After global deal making in H1 failed to meet expectations, an on-demand capital markets webinar from Refinitiv has taken a closer look at the trends in M&A and capital raising. Join International Financing Review (IFR) senior U.S. Editors, Stephen Lacey and Anthony Hughes with John Foley, U.S. Editor, Reuters Breakingviews, for the latest analysis.
- H1 trends in M&A and capital raising show deal making lagged the stock market recovery, with double-digit drops in fee income across most asset classes.
- M&A struggled globally in H1 but thrived in the United States, where the 60 percent market share was the highest at any time this century.
- While sentiment is subdued for deal making in H2, experts are most optimistic for the biotech and healthcare sectors, and possibly for corporate tie-ups in banking.
Refinitiv data for the first half of 2019 provides a sobering backdrop: double-digit drops in fee income across most capital market asset classes, including a 12 percent fall for M&A, a 25 percent fall for global ECM, and a weak showing for IPOs, albeit offset by a belated surge in the second quarter.
In contrast to this, our webinar guests noted the strength of the stock market recovery so far this year, particularly in the United States, which has taken many by surprise after the S&P 500 ended the half 19 percent up.
Big U.S. transactions, but are they clever?
Mega deals of more than US$5 billion constituted more than half of transactions so far this year. This flurry of big transactions in the U.S. may have created a buzz, but CEO enthusiasm is rarely reflected by shareholders.
According to John Foley, “several big deals are going to destroy value for shareholders, quite obviously”.
Adding to the frustration, such deals are increasingly structured to keep issued equity below 20 percent, so shareholders don’t get a say.
“Shareholders can see straight through that and don’t like it,” said John. As a result, we are frequently seeing the share price of the acquirer falling, as CEOs over reach and investors punish them for subverting shareholder democracy.
The role of activists is also not straightforward: they are both generating some of these deals and challenging them.
One activist investor described the rationale behind a proposed acquisition by United Technologies as ‘a word salad’. Where shareholders are not offered a vote, such activists are finding other ways to exert influence, such as ousting directors.
Mixed picture on global M&A
Beneath the headline drama of mega deals, the overall M&A picture may be tougher still.
By number of deals, corporate activity followed a clear downward trajectory, across all size ranges, hitting a five-year low by volume — a fact that may say more about overall CEO confidence.
Certainly, there are plenty of things to be nervous about at a macro level, particularly as the stimulus of the sweeping tax reforms start to recede.
Strange, then, that the US strongly leads the way in M&A, capturing 60 percent of the market, a greater proportion than at any time this century. And as cross-border activity falls 45 percent to just a quarter of worldwide deal making, the US domestic scene also dominates.
This could be partly driven by buoyant U.S. stock markets, raising the currency of corporate paper. It may also say as much about European weakness, where M&A fell 56 percent to a six-year low. Whatever the reason, U.S. companies seem more willing to take the plunge, both cross-border and nationally.
Watch: M&A Q2 2019 Review — Refinitiv Investment Banking Quarterly Review
How cross-border activity fares from here will be somewhat defined by the 2020 Presidential election. “People will then decide if a retreat from globalization was a four-year phenomenon or semi-permanent thing,” says John.
There has also been “a big surge” in overseas interest to list in the U.S., according to Stephen, including from China, Latin America and Europe. “The U.S. remains a central source of liquidity for foreign companies.”
Healthcare and biotech lead the way
Most major industries saw big declines in corporate activity, but there were exceptions, including healthcare and technology.
“Healthcare has been a phenomenal area for both M&A and IPOs, maybe forming a virtuous circle,” said Anthony.
He says that biotech companies and those with a technology twist on healthcare that can help reduce waste in the U.S. healthcare system is “an amazingly vibrant area”, while biotech IPOs “seem like an unstoppable trend.” However, he warns success is very binary: sometimes they work, sometimes they don’t.
Other such listings can also be “almost manufactured outcomes”, according to Stephen, where incumbent venture capital backers participate in the IPO but it’s a “pseudo-public” process, with limited broader interest.
