With the U.S. election results behind us, private equity players are already looking ahead at how the merger and acquisition (M&A) landscape will shape up over the next four years and where to find the next big opportunity under President-elect Donald Trump.
Currently, corporates are flush with cash, while the private equity market is still seeking to deploy a record amount of capital overhang. In particular, there is significant activity in the healthcare industry, likely driven by Trump’s proposal to “repeal and replace” Obamacare, as well as general industry regulation and the aging American population. The technology industry is also active as it continues to permeate and disrupt more and more traditional businesses.
In the energy sector, while deal flow had slowed recently, oil prices may have hit bottom given the rebound we are beginning to see since the election. Many players in this sector have available cash and are waiting for the right moment to jump in. We will likely see a significant uptick in M&A activity in 2017.
I expect these fundamental dynamics, combined with a positive reaction to election results from the equity markets, will continue to drive M&A as CEOs and transaction leaders find renewed confidence for dealmaking.
As corporate America anticipates what the future M&A market will look like, my read for 2017 is to buy growth now, based on four key reasons detailed below.
1. Trump’s Plan to Double GDP Growth
Nothing rattles the market like uncertainty, which Trump’s election created plenty of. This environment would typically suppress deal activity, but I believe it will be offset by the incoming administration’s plans to focus on job creation and to hire and buy American. After lackluster or even anemic growth over the past eight years, Trump hopes to jumpstart the economy with the goal of doubling gross domestic product (GDP) growth from 2 to 4 percent.
If these results materialize, corporate America will start to experience real organic growth again, where historically it has been buying growth through M&A. Stock prices and management confidence will rise. Corporates that are still flush with cash will continue to transact, especially in a continued low interest rate environment where leverage is inexpensive. When comparing the interest cost to borrow to the cost to do a deal (or the opportunity cost of using cash on hand to transact) to what the economic benefits are of buying a business, it doesn’t take much to make a deal work.
Looking internationally, the dollar has been stronger relative to almost every other global currency since the election. This trend will cause our goods to become more expensive as goods from other countries become less expensive for the U.S. Similarly, in an M&A environment, currency fluctuations can drive the direction of activity as deals outside of the U.S. look more attractive to U.S. firms and vice versa. In Brazil, for example, the value of the Real has dropped significantly over the last year, while heightened cross-border deal interest has appeared from all over the world as valuations of businesses have dropped.
2. Record-Low Interest Rates Poised to Rise
Interest rates on debt to fund deal activity are still at record lows and will continue to be for some time, so I do not expect the M&A market to be immediately impacted. Further, rates will rise eventually but very gradually and over an extended period of time as the Federal Reserve tries to avoid shocking the system. It will take several years of small to moderate interest rate hikes to start materially impacting borrowing costs and deal activity. Additionally, the mega deals of past years are long gone, so most deal activity is taking place in the upper middle market and less leverage is being utilized in general.
Regardless, when interest rates do get to a point where they start to impact M&A activity, asset valuations will come down and the market will adapt to what will ultimately be the new normal as it has in the past. There is too much capital to deploy, both on corporate balance sheets and in private equity, to slow down deal activity as long as leverage is available, regardless of the price. Dealmakers are keeping this potential increase in mind and may execute deals in the short term while debt is still inexpensive.
3. Anticipated Tax Law Changes
The market is also bracing for tax law changes, particularly related to carried interest and personal income tax rates, causing many dealmakers to act now. Trump has signaled that he expects to enact a significant overhaul to the tax laws, and I predict that he will do so. If he hints at an increase in the tax rate on carried interest or the elimination of it altogether, there will be a flurry of M&A activity in order to get ahead of it. We saw this situation in the fourth quarter of 2012 under President Obama, although no changes were actually made.
Conversely, if there is a signal that Trump will lower the personal income tax rate for individuals, investors will wait to see if they can benefit from these changes by deferring M&A activity into the future.
I expect investors will now begin incorporating into purchase and sale agreements some type of provision for future refunds / payments based on any benefit or detriment arising from tax law changes related to the treatment of carried interest.
4. Loosening of the Regulatory Environment
I believe Trump’s stated intentions to relax the regulatory environment will not only drive M&A but also spur significantly more initial public offering (IPO) activity, which may become a more attractive option under less regulation. In particular, specialty pharmaceutical, biotech and device companies will benefit from this environment and as a result will see improved valuations and related activity.
However, don’t lose sight of the fact that Trump has also indicated that he would block certain deals that he deems detrimental to competition and the consumer.
In addition to these four key reasons, other economic factors, such as cheap oil and currency exchange rates, will certainly impact the breadth and depth of deal activity in 2017. Although these are still somewhat volatile, signs are pointing to favorable deal activity. This volatility will spur hedge fund trading activity and greater risk-taking in the financial markets as firms look to drive alpha.
President-elect Trump is by nature a dealmaker. Ultimately, I expect that the actions of his administration and a Republican-controlled government will favor M&A deal-making in the near future and over the next four years. For companies considering options and opportunities, now might very well be the time to act.
Paul Aversano is a managing director in Alvarez & Marsal’s private equity services practice, which provides PE firms and their portfolio companies with integrated financial accounting, tax, operational, industry and functional expertise across the investment lifecycle. Aversano is the global practice leader of the firm’s transaction advisory group.