This Year's Robust M&A Activity Will Likely Continue in 2020

This Year's Robust M&A Activity Will Likely Continue in 2020
By Brian Fahrney (December 20, 2019)

The long mergers and acquisitions boom that began after the financial
crisis roughly nine years ago continued in 2019, albeit at a slightly
moderated pace. After a gangbuster 2015 and very strong years in 2016,
2017 and 2018, a number of M&A practitioners braced for a down year in
2019.

However, based on initial data for activity levels for the first nine months
of the year and anecdotal information for the fourth quarter, it appears
2019 will go down as a reasonably active, though not record-setting, year
for M&A.
                                                                                   Brian Fahrney
In 2019 we saw very significant large-deal activity, particularly in the first half of the year.
Blockbuster deals included Raytheon Co.’s merger with United Technologies Corp., Bristol-
Myers Squibb Co.’s acquisition of Celgene Corp. ($74 billion), AbbVie Inc.’s deal
with Allergan PLC ($63 billion) and Occidental Petroleum Corp.’s topping bid for Anadarko
Petroleum Corp. ($38 billion), to name a few.

Due to the unusually high number of megadeals, overall deal activity in the U.S. measured
by value was only a bit below the prior four years. The number of deals was markedly
down, due in part to a slow third quarter. The numbers in Europe and Asia (excluding
Japan), measured by both value and number of deals was down markedly for the first six
months of the year. The last half of the year saw a bit of an uptick in European M&A
markets, while the metrics for Asia remained challenged.

While political uncertainties have been omnipresent in 2019 (see the impeachment of
President Trump, U.K. Brexit, trade wars, Hong Kong protests) and M&A decision makers
normally become conservative in turbulent times, these uncertainties were overcome by a
variety of positive factors.

Economic growth continued in the U..S, although at a moderately lower level than the prior
year. Other major economies either grew moderately or at least managed to avoid
recession. Interest rates remained low and credit markets, after experiencing a scare in the
final months of 2018, remained open and favorable to borrowers throughout 2019.

Cash piles available to private equity and corporate firms remained at all-time highs. Equity
markets continued to be robust, providing many companies across the globe with relatively
high valuations to use as acquisition currency. Tax reform, which took effect in the U.S. in
2018, may also have boosted activity levels, or at the very least helped create the favorable
macro climate that existed throughout much of 2019.

While many industries experienced relatively strong M&A activity levels in 2019, several
industries were particularly active. Health care, technology and industrial companies led the
way with large years. Within the health care space, pharmaceutical companies worldwide
inked over $300 billion in deals, led by (but not limited to) megadeals including the
BMS/Celgene deal announced in the first quarter of the year, continuing throughout the
year with deals like the combination of Pfizer’s off-patent branded drug business with Mylan
NV ($24.6 billion). The energy and financial services industries also had reasonably high
levels of activity in 2019 compared to the averages.

The presence of activist investors, once primarily a U.S. phenomenon, has continued to
grow and spread globally, which in turn has created more M&A opportunities. The proportion
of activist campaigns in the U.S. that had an M&A thesis was quite high in 2019 compared
to historical levels. These campaigns generated actual or potential M&A activity ranging
from a company sale (see Jana Partners LLC’ campaign against Bloomin’ Brands Inc.), to
break up (see D.E. Shaw Co.’s proposed breakup of Emerson Electric Co.) to selected spin-
offs (see Marathon Oil’ Corp.'s announced spin-off of its retail assets following a campaign
led by Elliott Management Corp.).

According to a recent report, U.S. funds have deployed approximately $82 billion in
European companies in which they seek change. A recent example is the proposed merger
of Just Eat plc and Takeaway.com NV to form a $10 billion food delivery company. The
transaction came in the wake of pressure from Cat Rock Capital Management LP, a U.S.-
based fund that took stakes in both companies and had initially pressed Just Eat to consider
a sale.

Technology also continued to drive M&A activity. Pure-play tech companies engaged in
meaningful M&A at high levels of activity, for example PayPal Holdings Inc.’s bid for Honey
Science Corp., Google Inc.’s proposed acquisition of Fitbit Inc. and Facebook Inc.'s bid for
CTRL-Labs. Fintech plays continued to be active, most notably in deals involving payment
companies such as Fidelity National’s acquisition of Worldpay Group plc and Fiserv Inc.’s
acquisition of First Data Corp.

As significant as M&A activity by pure tech companies, however, is the continued strong
interest by nontech companies — so called old economy companies — in pursuing tech
assets and businesses for a variety of strategic reasons. One key reason is obtaining new
access points with customers. PetSmart Inc.’s bid for Chewy.com represented one such deal
with this strategy in mind, as an established brick and mortar pet supply retailer got an
immediate presence in the fast-growing online direct to consumer pet products market.

Similarly, Prudential Financial Inc. acquired Assurance IQ Inc., presumably as a means of
quickly accessing a robust direct marketing channel to insurance consumers. Prudential also
obtained cutting edge data science and digital capabilities to enhance front-end application
processing across its other businesses.

Quickly acquiring key technologies to improve customer experience or to automate or
enhance business or manufacturing practices has been another key driver for old economy
businesses in seeking out tech M&A. Old-line automobile companies continue to invest in
technology and partner with tech companies to pursue the development of autonomous
vehicles, most recently evidenced by investments of Ford Motor Co. and Volkswagen AG in
stand-alone autonomous vehicle platform company Argo.

Megaretailer Walmart Inc. acquired natural language processor startup Aspectiva Ltd. to
enhance its online shopping experience. Iconic global food service retailer McDonald’s Corp.
acquired Dynamic Yield, a leader in personalization and decision logic technology for
incorporation into drive-through menu displays.

