific investment falls under the scope of the “covered transaction” definition under FIRRMA. Even noncontrolling investments may fall under the definition of a “covered transaction.” FIRMMA is expected to primarily affect Chinese inbound investment.
Overall, despite the estimates of recession in 2020 and possible fluctuations in the market, we expect a robust dealmaking for the U.S. M&A market.