Could deal-making log another record run? Morgan Stanley bankers see opportunities for strength in international M&A and mergers of equals among mid-sized companies.
Companies around the world grappled with plenty of macroeconomic uncertainties in 2019, including a U.S. government shutdown that essentially paused certain financing markets, concerns about U.S. interest rates, U.S.-China trade tensions and Brexit. Yet, by the end of the year, total annual M&A volume had exceeded $3 trillion for a sixth year in a row (Morgan Stanley advised on more than $1 trillion of announced transactions).1 The strength of megadeals continued in 2019, with 39 transactions exceeding $10 billion in value and 18 surpassing $20 billion,2 with some of the biggest activity in the technology and healthcare sectors.
What’s in store for 2020? Despite a slow start and potential headwinds including the U.S. presidential election, several crucial trends are likely to fuel M&A momentum this year. Debt and equity markets are still supportive of deal-making, there are more opportunities for cross-border activity, particularly in Europe, and there’s increased appetite among mid-capitalization corporations to scale up and compete with larger competitors.
Uncertainty related to the coronavirus and its toll on global markets could slow down M&A activity as companies assess the overall impact. With that said, positive factors that have driven the market for the last several years are still in place, according to Rob Kindler, Global Head of M&A at Morgan Stanley.
“Companies need to deploy capital and drive growth, and M&A is an effective way to do that,” Kindler says.
Morgan Stanley bankers anticipate a robust 2020 M&A market, characterized by these four trends:
Many companies continue to seek benefits of scale. They realize that not acting on strategic acquisitions can mean they run the risk of being left behind competitively.
U.S. presidential election years historically portend a sluggish M&A market—but 2020 may be different. High CEO confidence, low interest rates across the globe and ample availability of capital may outweigh policy uncertainty. Indeed, many companies have better visibility into earnings and cash flow than they did a year ago, when a U.S. government shutdown and recession fears were top of mind.
“Many companies continue to seek benefits of scale to drive growth and effectively compete in their core markets,” says Tom Miles, Co-Head of Americas M&A for Morgan Stanley. “They realize that not acting on strategic acquisitions can mean they run the risk of being left behind competitively.”
This year, Morgan Stanley expects strong transaction activity across most sectors. In healthcare, pharmaceutical companies still see M&A as a key driver of topline growth and market share expansion, which was the case in 2019—for example, Bristol-Myers Squibb’s $93 billion acquisition of Celgene and AbbVie’s pending $84 billion acquisition of Allergan3 (Morgan Stanley advised on both transactions). Other sectors where bankers expect significant activity in 2020 include technology, industrials and financial services.
Despite high equity market valuations, private equity firms are likely to be a bigger driver of global deal volume in 2020. Looking to deploy record amounts of equity capital—some put this dry powder at more than $1.5 trillion4—financial sponsors are searching for sizable investments across virtually all sectors and geographies. Meanwhile, debt markets remain strong and supportive of private equity deals, from middle-market transactions to megadeals.
Private equity activity remains a steady share of M&A volumes, despite an overall decline last year from record 2018 levels—financial sponsors accounted for approximately 21% of global M&A volume in 2019, essentially on par with 2018.5
“As private equity firms continue to deploy capital in strategic and innovative ways, we expect them to remain competitive with traditional corporate buyers,” says Bill Sanders, Global Head of Financial Sponsors at Morgan Stanley. “The buyer universe for M&A targets continues to expand, it’s not just traditional private equity—competition is being driven by family offices, sovereign wealth funds, infrastructure funds and other pockets of capital, with high levels of capitalization and a desire to put money to work.”
Larger, well capitalized European corporates are in search of growth through potential acquisitions, while U.S. and Asian companies are poised to create additional inbound activity.
The market for international M&A deals, which slowed in 2019, is poised to improve this year, amid growing certainty in the wake of Brexit and the signing of a Phase 1 trade agreement between the U.S. and China. In 2019, 16 of the top 20 largest M&A transactions involved only U.S. companies, which helped account for the 26% decrease in overall cross-border volume year over year.6 This trend is likely to reverse, with cross-border transactions comprising a higher percentage of overall volume in 2020.
Morgan Stanley expects U.S. and Asian companies to capitalize on their currency strength and relatively higher valuation levels to become active buyers in Europe. In turn, European companies are motivated to consider combinations to compete with their global counterparts, who continue to grow through acquisitions.
“We see an opportunity for a meaningful rebound in U.K. activity with Brexit tail risk now removed,” says Colm Donlon, Head of M&A for Europe, the Middle East and Africa at Morgan Stanley. “Larger, well capitalized European corporates are in search of growth through potential acquisitions, while U.S. and Asian companies are poised to create additional inbound activity.” Bankers expect to see additional outbound activity from Japan, with tempered expectations of outbound investment from China.
With stock valuations hovering at historic highs, companies are incentivized to use their shares as currency in transactions for similarly valued peers. In addition, mid-sized companies, with market capitalizations under $10 billion, may seek value through greater scale by merging with similar-size corporations.
“In this relatively high valuation environment, it’s logical that two companies would want to combine in all-stock transactions at no, or low, premiums,” according to Brian Healy, Co-Head of Americas M&A for Morgan Stanley. “The shareholders from each side can benefit from the value of combination synergies, such as redundant cost reduction, and can gain greater scale to better compete with much larger rivals.”
Stock-for-stock mergers, where shares of one company are traded for another, may offer mid-sized companies certain advantages, such as avoiding the kind of balance-sheet expansion sometimes seen in cash-heavy mergers. One recent example is the all-stock merger between Harris Corp. and L3 Technologies completed in June, for which Morgan Stanley acted as an advisor. Given high valuation levels and positive investor reception to these transactions, Morgan Stanley sees another strong year for all-stock transactions in 2020.
While macroeconomic uncertainties exist, Morgan Stanley bankers see the long-running strength in M&A activity continuing this year, driven by a strong U.S. economy, an eventual reduction in geopolitical uncertainty, low interest rates and financially compelling opportunities in the U.S. and internationally.
“The basic view is that the M&A market should power through the U.S. election,” Miles says. “While there may be a slowdown as companies assess various outcomes, in most scenarios, the market should continue to be active.”