M&A Outlook: Top Trends of 2019 and 2020 Forecast
Grace Maral Burnett, legal analyst at Bloomberg Law, and Lynda M. Twomey, a partner at Fenwick & West LLP, recently participated in a Market Trends in Corporate Transactions webinar to wrap up 2019 and provide thoughts on how M&A might look in 2020. Below are excerpts from their remarks, edited lightly for readability.
The mergers and acquisitions field saw a number of changes and trends in 2019 – deal size was up despite deal volume being lower compared to 2018, and political and cultural phenomena like Brexit, new data privacy legislation, the #MeToo movement, and increased regulation of foreign investments created shifts in the way deals are constructed.
Deal Size
We saw a very high average deal size for 2019 – the highest since 2015, which was a record M&A year.
The private equity industry, which has been attracting much attention and scrutiny recently, is involved in a large slice of M&A deals in the U.S. For deals valued at $100 million or higher, private equity deals comprised 20 percent of all deals. And private equity sales have far outpaced buyouts, both by market share percentage of these deals and by volume.
-Insight from Grace Maral Burnett
2019 Deal Drivers and 2020 Outlook
M&A had two stories in 2019: the first half of the year, deal volume was down a bit from prior years, but finished up strong. While volume was down, the size of the deals increased. Likewise, valuations have increased significantly in recent times, and maybe to levels that are unsustainable. That could have implications in terms of what 2020 and beyond look like.
The deal drivers for the last couple of years have been fairly consistent.
- Economic growth is fueling optimism about using M&A as a strategic tool to bring growth to businesses.
- Technology disruption – we’re seeing the blurring of lines between industries as technology goes everywhere and new tech-enabled business models are developed. That’s bringing a lot of sector conversions. For example, the mobility companies and technology, like ride-sharing apps Uber and Lyft, coming in on traditional mobility players like taxi services.
- Internet of Things (IOT), AI, and cloud-based technologies are becoming pervasive across sectors. Corporates are seeing the need to invest in them. They can’t easily produce the tech quickly in-house, so they go out and buy it by acquiring companies.
- We have a record level of dry powder, in terms of cash in corporate bank accounts and PE buyers. The PE buyers have increased their level of cash on hand by about 75% in the last five years, and they are aggressively investing as well as exiting their investments, bringing them even more cash. Because of that level of cash, we’re seeing a lot of cash deals.
- Shareholder activism – boards are being pressured to restructure and divest nonperforming assets. I’ve seen in my own practice a huge increase in divestitures across the board. PEs are looking at high valuations and seeing good opportunities to cash out of businesses they have acquired.
-Insight from Lynda Twomey
[Take a look at the corporate transaction market evolution in 2019 through data and Bloomberg Law analysis.]
In terms of the outlook for 2020, there is optimism that M&A deal drivers will continue, but that is tempered by headwinds.
- Are high valuations sustainable? Investors are starting to question whether the amounts being paid are warranted and are bringing the value that management teams are hoping for. Valuations are getting to such a high level that we are almost at the top of what people are willing to pay. Could that be a dampening factor?
- A lot of action in the regulatory space – The DOJ is now aggressively challenging vertical mergers. We saw their court challenge to the AT&T-Time Warner Deal. They lost that, but they have said they’re not going to back off these deals that they don’t see as being in the consumer’s best Congress is focused on big tech right now. It’s under an antitrust microscope pretty much everywhere, with politicians at the federal and state levels advocating for the breakup of big tech and changes to antitrust laws.
- Threat of economic downturn – There are also concerns about an economic downturn. If we go into a recession, I think we’re still going to see M&A chug along. Valuations will come down, and the corporates and PEs will see opportunities in assets that come down in value.
- Trends in representations and warranties
- There’s a major focus on privacy, with GDPR and now the California Consumer Privacy Act coming into effect in January. Data security and privacy are huge areas of focus for buyers, probably the number one new concern. Reps on privacy and data security have gone from two paragraphs to pages in terms of compliance and seeking disclosure on breaches.
- Survival period for nonfundamental reps and warranties is still within around 12-18 months but trending toward the shorter end of the range.
