We are in the second quarter of 2016 and deal data is now available through the end of the first quarter. In this report, we review our region’s most active industry sectors and give an outlook for the remainder of 2016.
M&A across All Industry Sectors and the Macro Drivers of M&A
The business mood in the Midwest, Oklahoma in particular, has improved in the last few months. There is a feeling of tempered optimism, with talk of volatility and a bumpy road ahead. Many are still concerned about the implications of Federal Reserve action in the upcoming months, as well as the stability/fragility of the energy markets and a divisive political climate in the run up to the November elections.
At ClearRidge, we have felt a strong pick up in deal activity across most business sectors in the last couple of months. Many business owners in our region, who had been sitting on the sidelines, are now getting prepared to test the market for deals (buying and selling). Despite a slow start to the year, we are as busy now as we have ever been. Our sense is that we have turned a corner in the Midwest, so long as we don’t have any surprises in the next few months (energy, interest rates, labor market). After a slower start, 2016 could end up being a really active year for M&A.
The U.S. GDP forecast for full year 2016 is 2.0% growth, down from 2.4% in 2015, but it may be stronger than that in our region for the second half of the year. Q1 growth was a weak 0.5%, but Q2 is forecast to post 2.0% growth and a strong second half for the U.S., with GDP growth forecast at 3.0% for the final 6 months of 2016.
Consumer spending accounts for approximately 70% of the U.S. economy. Credit card spending is increasing, jobs and wages have been picking up and housing is promising; all contributing indicators to a stronger consumer for the remainder of 2016.
Interest rates are predicted to rise only once this year from 0.5% to 0.75% (federal funds rate), either in July (after the Brexit vote) or December (outside of run-in to the Presidential race). At 0.5%, the Federal Reserve is still some way off its target “normal” rate of 3.0%. The forecast for 10-year treasuries at the end of 2016 is a 10-year yield of 2.1% compared to 1.7% now and a 30-year mortgage rate at 3.9%, up from 3.6%.
Job growth and wage growth were strong in the first quarter of 2016, then weaker in the last month or so with a dismal gain of only 38,000 jobs in May. For the rest of 2016, analysts predict job growth, somewhere around 150,000/month, rather than the 200,000 per month job gains of the last couple of years. Continued job growth is an encouraging sign for the U.S. economy. The headline U.S. unemployment number is down from 5% to 4.7% this month, albeit with many workers who have dropped out of the labor market altogether instead of finding jobs, so that number may not be as healthy as it appears on the surface.
Business spending is up slightly in 2016, but it is not helped by lower exports, due to weak international demand, a strong dollar and reduced capital investments in the energy sector. However, analysts predict a modest 4% gain in business spending in 2016, so overall still positive for the year.
Analysis by Sector
These 7 industries are also among the most active sectors that drive M&A Activity in our region:
- Construction and Engineering
- Energy: Oil and Gas
- Transportation, Logistics, Distribution
Deal volume declined in the first quarter of 2016 compared to Q4 2015. On a year-over-year basis, deal value and volume declined when compared to the first quarter of 2015.
Strong demand continues to drive Aerospace OEMs. Airbus had a backlog of approximately 6,700 aircraft (mostly single aisle airliners) at the end of Q1 2016 and Boeing also has a strong backlog. This drives demand from suppliers across the industry. There was one megadeal that fell through in Q1 2016 – Honeywell’s failed bid to acquire United Technologies Corporation. While this deal failed to go through, this highlights an overriding trend of consolidation and will likely flow through to many smaller transactions in 2016.
M&A activity decreased in the chemicals sector in the first quarter of 2016 compared to Q1 2015. However, deal value increased substantially year-over-year. The leap in deal value was largely attributable to a number of megadeals.
On a segment basis, the first quarter of 2016 was driven by the specialty chemicals segment, which accounted for half of the quarter’s overall deal volume, compared to Q4 2015.
As noted at the end of 2015, we expect to see strong deal activity in 2016. A lack of organic growth and lower R&D spending in the past few years should drive chemical companies to continue pursuing strategic growth initiatives. Increased deal activity should also result from several pending megadeals and we expect to see an increase in spin-offs and divestitures as companies continue to look for ways to increase efficiencies and improve future profitability. While there has been an uptick in recent oil prices, they remain relatively low, which should continue to help offset margin pressure in many chemical segments. As a result, this lower cost environment could continue to free up additional funds for M&A activity in various segments.
