Mergers and acquisitions (M&A) is on a multi-year run of unprecedented activity and currently shows no signs of slowing. The factors propelling this growth are myriad, but the main drivers include the continued strength of the equity markets and the broader economy, giving CEOs and boards the confidence to pursue M&A as a core component of their growth strategy. The decade-plus bull market has spurred record levels in M&A that may not be waning anytime soon.
Private equity (PE) has also been a meaningful participant in recent merger activity, benefiting from robust financing markets and a continued low interest rate environment. Since the 2008 financial crisis, the volume and number of PE transactions have grown at a compound annual growth rate (CAGR) of 20%, reaching $741 billion in total deal value, according to financial data provider PitchBook.
The popularity of PE as an asset class has also continued to grow among investors. As an example, in the past three years, more than $600 billion of capital has been invested into buyout funds, according to data compiled by PitchBook. Even with the increased deal volume, private equity funds have a record amount of “dry powder” or committed capital available to fund investments. That figure stands at more than $2 trillion across all fund types. Meanwhile, the number of U.S.-based, sponsor-backed companies has grown by 5.3% CAGR over the past decade.
Even with increased valuation multiples and some fear of a global economic slowdown, I predict that private equity deal activity will remain elevated as sponsors seek to deploy their capital and continue to generate returns for their investors.
One trend my team and I have observed is the increased focus by PE firms on platform investments, that is, investing in companies in one vertical as a starting point for add-on acquisitions in the same area. In fact, according to Pitchbook, add-on acquisitions have grown from 53% of all PE acquisitions in 2008 to 66% in 2018. This trend is driven by PE firms’ proclivity for buy-and-build strategies. This has also led to PE firms targeting companies that are more mature, a trend that PitchBook links directly to the substantial stockpile of dry powder that currently exists, as noted above. The median add-on size of $159.2 million was up more than 157% compared to 2017’s median of $61.9 million. This is largely because more firms are staying private longer, rather than going public.
When it comes to strategic M&A deals, these are primarily driven by two factors. One is the general economic outlook, and the other is how companies look to stimulate growth. One avenue is organic growth, but a big part is also through M&A. As part of their strategy, corporations are increasingly looking at acquisitions as a way to add capabilities and insulate themselves from disruptions to their business models, especially those coming from new technologies.
In fact, one of the primary drivers of these types of transactions is to acquire and integrate innovative new technology capabilities, according to Harvard Business Review. This can often be viewed as less expensive and more efficient than internal research and development efforts spent on technology innovation. Companies are also looking at such prospects as a shortcut to build distribution networks or gain a foothold in a new market, which can normally take years, the HBR notes.
What makes a good M&A deal?
It is my view that, at least over the short-to-medium term, the economy will remain strong, and M&A activity will continue to be robust. However, PE firms and companies don’t want to make deals just for the sake of it — they want deals that add significant value. But what makes a good M&A transaction?
For PE transactions, the main point to consider is this: What is the thesis for the investment, and is the proper team in place with the capability to execute on that thesis? Then, will the capital structure allow for the flexibility to weather any downturns? These contingencies must be planned for.
For strategic acquisitions, cultural fit and the ability to successfully integrate are often more important than just price when it comes to what determines a successful acquisition. Indeed, price often should be secondary to these matters.
Looking ahead, there are growing fears of a recession, or at least an economic downturn. Is the black cloud of a slowdown in the future? I would tend to disagree with that assessment. As I have said, at least in the near-term, I predict that the economy will be stable, and low interest rates will persist. I also see strong M&A activity remaining an important part of the arsenal of corporate growth strategies. This will continue to be the case in areas undergoing major change or disruption, such as telecom, pharma and media. In pharma, for example, established companies are wrestling with investing resources to develop new drugs themselves, versus acquiring up-and-coming drug makers. Trends such as this will continue to fuel further growth in M&A. It’s still a strong market for M&A, but the key for dealmakers will be to identify value and synergy in an ever-changing marketplace.
