A mix of economic optimism and the availability of capital should yield another strong year for acquisitions in 2017.
That’s according to a number of M&A professionals who say despite the uncertainty surrounding the incoming Trump administration, deal flow in the year ahead should remain on par with 2016.
“From a pure business standpoint, the business owners we’re interfacing with have some optimism and I think there’s still plenty of capital chasing and seeking high-quality deals — whether that’s in the lending community, the private equity world or with strategic buyers,” said Gary Lewis, a managing partner at Birmingham-based advisory firm Amherst Partners LLC. “I think with optimism typically comes strong deal activity and I don’t think that’s going to stop. Despite a small move in rates, we’re still around historical lows. Combine that with the traditional lenders still trying to aggressively chase market share, it makes a recipe for a compelling deal environment going into 2017.”
Through the third quarter, companies completed 12,512 deals valued at $1.68 trillion in 2016, according to Pitchbook. That compares to 17,304 deals valued at $1.53 trillion that closed over the same period the prior year.
Lewis notes some companies have pushed their deals into 2017 in a bet that corporate tax rates will decrease under the new Trump administration.
“(They’re) strategically delaying deals with a little bit of the hope and a prayer that a tax rate (decrease) will benefit them,” he said.
Looking ahead, 75 percent of participants in Deloitte’s M&A Trends year-end report expected deal activity to increase this year, while 64 percent expected deal size to grow.
Globally, M&A activity is expected to concentrate on technology as companies and private equity firms look to position themselves for the future, according to Deloitte.
While manufacturing deals will continue to be the most prevalent in the region, Lewis expects to see further consolidation within the health care services industry given the likely reforms to the Affordable Care Act (ACA).
“The potential reform in ACA is going to cause uncertainty and that may pose caution for some buyers, but I think others are going to find that as significant opportunity,” Lewis said.
In the automotive industry, acquisitions and strategic partnerships will likely continue their pace this year, he said.
According to a Global Capital Confidence Barometer published by Ernst and Young, 54 percent of respondents in the automotive industry expected to pursue acquisitions over the next 12 months, particularly deals to acquire new technology such as autonomous driving capabilities.
Despite the overall optimism in the deal market, most experts are approaching 2017 with some degree of caution, driven in part by the unknown implications the incoming Trump administration will have on the economy.
Moreover, interest rate hikes that increase the cost of capital could act as a drag on deal flow in 2017, said Rajesh Kothari, managing partner of Cascade Partners, an investment banking firm based in Southfield.
“I have much more of a cautious tone because I think economically we’re going to have strong year, but I think that strong economic year and rising interest rates environment will put pressure on your ability to maintain these valuations,” Kothari said.
However, Kothari notes that the impacts of those interest rate hikes, if they materialize, likely will not be felt until the end of 2017 or beginning of 2018.
Already, high valuations have made it a challenging environment for some firms.
“It’s been very high and it’s really hard to get good deals,” Martin Stein, managing partner at Grand Rapids-based private equity firm Blackford Capital, said of valuations. “The better that people feel, the more they expect to be paid and the more folks are willing to pay.”
Despite the high valuations, Blackford Capital closed four deals in 2016 and expects to continue along a similar trajectory this year.
INCREASES IN BOLT-ON ACQUISITIONS
As valuations remain elevated, most experts predict that private equity funds will focus their attention on bolt-on acquisitions as opposed to adding new portfolio companies.
That’s played out for Blackford Capital as 80 percent of the firm’s deals in the last two years have been add-on acquisitions, Stein said.
“I could imagine that we’ll probably be doing a number of (bolt-on acquisitions) next year and we certainly have some big ones on the radar,” he said.
Blackford Capital’s appetite for add-on deals plays out nationally as well. Approximately 56 percent of private equity respondents to the Deloitte survey said they expected to focus more on bolt-on acquisitions to build platform investments.
Kothari of Cascade Partners sees the focus on add-on acquisitions as part of a larger push toward consolidation across sectors. He also believes that valuations are continuing to push private equity firms down market.
“They’ve gone down market to buy businesses at more moderated valuations and then grow them by assembling smaller players into the mix,” Kothari said.
After a strong wave of deal activity over the last five years, experts in the M&A industry expect to see a substantial increase in divestitures in 2017.
According to the Deloitte survey, approximately 73 percent of corporate and private equity respondents said they intended to sell off assets or business units this year. That compares to the 48 percent of respondents who made similar statements in the previous year’s report, leading Deloitte to proclaim “divestitures will be in vogue in 2017.”
For its part, Blackford Capital plans to exit at least one of its portfolio companies in 2017. Stein declined to name which company the firm was considering selling.
However, Kothari takes a contrary view about the likelihood of a rise in divestitures in the year ahead.
“If your portfolio company is doing well, you’ve been trying to sell it,” Kothari said. “If your portfolio company has been doing OK and you can get a boost in performance because the economy is growing, you’re going to wait until that boost hits your financial statements. Then you’ll go to market. (But) we haven’t seen that boost in the economy yet.”
That’s not to say that a boost to the economy — benefiting companies and private equity firms looking to make divestitures — isn’t coming. However, the main question on everyone’s mind seems to be exactly what effect a Trump presidency will have on the economy, sources said.
“I think you’re hearing caution from folks. A lot of it is that we’ve gone through an election and there’s always uncertainty as to seeing how that’s actually going to play out and what policies are going to look like,” said Lewis of Amherst Partners. “In general, while there’s optimism, there is caution around that. It’s new and new is risk.”