We are in the fourth quarter of 2016 and deal data is now available through the end of the third quarter. In this report, we review our region’s most active industry sectors and give an outlook for 2017.
These 8 industries are also among the most active sectors that drive M&A Activity in our region:
i. Aerospace
ii. Chemicals
iii. Construction and Engineering
iv. Energy: Oil and Gas
v. Healthcare
vi. Manufacturing
vii. Transportation, Logistics, Distribution
viii. Telecommunications
Scroll down for transaction activity in each of these sectors, but first…
Outlook across all sectors and the macro drivers of M&A in 2017
The business mood in the Midwest and Southern States continues to be positive and there continues to be acquisition demand from both strategic and financial buyers for niche companies that are outperforming their competitors. There is no shortage of cash available for acquisitions; it is a matter of being able to illustrate and prove out a business case for a compelling acquisition.
Before we consider each industry, let’s start with the overall economy and the most talked about Trump effect. The polls were wrong and the improbable happened. The economic outlook for 2017 has also changed as a result, mostly for the better. The Federal government is an oil tanker and will take a long time to feel the effects of a new administration and consequently, GDP in 2017 will only be slightly impacted, more so in 2018. While Trump’s proposed tax cuts can impact consumer spending in the short-term, history shows us that consumers initially respond to tax cuts by reducing debt before ultimately increasing spending and in turn driving GDP growth. However, 2017 does also look likely to post stronger wage and employment gains. The October employment report posted a gain of 161,000 jobs and August and September were both revised higher. The unemployment rate now sits at 4.9% and is expected to decline to 4.6% by the end of 2017.
Furthermore, Trump’s plans for infrastructure spending would likely flow through to infrastructure projects in 2018. Despite many concerns in advance and significant volatility on election night, the stock market has responded well to a Trump presidency.
For full year 2016, GDP is likely to come in at 1.5% versus 2.6% in 2015. The third quarter of 2016 posted the highest GDP growth in two years and the outlook for GDP growth in 2017 has been revised higher to 2.5-3.0%.
Consumer spending grew 2.8% in Q3, spurred by a surge in motor vehicle purchases. There has also been strong momentum in retail sales leading up to the holiday season, with holiday sales predicted to rise 4.1% this year, up from 2.5% last year.
On December 14, the market expects a 0.25% interest rate increase by the Federal Reserve, in part responding to expectations of inflation gains in 2017. The Fed is expected to raise rates another couple of times in 2017 and the 10-year Treasury is expected to hit 2.7% by the end of 2017, up from 2.4% today.
Along with interest rate rises, mortgage rates will increase and may be a headwind to the positive home sales we’ve seen this year. Housing starts jumped in October, responding to rising home prices and steady demand. Inventory of existing homes is 4.3% lower than a year ago.
Business spending is slowly increasing and is forecast to rise by 3-4% after a flat 2016. Factory orders (a leading indicator) posted a fourth straight quarter of gains in October, boosted by commercial aircraft orders. However, there are concerns about overseas trade and slow growth in Asian markets.
Our trade deficit with the rest of the world keeps growing (worsening), up to around $520 Billion in 2016 and will likely widen in 2017. Given the strength of the U.S. Dollar, prices for U.S.-made goods are higher in the rest of the world, but exports have still been rising for a few months now.
Energy markets were boosted by OPEC’s agreement and non-OPEC agreement to reduce production, but there are still some points of concern – Libya and Nigeria have a free pass given their internal conflicts which recently dampened production. Iran has also been allowed to boost exports to their pre-sanctions levels. The question remains whether OPEC members will respect the agreement when some members increase production. Nonetheless, oil trading above $50 is a relief for every company that serves or benefits from the oil industry. Natural gas prices have been trending higher, but recent spikes may not be sustainable if the weather warms, given the historically high stockpiles of gas.
M&A Transaction Report and Outlook by Sector
I. Aerospace
Global Aerospace deal activity recovered slightly from the second quarter of 2016. Deal activity increased by 38% in the third quarter of 2016. Total deal value was up 4% from the second quarter of 2016.
Areas of heightened merger and acquisition activity include identity/security services and additive manufacturing, in line with evolving technology in the industry. As an example, GE Aviation has offers to acquire Arcam AB and SLM Solution Group AG, both metal-based additive businesses, with a goal to reduce design and material cost by $3-$5 billion over the next 10 years.
While the number of announced transactions regained momentum this quarter, the number of smaller transactions declined.
The share of mergers and acquisitions attributable to private equity investment has been on an upward trend. Financial investors contributed 57% of deal value and 27% of deal volume in the third quarter showing increasing external interest in the sector.
Likely drivers of decreased deal activity include the election cycle and uncertainty around government spending and the global economy. We expect M&A activity to recover in 2017.
II. Chemicals
Merger and acquisition activity in the chemicals sector declined sharply in the third quarter of 2016. After three consecutive quarters of increased activity, we saw deal value return to the average prior to the fourth quarter of 2015. During this quarter total deal value decreased by 73%. The volume of transactions decreased 47% in comparison to the second quarter of 2016.
