2014 US deal activity will be steady, but a few companies may pursue bigger, bolder deals, says EY
New York, 9 December 2013
Technology, Life Sciences, Healthcare and Consumer Products Top Transformational Sectors to Watch
US executives are confident about 2014 deal activity, but increased volumes will rely on clear signs of an improving economy and political stability, according to EY Americas Transaction Advisory Services.
US M&A activity declined 9.2 percent in 2013, with 7,656 deals this year compared to 8,428 last year.1 Meanwhile, US deal values grew to $ 838.6 billion in 2013 from $685.2 billion in 2012, a 22.4% increase, due to a number of headline-grabbing mega-deals.2 Although there has been a drop in overall deal activity over the past twelve months, 41% of US executives expect to pursue an acquisition over the next year, compared with 23% a year ago, according to EY’s latest US Capital Confidence Barometer. Moreover, 51% of respondents are confident about the likelihood of closing acquisitions over the next year, up from 33% a year ago, and nearly half of the US executives surveyed are positive about the quality of acquisitions that will be available.3
“We didn’t see the uptick in deal volumes this year that we would have liked, but executives may have a reason to be optimistic about M&A activity for the next year. However, we are unlikely to see a huge surge in deal number as most CEOs remain hesitant to bet on M&A,” said Richard Jeanneret, Americas Vice Chair, Transaction Advisory Services for the EY organization. “In 2014 we may see a modest uptick in M&A if the improving economic sentiment continues, but the political uncertainty surrounding tax policy, the fiscal cliff, QE and healthcare reform has made executives risk averse and we don’t expect many CEOs to fire the M&A cannon.”
Sectors to watch for 2014 include those that are experiencing transformation. While they may not all see a surge in deals, technology, life sciences, healthcare and consumer products will be the sectors to keep tabs on next year as these industries rapidly evolve.
By nature, the technology industry is always innovating and changing. Technology remains one of the stronger sectors for M&A activity in terms of deal size, with deal values jumping to $98.1 billion in 2013 from $76.2 billion in 2012 - a 28.7% increase.4 However, the number of deals fell this year with 1,583 in 2013 compared to 1,886 in 2012, a 16% decrease.5 This downward trend may reverse next year. According to EY’s Technology Capital Confidence Barometer, 33% of tech companies plan to pursue an acquisition next year, up from 20% a year ago. 6
“A strong IPO market has increased equity valuations,” said Jeffrey Liu, US Technology Sector Leader for Ernst & Young Capital Advisors, LLC. “However, technology assets are still very desirable and scarce, meaning deals will continue to happen even at these higher valuations -investors will not let these assets go.”
2014 dealmaking will be driven by disruptions in smart mobility, cloud computing, social networking, big data analytics and accelerated technology adaptation. More specifically, activity will, in large part, come from marketing automation, machine to machine (M2M) deals, healthcare technology, and financial technology. With cloud and mobile computing expanding greatly, companies that have not made acquisitions to increase their capabilities in these areas may see their competitiveness decline and could therefore face pressure from shareholders.
“Corporate buyers will continue to realize over the coming quarters that they do not need to make fewer, but larger, deals in order to have a more meaningful impact on revenue and earnings growth,” continued Liu. “Private equity remains strong and we are seeing a comeback in cross-border M&A.”
Although the healthcare sector did not close out the year as well as in 2012, healthcare providers and payors continued to do deals to position their businesses for success in the unfolding healthcare reform environment. Healthcare was down in volumes: 353 in 2013 from 400 in 2012, an 11.9% decrease. Values in 2013 were $19.9 billion, down slightly from $26.5 billion in 2012, a 25.1% decrease.7 Deal activity that did occur was supported by continued confidence in the debt markets, which made healthcare financing attractive to issuers by historical standards in the areas of cost, structure and debt capacity.
Dramatic changes due to pricing pressure and a changing regulatory environment tied to the adoption of the Affordable Care Act are catalyzing the healthcare market. Moving forward, there will likely be an increase in activity as companies strengthen their value proposition by transacting for scale, convergence and to meet rolling milestones by the Affordable Care Act. Deal activity will tend toward the middle-market, and there may be increasing large scale M&A discussions as companies navigate the evolving landscape.
“As the Affordable Care Act comes into play, we anticipate an increase in convergence within the industry,” said Gregory Park, US Mergers & Acquisitions Healthcare Services Sector Leader, Ernst & Young Capital Advisors, LLC. “Subsectors within healthcare will come together in order to offer more value and to become more relevant to the patient across a longer continuum of care. Tangibly, this will be seen through mergers and acquisitions of varying sizes, such as among payers, hospitals, physicians and other providers so that players can continue to compete and capture more of the healthcare dollar.”
