M&A market hottest in a decade

A boom in merger and acquisition (M&A) activity has often spelled trouble for global equity markets. It's taken as a sign that the good times are nearing an end. M&A cycles are getting shorter, and deal values plunged by over 80% following the past two market peaks in 2000 and 2007, according to research from management consultants BCG. Getting acquisitions to boost the bottom line is often difficult too.

With interest rates stuck at record lows and corporate cash reserves piling up after years of emergency balance sheet strengthening, the value of the global M&A market reached almost $2 trillion in 2014, as bosses looked to grow earnings in stagnating markets. Up 20% on the previous year and with momentum continuing into 2015, this is the hottest M&A market since 2005-2006, says BCG.

And deal-making has been broad, with activity across geographies and in the high-profile energy, media, health care, consumer goods and financial services industries. While many are smaller, bolt-on acquisitions to drive top-line growth, so-called megadeals - those valued at over $10 billion (£6.6 billion) - have become increasingly commonplace and contributed 14% ($262 billion) to the total value in 2014.

With an aggregate value of $1 trillion, North America was the HQ of M&A last year, with low interest rates and high corporate and private-equity cash reserves driving values 18% higher than the year before.

Megadeals also played their part in fuelling growth in Asia-Pacific, which saw the largest increase year-on-year. Also buoyed by China, deal values increased 50% to $330 billion. Transaction levels in Europe also reached levels not seen for years, as companies expanded geographical exposure. Activity did cool in Eastern Europe, however, partly due to the conflict in Ukraine.

There were, however, many high-profile deals that didn't make it, as unsuccessful bids reached their highest level since 1999. Three withdrawn offers - worth $300 billion - represented 15% of the year's total, according to BCG's research.

"The high failure rate may be rooted in the fact that megadeals are inherently more complex and difficult to complete than smaller transactions," explain the analysts. "Their size means they often reshape industry landscapes, which can engender both strong opposition from the target's management and greater scrutiny from regulatory authorities."

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Three global trends

Three key global trends have emerged from BCG's data: improving high-tech markets, companies adapting to the "new normal", and consolidation for innovation.

The high-tech sector boasted the most impressive increase in deal values and the largest deal premiums - some as high as 31%. Google completed 30 deals in 2014, while Daimler bought Intelligent Apps and RideScout, for example.

Companies have also been using industry consolidation to adapt to what industry commentators are warning could be the "new normal". Take the oil & gas sector: as companies scramble to operate with oil around $40-$70 per barrel (/bbl) compared to $100-$120/bbl, many are consolidating to grow exposure to more profitable operations and save cash. The big ones were the Halliburton-Baker Hughes, Repsol-Talisman Energy and Encana-Athlon Energy deals. Shell's acquisition of BG is still being worked out.

M&A is also stimulating innovation, as pharmaceutical majors try and create synergies for research and development. Look at the Roche-InterMune deal, AbbVie-Pfizer marriage and the Valeant-Salix tie-up.

"Deals such as these are often big, costly, and complex. But large players need products to feed their global sales networks, and their networks can better market established drugs than the sales networks of the smaller companies that develop the drugs. There is significant upside for the acquirer, despite high prices and premiums," explain the BCG analysts.

Momentum has continued into 2015, with the total deal value in the first six months of 2015 already 65% of the $2 trillion total deal value seen in 2014 (see chart). But can this continue?

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M&A: A smart strategy?

While rising EV/EBITDA multiples are closing in on 2007's record 13.7 times and acquisition price-tags are getting increasingly lofty, takeover premiums of 27.7% are still 4 percentage points below their 32% long-term average, according to BCG. Interest rates are still at rock-bottom, credit is easy to get hold of and buyers don't mind borrowing: all this points to the M&A bull market having further to go.

"Cash reserves remain at record highs, and public-company investors, like their private-equity counterparts, become impatient when money is not put to productive use," explain the analysts. "Companies are not raising dividends - both gross payouts and payout ratios have been flat or declining in recent years.

"Corporate capital expenditures, in both dollar terms and as a percentage of sales, have also plateaued. M&A is one of a few remaining strategic alternatives, especially for companies seeking growth."

And while this can be a "smart strategy" when markets' economic expansion looks limited, it doesn't come without its risks and requires meticulous planning, precise execution and a strong knowledge of the capital markets. There is also the body of research that questions how useful acquisitions are for bottom-line growth and value-creation for shareholders. Also remember that inflated M&A markets have sometimes preceded financial trouble in the past.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.