Average deal value also dropped after three straight quarters of industry-transforming deal announcements, including ChemChina-Syngenta, BayerMonsanto, and Dow-Dupont. Nevertheless, the Chemicals industry in Q3 2016 was not without transformation; the largest announced transaction was Potash Corp. of Saskatchewan placing a $13 billion bid on Canadian fertilizer giant Agrium Inc. A continued trend in the Fertilizers and Agricultural segment shows the industry is still looking for opportunities outside of commoditized products. Lanxess announced that it plans to acquire flame retardant and lubricant additives company Chemtura Corp. This deal is the second largest announced deal in Q3 2016 and along with the Agrium acquisition accounts for the majority of announced deal value.
As a pre-emptive outlook for Q4, October activity posted an uptick as several divestitures emerged potentially connected with pending megadeals such as Bayer’s sale of their home garden agriculture business and Air Liquide’s plans to sell Aqua Lung.
Seven of the eight largest deals in 2016 are still pending and it is not unusual for some of these deals to be withdrawn due to antitrust legislation or competitive bids. In September 2016, Bayer increased its takeover bid for Monsanto by 20% to solidify its competitive advantage. Alternatively, this could signal a strong close to 2016.
Also of interest is the announcement from Carlyle to acquire the Atotech business for $3.2 billion from Total. This is a sign that private equity players came back to the table for Chemicals mergers and acquisitions.
III. Construction and Engineering
Engineering and construction merger and acquisition deal value is up over 2015 and over 2014. While both value and volume declined in the third quarter of 2016 compared to 2015, on a year-to-date basis, 206 deals through Q3 2016 outpaces 2015 and 2014 (187 and 103, respectively). There were 66 deals this quarter, with the Construction Materials Manufacturing category contributing 26 deals and Construction 16 of the 66 deals.
In the third quarter of 2016, deal value increased by 13% over the second quarter, but decreased 30% from the third quarter of 2015. On a year to date basis, 2016 average deal size decreased by 10%. Civil Engineering registered the highest growth on both year-over-year and quarter-over-quarter. Construction and Home Building declined 34% and 31%, respectively, from the second quarter of 2016, but increased 38% and 76% when compared to the third quarter of 2015.
There were five megadeals announced in the third quarter of 2016, accounting for 45% of the total deal value for the quarter.
For our outlook in 2017, rebounding energy prices could benefit construction and engineering firms, many of whom had expanded into higher margin energy-related work in recent years, which had subsequently led to higher cost structures and financial stress in the energy downturn. Those firms that had since diversified away from the oilfield and/or reduced their cost structures and managed cash flow may have realized lower margins, but stayed in business and would benefit from a future rebound in energy prices.
IV. Energy: Oil and Gas
The oil and gas industry showed continued signs of improvement in the third quarter of 2016, with oil trading above $50 at times. Thawing capital markets, higher commodity prices, and renewed investor enthusiasm for mergers and acquisitions in the energy industry have led to two consecutive quarters of increased deal activity.
Investor confidence has also been supported by continuing productivity enhancements.
While E&P merger and acquisition activity has rebounded over the last two quarters, there has been little activity in the oilfield services market. However, the oilfield services landscape is shifting, with signs of readiness for corporate activity among those companies with a strong product positioning and access to capital. Activity in the oilfield services sector has continued to lag as cash flow remained tight due to pricing in the sector. In the first three quarters of 2016, many deals were driven in part by a seller’s need to pay down debt.
The midstream segment is also showing signs of a rebound, highlighted by the return of some larger transactions. Midstream mergers and acquisitions saw a 38% increase in the number of announced deals in the third quarter compared to the second quarter of 2016.
There is optimism that commodity price deflation is behind us now as deal values increased 118% quarter over quarter. Consistent with the historic trend, strategic buyers led the way, accounting for 85% of the deal volume and over 85% of total transaction value.
Transaction activity among financial buyers was depressed in Q3. There were 7 private equity sponsored transactions generating 15% of the total deal volume and 13% of total deal value.
The first oil and gas IPO in over a year was completed during the third quarter with two additional IPOs following in the first two weeks of the fourth quarter.
V. Healthcare
Transaction activity in the US healthcare services industry declined in Q3 compared to the second quarter and third quarter of 2015. Although deal volume decreased by approximately 15% compared to the second quarter of 2016, deal value increased approximately 24% during the same period. The total number of deals decreased to 214, versus 252 and 262 respectively. Total deal value increased 23.8% when compared quarter-over-quarter, but decreased by 82.0% year-over-year.
The most active sector was Physician Medical Groups with 30 reported transactions, representing a 14% share of total deal volume for Q3.
There were no IPOs reported in the third quarter of 2016 for the healthcare services sector, with only one IPO in 2016 thus far.
The Hospitals sub-sector was the most active in terms of deal value, accounting for approximately 42% of healthcare services transactions in the third quarter of 2016. The Long-Term care sub-sector accounted for 32% of the total transaction volume.