- We’re seeing a very large increase in the use of reps and warranties insurance by buyers, particularly in the PE space. The insurance policy is essentially replacing the indemnity from sellers. That’s very attractive to sellers and, I think, has been adopted by PE funds to be competitive.
- Increase in indemnity deductibles, decrease in indemnity caps – 74% of 2018 deals featured deductibles rather than first dollar recovery baskets. This is a significant increase over recent years. Indemnity caps that would have been in the 15% range a year or two ago have recently been in the 10 to 12% range.
[There’s a reason for optimism about corporate transactions. Download this report to learn the trends financial analysts are watching closely.]
A New Era in CFIUS
The Committee on Foreign Investment in the U.S. (CFIUS) is now of critical importance to cross-border deal lawyers working on inbound investments to the United States. The Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) significantly expanded the committee’s jurisdiction.
Noncontrolling investments are now included, investments by certain investment funds are included, and investments in what they call TID U.S. businesses are now included – those are businesses that deal with certain technology, infrastructure, or sensitive personal data.
Some CFIUS official data was released a couple weeks ago. Unsurprisingly, the overall number of notices filed with CFIUS went up significantly in 2017 and 2018. More importantly, the number of investigations went up significantly, and the number of notices filed that didn’t lead to investigations apparently decreased. This trend means that CFIUS’s capacity to conduct reviews has increased, which makes sense in light of FIRRMA.
-Insight from Burnett
Trends to Watch: Brexit and #MeToo
Burnett: Brexit is on the minds of many, so I recently took a look at U.K. cross-border flows. It seems that Brexit is having an impact on the United Kingdom’s inbound and outbound cross-border M&A.
The U.S. dollar value of U.K. acquirer out-bound, cross-border M&A deals is 47 percent less in 2019 than it was for 2018. Interestingly, despite the fact that the volume in 2019 has shrunk, the majority of U.K. outbound deals are to U.S. targets. And this is something that we also saw in 2016, which was the year of the Brexit referendum. Despite an overall downward trend in the U.K. outbound M&A, there’s been an upward trend, at least for this year, in U.K. investments in the U.S.
Burnett: Another thing that that I’ve begun to see is Brexit is that being excluded from the scope of material adverse effect (MAE) provisions. This would most commonly be a pro-seller/pro-target request. They’re saying, “We know the risks and we’ve already taken them into account.” Sample exclusion language:
Provided, however, that no event, development, change, effect or occurrence resulting from or arising out of any of the following shall be deemed to constitute, or shall be taken into account in determining whether there has been or would reasonably be expected to be, a “Material Adverse Effect”: (x) any actual or potential break-up of any existing political or economic union within any country or countries or any actual potential exist by any country or countries from, or suspension or termination of its or their membership in, any such political or economic union (including, for the avoidance of doubt, “Brexit”).
Twomey: The #MeToo movement has also seen new representations, such as sellers having to represent the absence of settlements or allegations of any sexual harassment or hostile work environment. And then we are also seeing MAE qualifiers expand. I think as new issues come in that generally affect companies, they are finding their way into MAE qualification definitions.
Burnett: I have looked at a large number of publicly filed M&A contracts that contain these #MeToo reps and warranties. I’ll refer to them as “#MeToo reps.” They have also been referred to as “Weinstein provisions” in the market. These provisions are generally in the section of the contract dealing with labor and employment representations and warranties. They’re usually made by the target, but they can be made reciprocally by both sides.
In the contracts I looked at, five years was the most common lookback period and most of them had a knowledge qualifier. Here’s a sample based on a rep that was included in a mega deal:
To [target/seller]’s knowledge, in the last five (5) years, (i) no allegations of sexual harassment have been made against any employee at the level of vice President or above, and (ii) neither the [target/seller] nor any of the [target/seller] Subsidiaries have entered into any settlement agreements related to allegations of sexual harassment or misconduct by any employee at the level of Vice President or above.
[Download Bloomberg Law 2020 – Transactions to get a first look at the market-shaping issues our analysts will be following in the new year.]