Financials is another sector to watch. The Sun Trust acquisition of BB&T is seen as a temperature test for a broader consolidation of the fragmented U.S. domestic banking market. “Such deals don’t happen easily, but there is definitely a case for more bank M&A, and regulatory conditions appear pretty conducive,” according to John.
Add ‘tech’ to the ‘fin’ and not everyone is so happy. Fintech start-ups are coming to market, seeking to undercut lending rates, and expand revenue lines, and wish to unseat incumbent banks rather than sell up to them.
Meanwhile, incumbent investment banks also face competitive pressures, with boutiques consistently capturing around one-third of fees. However, the top five are all major U.S. banks, raising questions as to whether the European banking market remains a global enterprise.
IPOs: Stranger than fiction
It might not feel like it, but although IPO activity tripled from Q1 to Q2, for the first half as a whole, proceeds were at a three-year low.
So-called unicorns — tech startups that achieve valuations of $1 billion or more in private hands — grabbed the spotlight, but sponsor-backed activity was more muted in both IPOs, follow-ons and block sales.
The disappointing debuts of hyped stocks such as Uber and Lyft may speak to a wider structural disruption in the interplay between the private markets and public capital markets.
Stephen notes that this signals a real problem in terms of how we think about the IPO process and its technical dynamics. “Uber may be a great company in the long term, but it’s very difficult to price IPOs when you have a great wall of money behind them.”
Watch: Equity Capital Markets Q2 2019 Review — Refinitiv Investment Banking Quarterly Review
Meanwhile the jury seems to be out on that other recent Silicon Valley disruptor — the direct IPO — a circumvention of traditional investment banking IPO services made famous by Spotify.
John expects to see this used more frequently, but only for brand name business that don’t actually need to raise new capital.
As a way of allowing various private investors to arbitrate independently a price that works for them, it may be a solution. Interestingly, the team noted that direct listing trend begun by Spotify was very much improved by Slack.
Another tactic that may catch on was WeWork’s multi-billion dollar debt raising just before going public. “Maybe that’s the antidote,” says Stephen.
The buyout fundraising boom
While a glut of venture capital is pushing up values for tech startups, their private equity cousins are underpinning valuations for more mature businesses. The buyout fundraising boom shows no sign of slowing and so the asset class’s ‘dry powder’ is growing.
Anthony believes the growth of private equity has become a secular trend, with the buyout barons becoming “the biggest payers on Wall Street”.
“They are much more central to the Street than ever before.”
Meanwhile, private equity firms themselves are increasingly shunning the IPO markets when it comes to exiting their own businesses. The reasons are twofold: they are increasingly put off by the “crazy behavior” of the IPO world, with highly valued unicorns that may never see profits.
And at the same time, the market continues to view private equity-backed companies with some suspicion, given they are typically highly indebted, cash generative, but not always high growth — creating further incentive for them to seek out alternatives such as secondary buyouts and trade sales.
The H2 trends in M&A and capital raising
Maintaining stock market momentum through the second half of the year seems a big ask. The average IPO in the first half is now up 30 percent — albeit skewed by Beyond Meat, up 600 percent since its IPO.
It may be that active managers who suddenly found themselves lagging their benchmark, as the major indices took off, opted to close the gap with some IPO action.
How sustainable all this will be for the rest of 2019 will depend on fundamentals, and earnings growth in particular. There is a stock of a dozen or so brand names queuing for their debut. As we get closer to the U.S. elections, things could “get nasty”, so maybe, the sooner, the better.
The biotech and healthcare boom has further to run, and you don’t need wild optimism to expect more corporate tie-ups in the banking sector. But elsewhere, sentiment appears very subdued.
Will aggressive CEOs continue to prop up aggregate M&A values through mega mergers, while watching their own share price get hammered as a reward, or will shareholders start to fight back? And how much longer can the U.S. prop up the global trends in M&A and capital raising markets? Something has to give.
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