3. Construction and Engineering
Construction and Engineering have witnessed significant volatility over the past year, but there are several sub-sectors and markets that continue to enjoy high demand. Overall construction and engineering demand has fallen as the 2015 collapse of energy prices led virtually every energy company to reduce spending, and postpone or cancel any major capital projects. Broader commodity prices have also declined, and the mining industry has reduced its capital spending considerably.
That’s not to say that there are no bright spots for engineering and construction companies. In the U.S., construction starts were up about 15 percent in 2015 and are forecast to advance another 6 percent this year.
Deal activity improved in the E&C sector in the first quarter of 2016, as volume and value increased year-over-year for the first quarter. The annual deal activity grew in terms of volume; however, it decreased in terms of total value, driven by a substantial decline of 43 percent in megadeal value compared to the previous period. Average deal value also decreased.
On a segment basis, first-quarter 2016 activity was driven by construction and construction materials manufacturing, which jointly accounted for more than 60 percent of the overall deal volume.
Energy prices and global economic growth concerns may cause companies to pause during 2016. On a more positive note, however, new construction starts in the U.S. and GDP are still expected to grow, albeit at a slower rate than in 2015. Reduced costs and margin growth remain relevant considerations, driven by low energy prices. E&C M&A activity will likely increase through the rest of the year.
4. Energy: Oil and Gas
The first quarter of 2016 saw a mismatch between global oil supply and demand, which depressed commodity prices and constrained industry profits, in many cases triggering significant losses and even bankruptcies. WTI dropped well below $30 in the first weeks of 2016, but made a recovery by the end of the first quarter to just over $40 a barrel, approaching $50 today. Total domestic production has finally begun to drop and the supply-demand imbalance should improve in the coming year.
Consistently depressed commodity prices led to a surge in cost-cutting that defined the industry in 2015. The low price environment will continue to push energy companies to constrain capital expenditures by an expected 30% in 2016, with over $200 billion work of projects already postponed or canceled.
As long as natural gas prices remain at lower levels, natural gas will continue to replace oil and coal in electricity generation, due to significant cost and environmental advantages.
M&A activity in oil and gas held steady in early 2016, while deal value was down during the first quarter compared with the first quarter of 2015. There remains significant cash on the sidelines looking to acquire oil and gas assets, as well as the industries that serve the upstream markets, but there continues to be a mismatch in pricing between a seller’s expectations and market valuations. Through 2016 and beyond, there will undoubtedly be buying opportunities for acquirers looking to pick up stressed assets, as well as sellers looking to capitalize on a rebound in prices.
2016 and 2017 will likely see increased deal activity, in part through distressed deals and also from equity investors looking to pick up assets before prices rebound.
Midstream stays strong despite the dramatic fall in energy prices. Many midstream executives have been targeting M&A instead of pursuing organic growth opportunities. In the current price environment, executives instinctually focus on cost reduction. It may be difficult to draw back from the moment’s price fluctuations and look at the bigger picture, but long-term success depends on shifting course now and taking advantage of this opportunity to improve your strategic position for years to come.
Although medical cost trends are continuing to outpace inflation, advances in the healthcare industry focusing on value-based care have reduced the healthcare cost growth rate. The number of adults aged over 65 is growing, which teamed with the continued implementation of the Affordable Care Act’s penalty tax, has resulted in significant coverage expansion for customers with pre-existing conditions. This, in turn, has contributed to industry cost appreciation. However, an overall deflation in spending growth is indicative of industry trends that are aimed at propelling more affordable care. These factors continue to drive industry consolidation, shared efficiencies, innovation and cost reductions.
In recent trends, a PwC Health Research Institute consumer survey revealed recently that Americans are willing to travel further to receive care from a respectable or well-known care provider, enhancing the importance of branding for healthcare providers.
As the average age for the U.S. population continues to increase and awareness around health and wellness increase, there are significant opportunities for companies to address rising this consumer demand to combat the effects of aging and to maximize overall health. Acquisition efforts are also growing for nutrition companies that have established strong brand recognition, consumer awareness and niche products.
