Long Bull Markets, Competition and a Chinese Buyer Comeback
Three Trends Baird's Global M&A team Is Tracking for 2018
By Chris McMahon, Head of Global M&A; David Silver, Head of European Investment Banking; and Lydia Xu, Head of China Investment Banking
Heading into 2018, the global M&A market faces a similar backdrop to last year. The economic environment and underlying market sentiments are positive, suggesting another year of strong M&A performance. Baird's Global Investment Banking team is particularly focused on a few trends that we believe will shape the M&A market in 2018.
What Cycle? Private Equity Ownership and an Elongated Bull Market
Those who've worked in or around M&A markets for more than the past few years know that cycles are familiar and seemingly inevitable. Historically, a typical M&A cycle involves three years of a bull run followed by a multiyear period of more subdued activity. Yet recent experience suggests otherwise.
In the U.S. and Europe, M&A activity has been robust and sustained. In the U.S., 2017 will be the fourth straight year with reported dollar value well above $1 trillion, after six years (2008–2013) with dollar value below $1 trillion. Average deal count has also been higher in 2014–2017 than in 2008–2013, with 2017's transaction total likely to be consistent with the 2014–2016 average. In Europe, reported dollar value in 2017 will be over $700 billion for the third consecutive year, following six years (2009–2014) of deal value below $600 billion. Deal count is up in the region, making YTD 2017 the most active period for European M&A since 2011.
The Brexit referendum vote in 2016 has not had a meaningful impact on M&A volumes. The lack of clarity in Brexit negotiations has thus far been offset by the strength of the M&A market. This could change toward the end of 2018 depending on the expected Brexit deal.
Fueling this unusually long bull M&A market is the large, continued growth in the number of private equity-owned companies. From 2011 to 2017, the number of PE-backed companies in the U.S. has grown by more than one-third, with meaningful growth every year, and now exceeds 7,000, compared to about 4,000 at the end of the last M&A cycle (2007). In Europe, the story is similar with the number of PE portfolio companies doubling over the last five years from approximately 2,000 to over 4,000. In addition, PE-backed companies represent a much larger presence in the M&A marketplace than at any previous time, as the number of publicly listed companies has fallen in recent years.
By their nature, PE-backed companies are much more likely to be involved in M&A activity than other types of companies. These companies fuel a steady stream of both targets and buyers as their PE owners seek liquidity for the former or build out platforms through acquisitions in the latter. Secondary and tertiary sales of portfolio companies have also become an increasingly common exit option for PE owners, and under new PE ownership, these companies continue to invest in organic and/or acquisition growth.
This trend is further supported by other market tailwinds such as strong PE fundraising in recent years and ample liquidity in the debt markets. And although elevated valuations and/or potential changes in the tax deductibility of interest could temper the activity, we see this fundamental change in the ownership model continuing to fuel strong M&A activity in the U.S. and Europe for 2018.
Strong Chinese Buyer Participation in Certain Sectors
After hitting record high levels in 2016, Chinese outbound M&A dropped significantly in 2017 as the Chinese government tightened its control on investments abroad. While not likely resuming to 2016 levels, Chinese outbound deal activity should rebound slightly in 2018.
In Baird's North American and European sell-side processes, we have actually witnessed higher Chinese buyer interest in 2017 than in 2016. Across both years, we have seen multiple Chinese potential buyers meaningfully participate at high valuation levels, resulting in transactions to Chinese strategic and private equity buyers in the consumer, education and travel sectors.
Recently published guidelines from the Chinese government establish what outbound investment will be encouraged and what will be restricted or prohibited. The details confirm that the Chinese government will support legitimate outbound M&A activities based on sound fundamentals and solid strategic logic. Indeed, Chinese buyers will be encouraged to pursue deals that help Chinese companies acquire technology, intellectual property, consumer brands and industry know-how that will help China move up the value chain, compete with Western multinationals and promote emerging consumer and service sectors.
The government's clarity provides assurance to Chinese buyers for whom the "go global" theme is critical for long-term growth. New regulations are expected to simplify administrative procedures and to provide more transparency and certainty in the approval process for Chinese companies investing overseas. We expect Chinese buyers to actively pursue targets, particularly in the encouraged sectors, and encounter easier paths to completing those outbound deals.
Red-Hot Buyer Competition
Driven by growing cash piles on corporate balance sheets and private equity dry powder, M&A processes have been increasingly competitive in recent years. Baird expects high valuation levels to continue in 2018 as both strategic buyers and PE firms compete for high-growth (GDP+), mid-market companies and defensive business models that can withstand the next economic downturn, whenever it may be.
Potential buyers are proactively identifying and targeting companies for their M&A pipeline, either positioning themselves to pre-empt a sale process or shut down a sale process before final round bids. Such buyers are completing due diligence upfront, taking a very high-touch approach to contract negotiations and reducing internal return rates to justify high valuations.
Very healthy EBITDA multiples will continue, particularly for those businesses that are taking advantage of secular growth themes; profitable, visible or recurring revenue streams; and inorganic growth opportunities.