2019 has been a great year for the M&A sector. Many large deals, like takeaway.com and Just Eat took place, but also many records have been broken. Before we look at what 2020 might bring us, we will discuss some records of 2019.
Private equity market at the highest point since the crisis
Private equity firms have invested the highest amount of capital since 2007. They spent 478 billion on acquisitions in 2019, against 460 billion in 2018. This represents 12% of the total takeovers worldwide. Want to know more about what private equity is and how it does business? You can read it over here: https://riskmagazine.nl/article/2019-10-01-when-private-equity-takes-over.
Analysts have three explanations for this, and all of them are about the low interest of nowadays. At first, money to finance the acquisitions can be lend very cheap due to the low interest. Secondly, investors experience lower returns since the interest has become significantly lower. Therefore, they went looking for higher returns by letting private equity invest their funds. Finally, a lower interest rate results in higher firm valuations. Simply said: when interest is lower, a firm is worth more. On a more technical note: future cashflows will be discounted less, since a lower risk-free rate usually results in a lower WACC.
Investors went looking for higher returns by letting private equity invest their funds.
Start-ups are funded more than ever in Europe, but decrease worldwide
In Europe, the investments in start-ups have increased by 40%, to 35 billion. These investments mainly are funded by venture capitalists. This contradicts however, with the global trend, where total investments in start-ups decreased from 302 billion to 258 billion. This can be explained by the fact that the hype of the fintech’s is decreasing. They get money injections in a later phase now, which leads to a lower quantity of investments but with a higher value. Worldwide the quantity indeed shrunk, but in Europe it stayed the same because of many investments from outside Europe. It is unclear if this trend will continue.
The dangerous downside of cheap financing opportunities
The high total deal value is not only fueled by a high amount of deals, but also by the fact that overpaying is more likely to happen in the current acquisition market. The cheap financing and high competition, drive the prices up and stimulate investors to take higher risks.
For instance, the light division of Philips which was bought in 2017 by private equity firm Apollo, is about to turn out into a disaster. Because of bad company results, trust in the future of the company is currently very low. This is shown by the rating of the loan of 1,7 billion that was used to finance this takeover. Moody’s valued the loan seven steps under investment-grade level, resulting in the fact that it is worth only half of its initial value. Not everything private equity touches, turns into gold!
In Europe, we are doing below average
However, when we zoom in further, we see that the trends are different per continent. The M&A market in the USA is flourishing, but in Europe the total deal value decreased by 4% (130 billion) and the overall deal value in Europe decreased by a shocking 25%. The worldwide records therefore are not fueled by Europe, but mainly by the USA and some other countries. For instance, Japan has hit the records, because some large company’s like Hitachi are slimming down. Private equity firms take the opportunities and are happy to buy a lot of divisions which are available for sale. This resulted in 2840 deals previous year, with a total value of 55 billion
The trend is likely to continue, since CEO’s are reshuffling their portfolios and focus on growth areas.
Will the upward trend stop to continue?
For several years, analysts have been predicting that the party is almost over and 7 scarce years will follow. However, the arrival of these scarce years keeps getting postponed and the business therefore ‘keeps dancing’. The low interest rate is not expected to change anytime soon, and therefore the acquisitions are expected to keep going in 2020.
So the fact that their managing directors received 115 million dollar per person, tells enough about how the firms are doing.
The USA has some large deals lined up already for 2020, like the elevator division of ThyssenKrupp with a potential value of 20 billion, but also American cosmetics producer Coty is planning to sell some huge brands. Apollo and BlackStone have made 250 billion available to finance takeovers and are ready for the upcoming year. The successes of previous years are always represented in the bonusses the managing directors. So, when you hear that their 10 managers, received 115 million dollar per person, that tells enough about how the firms are doing.
Something interesting to look out for, are large US banks mergers. The trend in the US is set to let the banks who were already humongous, merge into even bigger banks. This started in 2019 with BB&T and Suntrust, who merged into ‘Truist’ and control 460 billion of assets together. This merging trend kept going throughout 2019 and is expected to maintain in 2020. The main reason for this is the fact that profits stop growing and a merger gives the share price a bump-up.
As long as the music plays, you have to keep dancing.
In the Netherlands, the upcoming year will probably continue setting the trend of cross-border transactions like the one of takeaway.com and Just Eat. Financing will stay cheap since the ECB maintains its policy for 2020, but M&A advisors expect that the ridiculous prices that have been paid in the past years, will occur less often. Since people expect the economy to stop growing with the current pace, companies are valued lower.
However, private equity is still doing fine and is expected to keep going in the upcoming year. Also, Jumbo is looking for growth by taking over supermarkets in Belgium and Unilever is planning to sell brands that reached maturity and do not grow in size anymore. This will also bring a lot of movement in the market.
When will the party be over?
The trade conflict between China and the USA is slowing the world economy down. Like that’s not enough, now also the Corona virus is making the future more unsecure. Many investors will hold back to wait and see what happens. However, these volatile markets also offer new opportunities. Experts say that the acquisition machine will keep running as long as the interest stays low. Everyone knows this cannot keep going on forever, but no one knows when this party will stop. And therefore the investors say: “As long as the music plays, you have to keep dancing.”