The continued expansion of M&A regulations in the industry may force a portion of deal activity away from traditional acquisitions to affiliations, partnerships and joint ventures. Regional and niche companies are becoming more common acquisition targets due to unique strengths that allow larger healthcare providers to deliver value-based care.
In the first quarter of 2016, the Healthcare Industry experienced slower growth than in Q4 2015. Acquisitions are now geared toward capitalizing on strengths and eliminating costs, which has continued to make healthcare IT companies attractive targets.
Market activity is abundant in the pharmaceutical sector, as many of these companies are seeking investments outside of traditional drug manufacturing. By acquiring companies that provide complementary products and services, pharmaceutical companies are able to diversify their revenue sources and bolster their portfolios and pipelines. Many of these acquisitions involve specialty drug research, allowing the buyers to more easily identify and implement new care solutions.
Q1 2016 saw an increase in the value of deals from the fourth quarter and the first quarter of 2015, but the overall number of deals declined over the same period. The higher value of deals was attributable to a number of megadeals in this sector, including Tyco – Johnson Controls megadeal.
The number of deals and value of deals are expected to increase in 2016 as the global economy and industrial manufacturing sector continues to improve.
Valuation expectations are depressed from highs in 2014 and 2015, encouraging significant strategic and financial interest in industrial manufacturing. Furthermore, expectations of tighter capital markets, with rising interest rates, are encouraging acquirers to act now. Synergies and access to new markets and technologies continue to be primary drivers for manufacturing deal activity.
7. Transportation, Logistics, Distribution
Deal activity declined in the Transportation and Logistics sector in Q1 2016, as both volume and value declined. However, deal value increased on a year-over-year basis.
Despite the slowing growth of the global economy, it does continue to grow, driving the need for continued transportation and logistics services. Rather than taking a long-term organic growth-driven strategy, a number of Transportation and Logistics companies continue to drive growth through strategic initiatives; M&A. While we saw a decline in deal value compared to the fourth-quarter 2015, it should be noted that the first quarter of 2016 was the second-most active on the basis of average transaction value in the last three years. Continued depressed energy prices drive lower costs in the sector, freeing up funds for capital expenditures, including acquisitions. In the current environment, Transportation and Logistics companies are also working to cope with competition pressures and growing investment demands. These two factors are expected to continue driving increased financial and strategic investments, at least in the near-term. We expect the deal environment to maintain momentum in the coming months.
ClearRidge Perspective for 2016
Pre-emptive company analysis and due diligence continues to be critical for any business selling for a premium price in 2016. Clients trust ClearRidge to deliver a confidential and discrete preparation and sale process, to remove obstacles to close a transaction and ensure only the best prospective buyers with the capital and commitment to close a transaction make it to the closing table.
The leading strategic buyers demand professionally prepared data and analysis by a selling company, earlier in their review of each acquisition opportunity, including deep transactional and financial analysis. Companies that are better prepared prior to the sale process have been rewarded with higher valuations, smoother due diligence and a quicker cycle to closing the transaction and getting paid.
How Can ClearRidge Help You Sell Your Business?
ClearRidge advises business owners and helps them to make better strategic decisions about the future of their company; to provide an outsourced team of industry-leading professionals. Leveraging decades of experience successfully completing complex merger and acquisition transactions, ClearRidge clients benefit from discrete, professional and effective representation in the sale of their private company, acquisition, restructuring or capital sourcing.
ClearRidge is a team of best-in-class, multidisciplinary professionals. Our advisory services are provided with a focus to maximize value for shareholders and ensure that the process is confidential, timely and professional. ClearRidge is among the most active investment banking firms in our region and has a diverse track record of success. For further information on our team, industry expertise and transactions history, please visit www.ClearRidgeCapital.com.
Sources: This report has been compiled from reports and research including federal data, independent analysis, Kiplinger, PricewaterhouseCoopers, Janes, Deloitte, Bain and Company, Oil and Gas 360, SDR Ventures, Baker Hughes and other sources cited in the text.
Note: Unless otherwise stated, all deal data is for the United States only. In the report, you will see that some of the deal data is for larger public companies. The most reliable and timely data tends to be for the larger companies in each industry; however, deal activity of largest corporations is also a good barometer for M&A activity among midsized companies in the same industry.