The importance of technology to old economy businesses is evident from the pervasiveness
of corporate venture capital activities. These are formal or informal internal funds or
earmarked investment assets that are deployed to invest in early stage ventures of strategic
interest to the parent company. Typically, the parent will devote full-time employees with
VC experience to the effort, sometimes with special compensation arrangements.

Generally, the goal is to use modest-dollar minority investments to forge relationships,
identify industry trends, gain market intelligence and (sometimes) to accompany equity
investments with commercial relationships that can benefit both the parent and the venture
company. These investments can also be an incubator for potential M&A, intellectual
property licensing or strategic partnership opportunities at a later stage in these companies’
development.

So, after a long string of years in which M&A activity has been strong, the question many
are asking is: Can this level of activity be sustained in 2020? Some positive factors suggest
it can, including:

Macroeconomic Conditions

At its December meeting, the U.S. Federal Reserve indicated it expected GDP growth for
2019 to finish at 2.2%, followed by 2.0% in 2020. The Fed also held interest rates steady at
current favorable levels and indicated that no action is likely in the next year. Consumer
confidence measures in December were higher than historic averages and at their highest
point since May of 2019. While the current environment is not necessarily a high growth one
by historical U.S. standards, it certainly is conducive to maintaining a reasonably vibrant
M&A market.

Availability of Cash; Strong Equity Markets

According to various sources, private equity firms globally had access to an estimated $2.5
trillion of cash in mid-2019. A study of 3,000 U.S. public companies (excluding financials) in
late 2018 indicated that they collectively held approximately $2.7 trillion in cash.

All major global stock indices appear to be on track to finish up through year end 2019
versus the beginning of the year. This includes the U.S., where the S&P 500 has had
multiple record closes in the month of December, as well as Europe, where the Stoxx
Europe 600 recently had its first record high in over four years. High cash levels and stock
prices for public companies should provide ample acquisition currency for acquirors as they
enter 2020.

Activists (and the Threat of Activism)

Activist funds have also amassed record levels of available cash. As has been demonstrated,
virtually every public company, even one that is large and high-performing, is susceptible to
a potential activist challenge. As mentioned, many activists are increasingly focusing more
of their efforts on generating M&A activity, be it a whole-company sale or more granular
strategic moves like spinoffs and divestitures.

Even at companies where no activism threat is present or threatened, boards and their
management and advisors increasingly are engaging in more rigorous self-analysis to
determine whether certain of their businesses and assets should be sold. Increasingly, there
appears to be a bias in these analyses in favor of streamlining businesses, as opposed to
creating or maintaining a conglomerate model.

Capital Allocation Trends

Strong cash generation, high share price valuations and potential cash infusions from
divestitures, coupled with a low growth environment, may result in many public companies

being encouraged by investors to pursue M&A or greater levels of research and
development and capital investment. While investors in recent years have emphasized
capital returns in the form of buybacks and dividends (and most companies have obliged),
there is anecdotal evidence that boards and management are receiving more investor
support for allocating higher levels of capital to M&A opportunities.

Deal Maker Sentiment

According to EY’s Global Capital Confidence Barometer, published in October, 52% of C-
suite decision makers expect to be active in pursuit of M&A in the next 12 months. This is
above historical averages and consistent with the higher levels seen in some of the more
active recent years.

Other recent surveys of deal makers and their advisers are consistent with this. Additionally,
anecdotal evidence about M&A investment banker pipelines (including pitch activity), a good
leading indicator of near term M&A activity, is favorable and supports the view of reasonably
robust M&A levels for 2020, at least in the early going.

Some of the headwinds present in 2019 are likely to continue into 2020. These include:

   •   High Valuations: As mentioned, many public company valuations are at historic or
       near-historic highs. Sale transactions in many sectors are being priced at historically
       high valuations, causing many acquirors, particularly in the private equity world, to
       be cautious in selecting acquisitions. Note that by some reports, valuations in Europe
       are not as high, leading some to predict Europe may be a more fertile environment
       for M&A in 2020 than some other geographies.

   •   Regulatory Constraints: Many countries, including the U.S., are making acquisitions
       more difficult and time-consuming to execute. It is estimated that acquisitions by
       Chinese buyers in the U.S. decreased by 90% from 2016 to 2019, principally due to
       a more rigorous CFIUS regime. Other countries have similarly stepped up
       enforcement of their legal regimes governing inbound investment. Moreover,
       antitrust enforcement has been active in many jurisdictions.

   •   Tariffs and Trade Limitations: While encouraging news arrived in December with a
       limited trade agreement between the U.S. and China and passage by Congress of the
       US-Mexico-Canada Agreement modifying the North American Free Trade Agreement,
       trade restrictions and protectionism likely will continue to put a damper on M&A
       activity. Many companies are modifying their supply chains and suspending certain
       cross-border investment as a result of the current environment and this posture is
       likely to continue in 2020 barring a major breakthrough or shift in policy.

An additional factor that may be relevant in the U.S. in 2020 is the presidential and
congressional elections in November. As the campaign progresses, early prospects for a
Trump win or a win by a moderate Democrat likely would have limited impact on M&A
markets in 2020. The prospect of a win by a more progressive Democrat could dampen

enthusiasm for M&A in 2020 (and potentially beyond), as would-be deal makers may wait to
calibrate the impact of new tax and regulatory policies on the overall economic climate.

Brian Fahrney is a partner and co-leader of the global M&A and private equity group
at Sidley Austin LLP.

The opinions expressed are those of the author(s) and do not necessarily reflect the views
of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This
article is for general information purposes and is not intended to be and should not be taken
as legal advice.