2018 has been a great year thus far for M&A. The number of deals is down, but the deal sizes are increasing. Record-breaking deals are being proposed and executed both in the United States and globally. Just in the last week, Sprint and T-Mobile announced a $26 billion merger, and Marathon Petroleum announced a $36 billion acquisition. Other potential deals include Walmart and J Sainsbury, Walmart (or Amazon) and Flipkart, and Bayer and Monsanto. To provide a better idea, as of mid-last week, there has been 11,828 deals valued at $1.71 trillion globally. Deals are valued to be 63% larger on average than last year. Let’s analyze further.
First, M&A activity are cyclical in nature. The M&A activity typically increases when the economy is expanding. To verify, the previous boom cycle began in 2003 and peaked in 2007 with global value reaching close to $4.5 trillion. The following year, 2008, was the beginning of the downtrend which bottomed-out in 2009. From 2010 to 2013, M&A activity remained steady in the $2.5-2.8 trillion range. The period with sharp declines from 2007-2009 is synonymous with the recent global financial crisis caused by subprime loans. From this we can draw general assumptions that during economic booms, businesses expand and have the resources to purchase other businesses. Conversely, during recessionary cycles, such as the subprime crisis, businesses, typically, cannot afford to buy other businesses—businesses cannot support the cash flow and/or have added to their capital structure (taken on new loans) to stay afloat. Furthermore, companies are not operating at its potential, and are, therefore, not valued at their best. We are currently in an expansionary environment as the unemployment rate has hit new lows; financial markets have surged with record-breaking corporate earnings; and inflation and interest rate hikes loom. M&A activity has also increased because debt is still relatively cheap. During recessionary periods, interest rates on loans are lowered to stimulate spending and borrowing for consumers and for institutions and firms. The recent financial crisis brought out unprecedented measures of monetary policy on a global scale—zero lower bound. Zero lower bound reflects unprecedented levels of low interest rates set by central banks around the world. Some European banks even had interest rates reaching negative levels. The United States federal funds rate reached as low as 0.25%, a historic low, in December 2008. The federal funds rate has since been gradually raised around the world to compliment respective recoveries and inflation levels. Although interest rates are increasing, debt is still cheap—the US federal funds rate is currently at 1.75%– relative to past levels. With economic recovery and cheap debt, corporations can entertain record-breaking M&A deals, but some corporations are simply doing so as their competition gets stronger. Some companies are merging to play defense in the aforementioned deals. Walmart is attempting to purchase Flipkart to add on to its e-commerce business and to compete with Amazon; Amazon’s threat to enter the healthcare industry is partly responsible for CVS Health deal for Aetna; and Marathon’s deal for Andeavor will give it new refining in an industry with strong, global competition. M&A is not just a means for expansion but a means for survival and defense.
The above-mentioned reasons should provide some insight on why M&A deal sizes have been increasing in recent times. Economic expansion, low interest rates, and stronger competition are some reasons companies are interested or capable of buying out other businesses. Regardless of the intentions of a merger or an acquisition, companies must assess its fundamentals. Does your company have enough cash? Is the target business a profitable business? Does the target business have any proprietary assets (i.e., patent)? Does your company have the capacity to take on more debt if necessary? These are all relevant questions to ask when undergoing a highly strategic business decision.