There’s no doubt that 2015 was a banner year for mergers and acquisitions, as deal volumes hit record highs globally and nationally. For the first time, global M&A volume surpassed $5 trillion, up 37% from 2014, based on late-December figures from Dealogic. It was a particularly frenzied year for mega-deals, with 69 of them valued at more than $10 billion, accounting for 38% of global M&A volume.
Despite those heady figures, optimism for M&A appears to be waning. In the 2015 M&A outlook survey by Dykema Gossett, conducted in August and September, just 37% of the 147 respondents — CEOs, CFOs, other company officers, private equity professionals, investment bankers, commercial bankers, accountants, and lawyers across multiple industries — thought the market would strengthen this year, compared with 59% who had that expectation for 2015 a year earlier.
And, in the new survey, while 82% opined that the market would at least experience no significant pullback, that was down from 92% in the 2014 survey and 98% in the 2013 survey. At present the window for deals appears to remain open, but how long will that continue? The fading optimism suggests that would-be dealmakers might be best off jumping into the market sooner than later.
Other considerations that tend to suggest 2016 may be the right time to engage in M&A include rising interest rates, normalizing business valuations, international economic concerns, and aging business owners.
Rising Interest Rates
Survey respondents cited concern about interest rates as one of the top factors that could negatively impact global M&A this year, trailing only “a weaker economy.” On Dec. 16, a few months after the survey was conducted, the long-awaited rate hike occurred when the Federal Reserve raised rates by 0.25%.
At first glance, the rate hike may not appear to foretell a significant impact on the M&A market. There are several reasons for that. First, the hike was small, and rates remain historically low, even after the increase. Second, the Fed had telegraphed its intention to raise rates for some time, and the market expected the change. Finally, the Fed has made it relatively clear that it intends to pursue a strategy of gradual increases over the next couple of years.
On the other hand, that the Fed decided to implement a rate hike signals that the cost of credit is back on the rise. Just as easy access to capital has been a hallmark of the recent M&A boom, an increase in the cost of credit, however slight, may be taken as a signal that the deal window will begin to close and future opportunities to buy and sell will diminish. That suggests that deal-minded companies may want to consider pulling the trigger as soon as it’s practical.
Back in 2014, 47% of respondents to the Dykema survey had expected improving valuations to drive increased M&A activity in 2015. Compare that to the most recent survey, in which only 21% of respondents cited improving valuations as the top reason for an increase in activity in 2016.
These data points suggest that valuations for privately held companies have already peaked, and support the view held by many M&A professionals that the 2015 numbers are not sustainable and will normalize in 2016.
Respondents to the Dykema survey cited the U.S. economy as the second-most-important factor fueling current U.S. M&A activity. Those expecting a positive outlook for the economy dropped to 48%, down from 62% in the 2014 survey, and the percentage of respondents with a negative outlook was at its highest point since 2012. While the data shows that most respondents remain relatively optimistic, the downward trend suggests that now may be the time to get in on the action while the memory of a record-setting 2015 is still fresh.
On the global scale, respondents to the Dykema survey cited the economic decline in China and Asia generally as the second-most-significant factor in terms of potential impact on the global M&A market. In recent weeks, the slowdown in China has persisted and other economies are starting to feel the effects. Other negative factors that weigh on the global economy include growing security concerns in the Eurozone and the Middle East.
Aging Business Owners
Despite the drop in optimism about the U.S. M&A market as a whole, 72% of survey respondents expected an increase in M&A activity among privately held companies, although that was down from 82% in 2014. The top reasons cited for increased activity were concerns about aging business owners (31% of respondents) and that the window of opportunity for completing deals is closing (26 percent of respondents).
Over the next few years, many business owners who are part of the baby boomer generation will reach retirement age and could look to sell their businesses, according to various media reports. The resulting influx of quality M&A targets entering the market over the next several years is likely to increase competition for attracting buyers, driving down valuations. The longer a business owner waits to sell, the more likely that he or she will be in a crowded field of other business owners looking to make the same exit.
Engage in 2016
In light of the potential looming risks in the M&A market, 2016 may present a great opportunity for buyers and sellers to achieve their respective M&A goals. Market professionals and advisers indicate that they expect that the health care, technology, and energy sectors will see the most M&A activity in the coming year.
Health care continues to be a dynamic and growing industry, driven by cash-flush balance sheets and the push for regulatory compliance cost efficiencies. However, owners of businesses in that sector should pay particular attention to regulatory changes in 2016, as the uncertainty associated with an election year could cause dealmakers to be skittish.
In 2015, technology-sector M&A reached its highest level since the dot-com bubble, and the emergence of social media companies and other technology startups with potential for high value is expected to continue this trend into 2016.
Another industry ripe for increased M&A activity is the energy sector, where low oil prices are expected to drive bargain shopping. According to a survey last fall by Ernst & Young, 88% of energy-sector executives surveyed expected the oil and gas deal market to improve in 2016, and 59% expected their companies to close acquisitions in the next 12 months.
Finally, banking M&A may be on the rise. When responding to Bank Director’s 2016 Bank M&A Survey, 67% of participants said they believed their bank needed to grow significantly in order to compete in today’s marketplace, and more than half said planned to purchase a healthy bank in 2016.
The peak of M&A activity may have already passed, but working toward completing a deal in 2016 will allow business owners to take advantage of the conditions that drove 2015 to be the best year for M&A on record — and avoid many of the uncertainties associated with domestic and global conditions in the next few years.
John Pray III is an associate in the corporate finance group in the San Antonio office of Dykema Gossett. Jeff Gifford is co-leader of both the firm’s mergers and acquisitions subgroup and family business transition team.