Also, there will continue to be increasing conversations between the healthcare sector and the biotech/life sciences sectors as part of the convergence that will be seen across the industry. And of note, companies that have not traditionally been in the healthcare space including traditional IT, defense, consumer products and media companies will now be entering to take advantage of opportunities brought about by rising consumerism in healthcare and its growing percentage of the GDP.
There were 346 life sciences deals in 2013, dropping from 2012’s 371 deals, decreasing 6.7%. However, 2013 deal value skyrocketed to $64.0 billion from $37.6 billion in 2012, a 70% increase.8
There continue to be a few mid-sized players in life sciences that will feel the pressure to consolidate to reach the critical mass of the majors. In addition, biotech IPO's hit an all-time high in 2013 and many of those companies will be on the radar of major pharma as those smaller companies hit milestones in 2014.
There are a few new product launches that will drive revenue in 2014 but most growth will have to come through acquisition. You will likely see a continued focus on collaboration between industry participants (payor-provider or pharma-provider) but that is unlikely to contribute meaningfully to near term revenue.
M&A activity in the life sciences space will continue to be fertile grounds for the next few years as companies determine long term strategies to address the Affordable Care Act. Major pharma pipelines are starting to rebuild with innovative products from internal and external sources. Payors and providers will no longer accept a slightly better product; innovation under the Affordable Care Act will mean producing products with demonstrable improvements in quality of life and life expectancy, which could drive M&A activity.
“Multi-billion dollar trades have occurred because innovation is and will continue to be the lifeblood of this industry,” said Ben Perkins, US Life Sciences Sector Leader for Ernst & Young Capital Advisors, LLC. “Research and development groups will return to the era of going where the science takes them and allowing internal programs to cross over into other disease areas. High quality assets are difficult to find and we will continue to see high-priced acquisitions and robust valuations for unique assets.”
Another trend to anticipate in the life sciences sector is increased divestitures and spinoffs. Big service providers and large life sciences companies (pharma and medtech) alike will divest and spin off business lines that are non-core or low-margin in order to be more nimble. All participants in the continuum of healthcare are streamlining the business to prepare for the changes happening now and the expectations of continued shifting regulatory landscapes. Specifically, med tech and pharma subsectors will see a tectonic shift in how drugs and devices are being reimbursed and each product will be more closely scrutinized to understand the price to value benefit.
There were 393 consumer products deals in 2013, down 5.9% from 418 in 2012. Meanwhile, deal value dropped 9% to $62.4 billion this year, from $68.6 billion in 20129. We expect this sector to have modest growth in deal volume in 2014 driven by global demographic changes, increasing buying power in emerging markets, the rapid rise of disruptive categories, private equity appetite for acquiring brands, and shareholder activism.
“In 2014, CEOs will continue to focus on organic growth and capital alignment; in addition, shareholder activism will also be top-of-mind as corporates are pressured to grow and deliver value.” said Steven Potter, US Consumer Products Leader for Ernst & Young Capital Advisors, LLC. “Valuations are more stable and companies want to do private deals that could spur some activity. However, there is a huge supply-demand imbalance in the consumer products sector right now with very few quality targets but significant cash available for investment. Given the cost cutting still going on within the sector, it is likely that 2014 will see smaller spinoffs as commodity prices go down and companies are forced to lower their prices.”
Global demographic changes such as the increasing population in Europe and a new generation of young adults that are adopting healthier lifestyle options are forcing consumer goods manufacturers to significantly increase the effectiveness of their product lifecycle management processes. This is resulting in acquisitions of niche and emerging markets brands and distributors, while divesting non-core brands. The pace, with which new brands are becoming category leaders, is driving companies to revise their capital allocation strategies in order to enable their business to take prudent risks in new categories and products.
The growing convergence between life sciences and consumer products companies in many product categories, and the convergence between retail and technology are creating new opportunities for companies to add shareholder value. In addition to convergence, the impact of new trade laws in Asia and Latin America may create a higher degree of vertical integration for consumer goods companies.
“For sustained M&A interest in this sector, stable valuation must hold. There could be potential overheating in the consumer products M&A market, especially in smaller deals, if the IPO market continues to improve. Private equity will continue to be a proven buyer base for consumer products assets in 2014 provided the current valuation ranges remain,” said Potter.
Private Equity IPO Window Opens
In 2013 Private equity (PE) experienced a strong year for fundraising in the US with committed capital increasing to $208.4 billion, a 39.7% increase over the prior year and the number of funds increasing 17.9% to 277 from 235 a year ago registering the largest tally since the financial crisis.10 Multiple PE firms raised upwards of $10 billion this year, which is a sign of optimism for future deal making. This increased dry powder should lead to increased deal activity, although this past year, the market has been challenged by a lack of attractive acquisition targets consistent with demand levels. Acquisition activity declined 19.7% to 664 deals from 827 in 2012 and exit activity declined 7.4% to 378 deals.11 The bright spot in PE activity in 2013 was the IPO market which provided a key source of exits this year. Thus far in 2013 there have been 222 IPOs, 92 of which were PE backed valued at $29.9 million.12 An impressive 41% of all US IPOs were from PE backed companies.13 Recent fundraising activities are the drivers for future M&A. Despite relatively robust levels of exit activity over the last two years, there remains a significant backlog of PE exits. The increased interest in IPOs is a positive development for PE exits; however, an uptick in corporate M&A will ultimately be required to fully liquidate the current PE portfolio.
