Many of the factors that have underpinned recent M&A activity remain in place, but concerns are mounting.
Positive drivers of M&A, including the strength of the US economy, the availability of financing and the strategic imperative to consolidate or transform for many corporates have underpinned transactions.
However, concerns about the possibility of an economic slowdown, the US's deteriorating relations with China, and elevated valuations could, moving forward, all prove to be restraining forces on M&A.
Will the pace of M&A continue during the second half of 2019 and beyond? The answer will depend on a multiplicity of factors, but four are particularly significant.
1. Can the US defy the economic pessimists?
The yield curve for 10-year US Treasury bonds has been inverted for much of this year, meaning that investors expect lower interest rates in the future than today. In the last 60 years, an inversion of this kind has been followed by a recession in every case, except one.
A recession would clearly be difficult for the M&A market, dampening the enthusiasm of buyers and prompting a rush to exit among private equity firms, particularly those that bought at elevated valuations. The extent to which the US is able to dodge what the bond market appears to see as an almost inevitable downturn will therefore be crucial—though a recession could also create opportunities.
2. Will the Trump administration step back from trade wars?
President Trump's ongoing approach to trade negotiations with the Chinese—and the possibility of escalation in trade tensions with Mexico—are unnerving the M&A market. Without reassurance that solutions can be found to these disputes, strategic acquirers in the US will be reluctant to commit to transactions, whether domestic or cross-border. Inbound M&A will also suffer, as buyers of US assets fear increased scrutiny.
Any suggestion, meanwhile, that the President is prepared to take a step back from a protectionist agenda—and to do a deal with China—would give the M&A market the certainty that it craves, providing a boost to activity.
3. Will shareholders sanction more megadeals?
Deal volumes fell despite the rise in deal value, with megadeals in sectors such as healthcare and technology seemingly immune to the anxiety seen elsewhere in the M&A market. However, even these deals were given a much more hostile reception by shareholders than similar transactions a year ago. CEOs are finding it increasingly difficult to persuade the markets to back their acquisition strategies.
Shareholder skepticism about deals may persist or increase if anxiety about recession and protectionism continues.
Executives will become more reluctant to pursue deals in the knowledge that they may face a battle to secure the backing of their investors.
4. Can private equity find a way to invest record amounts of dry powder?
The record financial firepower that private equity firms currently have at their disposal could underpin a recovery in M&A activity—but only if firms can be persuaded to put this dry powder to work. While valuations remain at current elevated levels, the private equity sector will resist the pressure to spend its cash, particularly if the chance of a recession increases.
There will be new opportunities—expect to see more club deals and international acquisitions, for example—but having raised record funds, the private equity sector is wary of disappointing its investors.