In my last article, I reported on the record high level of activity in mergers and acquisitions in 2015, focusing on deals valued at $50 million or more. That activity was a function of low interest rates, economic stability, a stronger stock market and balance sheets, demographics and overall growth acquisition strategies. We are seeing some of the same factors in early 2016 as well.
In general, the outlook for the year looks strong and companies are on a mission to grow. Many industries are incorporating M&A into their strategy as a growth vehicle, particularly in those industries where disruption is a good thing.
The key drivers for this positive outlook in M&A growth are an environment of prolonged low interest rates and low inflation. These key economic factors are causing many industries to continue consolidating, which serves to reduce excess capacity and increase profitability, which results from economies of scale and scope.
Since 2008 and the Great Recession, we have been in a period of slow economic growth, low inflation, minimal wage growth and overcapacity. While last year saw improvements in the economy, a strong stock market and better corporate balance sheets, corporations are still struggling to grow their top lines and many have improved by becoming more efficient, thus improving their bottom line.
While periods of a growing and robust economy are reflected in an increase in inflation — prices of goods and services rise with time — during times of low or no inflation, the economy is flat and interest rates tend to stay low. Low rates, while bad for investors, are good for those who wish to borrow money, which circles us back to why M&A grows.
Acquisitions become a good alternative to organic growth, particularly when financing is inexpensive. With cheaper financing, due to low rates and low inflation, M&A is expected to continue to grow, and with some buyers — private equity groups — demand has even become pent up. There is more than $1 trillion in “dry powder,” money ready, willing and eager to be put to work, by private equity managers who are required to buy privately held firms with growth potential in order to generate return on investment promised to their investors.
On the sell side, you have similar growth issues driven by low rates and low inflation, and sellers are interested in the strategic partnership offered by a larger acquirer. They are finding similar interest in inorganic growth by seeking to be acquired, which offers access to additional resources and other growth potential.
In addition, demographics play a part in M&A deals. With baby boomers looking to retire, there is more demand on the sell side as well.
Depending on the industry, one can draw additional conclusions which all point toward additional growth in deals. Acquisitions have been motivated by add-ons to existing portfolio companies and customer base and other acquisitions are driven to capture changing customer behaviors, new geographical and demographic areas, increased delivery platforms with technology or innovations. As all industries seek to gain access to the latest technological advances, tech companies continue to create the most investment opportunities for both buyers and sellers.
For those feeling less positive, there are always exceptions, such as in the energy sector where pre-stage M&A activity suggests lower deal activity. Additionally, there are other factors that could point to a slowing in growth throughout the year. Many sellers believe that the M&A market has peaked and many buyers have concerns with valuation.
While the large amount of private equity dry powder is good for sellers, it has flooded the buyer pool and in general, there are an ever increasing number of players in the deal making industry.
Devon Fleming is a senior adviser at VR Mergers and Acquisitions in New Haven. She can be reached at 203-772-3773, ext. 105.