“The outlook for private equity fund-raising remains strong and deal activity should increase in 2014 supported by strengthening economic fundamentals and readily available financing,” said Jeff Bunder, EY Global Private Equity Leader. “As pension funds and institutional investors continue to search for yield they are turning to PE as they allocate more dollars to alternatives. We are also seeing a new class of investors from overseas, namely wealthy families and sovereign wealth funds, many of which reside in emerging markets who are interested in investing in PE, attracted to the differentiated investing model. Additionally, public pensions in markets such as China, Peru and Mexico are increasingly investing in PE, a trend we expect to continue in the coming years. ”
PE firms continue to have significant amounts of dry powder. In fact, dry powder amounts are once again rising after several years of steady decline, the result of a robust fund-raising market and a limited number of new deals. Buyout firms currently have more than $396.6 billion in capital available to fund new deals, 12% more than they had at the end of last year.14 According to EY’s October Capital Confidence Barometer, 97% of PE firms that are raising new funds are targeting fund sizes that are the same size or larger than their current funds.
So what will M&A in 2014 Look Like Overall?
Cash and credit are readily available to support M&A and as we have said, the pieces are in place for M&A comeback, but the market is experiencing a prolonged trough in deal activity. While the return to merger mania may not be imminent, there are five key trends that will likely influence boardroom decisions in 2014 and shape corporate and capital strategy.
Return of some larger deals – Next year we will continue to see deal values increase as more companies are planning slightly larger deals. Twenty percent of US executives say they plan to pursue deals larger than US$500m, up from 12% six months ago.15
Companies orienting around the consumer – Across industries, including technology, healthcare and financial services, companies are striving for efficiency and to capture the wallet and as a result we are seeing companies transforming their business around the needs of the end-user to drive growth. In 2014, expect to see companies make strategic plays to drive growth from the consumer.
Increased focus on shareholder activism – Activist investors are making an increasing impact on the boardroom agenda, and we expect to see them have an even greater influence in 2014. CEOs and boards will be forced to respond and in a few cases we may see drastic changes.
Cross-sector convergence – We have already seen many companies make non-traditional acquisitions from healthcare-IT to FinTech and healthcare and defense combinations as companies work to grow the top-line. This trend will not go away next year, especially as mobility drives innovation across all sectors.
Relentless focus on growth – While the economy has certainly recovered since 2009, companies now need to grow rather than just survive. CEOs will push their companies to pursue both organic and inorganic growth. Over the next 12 months, 65% of US companies say growth is their primary focus. Continued operational efficiency and cost-control measures, as well as an improving global economy, have largely eliminated US executives’ concerns about stability and survival.
“Next year deal volume will likely remain consistent with 2013 levels but 2014 could be an exciting year for corporates as transformational changes sweep several industries and boardrooms and CEOs react to the now expected certainty of uncertainty and strive to grow their businesses,” concluded Jeanneret.
1 EY analysis based on Thomson Reuters and Dealogic as of November 30, 2013.
2 EY analysis based on Thomson Reuters and Dealogic as of November 30, 2013.
3 EY US Capital Confidence Barometer, October 2013.
4 EY analysis based on Thomson Reuters and Dealogic as of November 30, 2013.
5 EY analysis based on Thomson Reuters and Dealogic as of November 30, 2013.
6 EY US Capital Confidence Barometer, October 2013.
7 EY analysis based on Thomson Reuters and Dealogic as of November 30, 2013.
8 EY analysis based on Thomson Reuters and Dealogic as of November 30, 2013.
9 EY analysis based on Thomson Reuters and Dealogic as of November 30, 2013.
10 Dealogic as of November 30, 2013 compared to November 30, 2012.
11 Dealogic as of November 30, 2013 compared to November 30, 2012.
12 Dealogic as of November 30, 2013 compared to November 30, 2012.
13 Dealogic as of November 30, 2013 compared to November 30, 2012.
14 Dealogic as of November 30, 2013 compared to November 30, 2012.
15 EY US Capital Confidence Barometer, October 2013.
EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.
EY refers to the global organization and may refer to one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com.
Ernst & Young Capital Advisors, LLC is a member firm of Ernst & Young Global Limited and a member of FINRA. www.finra.org. Ernst & Young Capital Advisors, LLC provides sector-specific advice on M&A, capital markets and capital restructuring transactions.
This news release has been issued by Ernst & Young LLP, a member of the global EY organization that provides services to clients in the US.