We’ll be issuing a list of top ten themes for 2016 at the start of January. M&A is sure to feature and this week’s blog has a sneak preview in honour of a significant milestone and the return of a ‘mega-deal’ mooted in the last boom. There’s no reason to think that the deal carriage will turn into a pumpkin and the horses driving it into mice when the clock chimes midnight on 31 December. Companies will be doing deals in 2016 for the same reasons as they did in 2015 – to fight slower growth, embrace new trends and adjust their portfolio to new areas of growth. But, it’s a good time to think about what changes we can expect in the next year, in particular what recent activity means for the type of deals coming to market and how companies might need to adapt to the changing capital environment.
More than 2007….
By the end of November, global deal values in 2015 had surpassed the previous record set in 2007 – excluding real estate asset acquisitions. Including all deal types, deal values in 2015 were less than 1% off 2007. I think we’re safe in calling this a record year.
Deal making in November in many ways epitomised the rest of 2015. We saw a wide-range of deals across all sectors and value ranges and a wide variety of deal techniques. Companies are still looking for ways to boost revenue and gain market share in slow growth environment and to do deals that help them fight – or indeed embrace – disruptive forces.
UK deal values also reached their highest level since 2007, with strong inbound activity again highlighting the continued attractiveness of UK based companies to acquirers seeking global reach and access to Europe. The UK’s outbound focus is on high quality assets in America, China and Europe.
….not like 2007….
Accommodating capital markets and supportive shareholders helped to create almost the perfect environment for deals in 2015. In mid-2015, BB rated debt indices were trading at around 3% – about the same as the equivalent ‘A’ in 2011. A faster rate of deal making than 2007 AND debt almost half the price…why aren’t we raising a red flag? Because most major deals have provided good rationales and the average EBITDA multiple is around 7x in 2015, compared with 10x in 2007. There are always hiccups in M&A; but we don’t see as many of the fanciful type of match-ups at sky-high multiples we saw last time. No names, no pack drill….
Where we could place a yellow flag is in more speculative areas of the debt market. There has been a significant shift in the balance of power from lenders to borrowers in recent years. European investors seeking scarce yield – and facing more competition from the US and bond markets – have edged along the risk curve and nothing epitomises this more than the rise of ‘cov-lite’. According to S&P Capital IQ, there were no so-called ‘cov-lite’ loans in Europe in 2011, but they comprised 45% of all institutional loans in 2015. According to Moody’s, for the first nine months of 2015, the overall European covenant quality score has fallen from moderate protection to weak.
In the last crisis, companies with looser covenants were in a better position to reorganise due to the flexibility this accorded. But, the absolute explosion of liquidity that accompanied the advent of QE makes the last time around a very special case in this regard. Companies might not find markets so accommodating next time and investors will have less power to intervene.
We’re by no means calling another financial crisis for 2016, but – as we’ve been saying all year – high yield debt is our canary in the coal mine and it’s started to look more sickly of late. High yield mutual bond funds have just reported a week of $3.5b of net outflows. This might be influenced by year-end adjustments, but there are other signs of HY jitters. Defaults are rising (not just in oil & gas), the closure of the Third Avenue HY Funds is a worrying echo and the likely Fed hike changes the rules of the game for the mass of debt taken out in this boom. As UBS recently noted: “the post-crisis theme of HY companies issuing or refinancing debt at lower and lower interest rates has almost certainly ended”. The bond yield chart above also shows the recent slow upward creep of yields in anticipation of this change.
Subtle changes in 2016
We’re clearly not talking about a 2008-type bust to follow a 2007-type boom and it might not feel much different in investment grade borrowing – barring a significant shock or contagion, But it certainly will be less accommodating for more speculative debt issuers at least. Equity markets too will feel the effects of US tightening and global uncertainties – with it seems only moderate ECB loosening to soften the blow. From here it looks like 2016 could be choppy. This might make funding more problematical for some companies. Funds for deals won’t dry up entirely, given that there is still a c.$10t war chest available for deals, independent of these markets. Non-financial companies in the S&P Global BMI index are currently holding over US$5.4t in cash and equivalents. PE funds have around US$1.2t of dry-powder for investment – half of that at leverage of 4-5x would create US$3t-US$3.6t of deals. There is also US$2t in trapped cash held by US companies overseas.
The question is then is whether companies feel confident and driven enough to spend? Again, we expect subtle, but not necessarily radical changes in behaviour – barring significant shocks. Record deal levels in 2015 have been inspired by a delicate balance between change and confidence. There has been enough challenge in the market to inspire and drive M&A activity, but not so much that it deters spending. In 2016, companies will have broadly the same growth and sector incentives to do deals as they had in 2015 – with further opportunities in diverging monetary policies. Deals should only come to a halt in extremis with a real shock to the system; but rising geopolitical uncertainties could still make some companies and stakeholders think twice. The potential for a UK exit from the EU isn’t a well-known issue outside of Europe, but it might start to affect deal decisions as the vote approaches – probably in late 2016 to early 2017.
We may also see a slightly different mix of deals, although again we’re not entirely calling a radical halt to the ‘mega deal’. Perhaps we won’t see the like of 2015 again – but there is still potential for further significant match-ups in the year ahead. There are still 900 non-financial services companies with a market cap greater than US$10b and over 6,000 greater than US$1b. Add in private and state-owned enterprises (SOEs) and there is ample supply for such deals to continue next year. Again it comes down to conditions and appetite – and the regulators.
If ‘mega-deals’ do fall away, the coming together of so many global giants in 2015 will have consequences that should still drive deal volumes in 2016. We expect a series of subsidiary transactions, as acquirers seek to divest assets to meet regulatory or antitrust concerns or just to reorganise their new portfolio. These deals in themselves could be pretty ‘mega’ as with the disposal of MillerCoors by AB Inbev/SABMiller for US$12b. A $130b Dow Chemical – Du Pont tie up will be the starting point for a break-up into three separate companies.It will probably be a bit of a slower year in 2016 – but it’ll be by no means slow!
Top 10 Deals in 2015 (To 1 December 2015)
|Royal Dutch Shell||BG Group||$70b|
|Charter Communications||Time Warner Cable||$57b|
|HJ Heinz||Kraft Foods||$54b|
|Teva Pharmaceutical||Allergan(Generic Drugs)||$41b|
|Cheung Kong||Hutchinson Whampoa (50%)||$36b|