The Behavioral healthcare services industry has seen strong growth in recent years, with revenue increasing on average 4.7% per year since 2011 to reach an estimated $18.7 billion in 2016. Growth has been largely driven by expanded coverage and access to preventative services through the Affordable Care Act. Strong industry fundamentals have resulted in an increased appetite for acquisitions by behavioral healthcare buyers. Questions remain about the impact of a new administration on the healthcare sector, with potential for an overhaul or repeal of Obamacare.
At this pace, 2016 deal volume should exceed the record levels set in 2015. Strategic buyers have accounted for the vast majority of acquisitions through July, while six have been made by private equity groups. In recent years, financial buyers have become increasingly active in healthcare.
VI. Manufacturing
Industrial manufacturing merger and acquisition deal value decreased 10% for the first nine months of 2016 compared to the same period in 2015. This was driven by a 22% decrease in transaction volume.
When comparing the third quarter of 2016 to the second quarter, there was double digit growth in both deal value and volume. There were 58 deals announced, compared to 49 deals in the second quarter, resulting in an 18% increase in volume and 65% increase in value.
In the third quarter, financial investor participation rates decreased to levels not seen since late 2013, accounting for only 17% of deal value and 21% of deal volume.
The increase in deal activity in the third quarter of 2016 may be a sign that deal acquirers’ economic and geopolitical concerns have begun to subside.
VII. Telecommunications
Technology, Media and Telecommunications merger and acquisition value improved in 2016, experiencing two consecutive quarterly increases. Deal value increased 39% in the third quarter of 2016 compared to a year earlier; however, fewer deals closed – 666 versus 888 in the same quarter of 2015.
With year-to-date activity (2,168 deals) lower when compared to Q1-Q3 2015 (2,410 deals), a re-balancing effect following the 2015 record high is still impacting the market.
The Telecoms and Networks sub-sector saw a rise in mergers and acquisitions fueled in part by increased private equity investment. Significant investment continues in wireless telecommunications.
Dycom Industries, Inc. announced on July 6, 2016 that it completed its acquisition of the current wireless network deployment and wireline businesses of Goodman Networks.
In October, AT&T agreed to buy Time Warner for $85.4 Billion, although there may only be a 50/50 chance of this acquisition gaining regulatory approval. President-Elect Trump has vowed to block the merger and we certainly won’t know the outcome until 2017.
AT&T is reportedly in the driver’s seat in winning a network service contract with the federal government’s First Responder Network Authority initiative, although a final decision may be delayed until March, 2017. FirstNet was expected to announce winners of the roughly $6.5 billion network contract on November 1, but at the last minute delayed the news. Rivada Networks confirmed it has filed a protest over its exclusion from the FirstNet bidding process. Whatever the outcome, FirstNet will further drive growth in the wireless sector in 2017.
VIII. Transportation, Logistics, Distribution
Transportation and logistics merger and acquisition activity remained stable in 2016 with over 50 deals in each quarter, though the third quarter of 2016 was marginally less active. The third quarter posted a decline of 11% in deal volume compared to both the second quarter of 2016 and the third quarter of 2015. Despite a gradual decline in volume, activity remains strong with respect to deal volume and value.
Total transaction value is down 30% from the second quarter of 2016, and has decreased marginally from the third quarter of 2015.
While strategic investors have historically accounted for a larger share of mergers and acquisitions in the sector, financial investors increased activity by 33% in the third quarter of 2016. Strategic acquirer activity was the lowest of the last 12 quarters.
Low demand for freight, more stringent regulations and slow growth in the trucking industry are significant factors motivating LTL companies to move into last-mile delivery, making it the latest front for competition and acquisition activity. The demand is driven by:
• over-dimensional products shipping direct to consumers instead of typical retail channels;
• increased online sales events;
• more complexity and higher demand for specific delivery windows and additional service days, such as Sundays.
However, last mile deliver is highly fragmented, and many providers need to make investments in technology to improve speed and provide end-to-end visibility. Truck driver shortages also are affecting the last-mile market, as drivers not only need to be qualified, but also have customer relationship skills.
In September, private-equity giant Blackstone Group LP agreed to pay $1.5 billion for a portfolio of logistics centers, as e-commerce-driven business continues to drive this segment of the industry.
ClearRidge Perspective for 2017
Pre-emptive company analysis and due diligence continues to be critical for any business considering a sale. Business owners that invest in due diligence before talking to a prospective buyer are rewarded with a higher purchase price and a greater chance of closing their deal.
Strategic and financial buyers want to see professionally prepared information, including business and financial data from with the business to allow them to rationalize a premium purchase price and validate their business case for the acquisition. Investing in this preparation up front pays dividends at closing.
Sources: This report has been compiled from reports and research including federal data, independent analysis, Reuters, CFA, Janes Capital Partners Sources, Kiplinger, Mergermarket, PricewaterhouseCoopers, and SDR Ventures.
Also appeared in The Journal Record:
[ClearRidge] Mergers and Acquisitions Report Q3 and 2017 Outlook
