US Dealmaking in Second Half of 2015 Set to Outpace First Half of Year, says EY

Companies in the life sciences, healthcare, financial services, tech and oil & gas sectors are ready to transact

News provided by

Jul 14, 2015, 07:30 ET

NEW YORK, July 14, 2015 /PRNewswire/ -- Deal activity in the first half of 2015 had one of the strongest starts in recent memory, but the second half of the year will see even more mergers and acquisitions (M&A), according to EY. For the first time in five years, more than half of US companies are planning acquisitions over the next 12 months.¹ M&A value surged 55% to $1.143 trillion in the first six months of 2015.² US deal volume, however, dropped slightly by 4%, with 5,822 deals announced so far, compared to 6,040 in the first half of last year.³

A number of headline popping megadeals drove deal values to near record highs in the first six months of 2015, particularly in the life sciences sector. There were 31 deals announced valued over $10 billion in the first six months of 2015, compared to just 18 in the same period last year, and the highest number ever announced for the first half of a year.⁴ It is not just the megadeals that are making noise however, middle-market M&A also picked-up in the first six months of 2015 with 268 deals announced in the $500 million-1 billion dollar range, up from 257 deals in the first half of 2014. In the $100-500 million range there were 1,480 deals in the first half of 2015 up from 1,364 in the first half of 2014.⁵ According to a recent survey from EY, 89% of US companies are planning lower middle-market deals in the next year. This activity will likely be driven by a greater number of smaller, more innovative acquirers re-entering the market after a prolonged period of inactivity.⁶

"Following an incredibly strong 2014, 2015 is shaping up to be a very good year for M&A," said Rich Jeanneret, EY Americas Vice Chair, Transaction Advisory Services. "US deal pipelines are full and companies are exuberantly seeking assets to grow and transform their businesses. After a period of intense focus on cost control and organic growth, CEOs are coming off the bench and doing significant deals, but they are keeping their eye on the ball and taking a disciplined approach to the deal frenzy."

The improving economy, sustained low interest rate environment, and strong US dollar are just some of the factors that are driving acquisitions. Not everyone is acquiring however, a number of companies are looking at divestitures, carve-outs, splits, and spins to optimize their portfolios and focus on core assets that will drive growth. According to a recent EY report on divestments, more than half of companies expect the number of strategic sellers to increase in the next year.⁷ This suggests that there will be plenty of available assets for those that are ready to transact.

¹ EY US Capital Confidence Barometer, April 2015 http://www.ey.com/US/en/Services/Transactions/EY-capital-confidence-barometer
² Dealogic as of 30 June 2015, accessed 2 July 2015
³ Dealogic as of 30 June 2015, accessed 2 July 2015
⁴ Dealogic as of 30 June 2015, accessed 1 July 2015
⁵ Dealogic as of 30 June 2015, accessed 1 July 2015
⁶ EY US Capital Confidence Barometer, April 2015
⁷ EY Global Corporate divestment Study, March 2015 http://www.ey.com/Publication/vwLUAssets/EY-global-corporate-divestment-study-2015/$FILE/EY-global-corporate-divestment-study-2015.pdf

Private Equity Chomping at the Bit
The corporate dealmaking frenzy is just one part of the equation, and while corporate M&A has spiked this year, private equity (PE) acquisition activity has declined modestly in 2015, impacted by higher valuations and increased competition from corporate acquirers. Year to date, PE firms have invested in 416 deals in the US with a total value of $52.4 billion, an 18% decline in deal value and a 4% decline in deal volume compared to the first six months of 2014.¹

"2013 and 2014 were very strong years and it's not surprising that buy-side activity in the first six months of 2015 moderated from the recent torrid pace," said Jeff Bunder, EY Global Private Equity Leader. "PE investment slowed down in the first part of the year but the capital and impetus to invest was very much still on display. Competition for quality assets has increased with an expanded pool of buyers competing for deals, creating a challenging investment environment. Despite this, many firms are still chomping at the bit and are committed to invest if the right deal comes along."

While this recent drop in activity can be attributed to a bevy of stacked market conditions, after a very strong 2014, PE firms are taking a more cautious and disciplined approach to acquisitions. Valuations have escalated and appear likely to rise, driven by a robust stock market and increases in deal multiples associated with recently completed deals. As a result, PE firms are potentially looking at longer hold periods in order to grow into the premiums paid for the acquired businesses. Firms are generally trying to be opportunistic, but they remain wary of a repeat of the buy-outs that occurred in 2007-2008.

On the sell side, coming off the exceptional exit tally of 2014, 2015 has continued on a similar trajectory, albeit at a bit of a slower pace. Whether exploring a sale to corporates, to another PE firm or going public, the market remains red hot for quality PE backed companies with well-defined growth prospects.

In terms of fundraising so far this year, PE funds focused on the US market have raised $133 billion across 214 funds.² That represents a decrease of about 4% relative to the same period last year. "We continue to see a growing bifurcation in the market between the large established funds that offer multiple asset classes and smaller pure-play PE managers that are in some cases struggling to attract capital," added Bunder. While allocations are up in PE, this larger pool of capital is being concentrated among a smaller number of General Partners (GPs). As a result, the average fund size for US-focused funds has topped $1 billion for the first time on record.³ Investors will remain committed to private equity going forward, and with many global LPs currently under allocated to PE, and the continuation of large amounts of capital returned to LPs over the last 24 months, a continued positive outlook for the fundraising market is anticipated.

The last two years have seen record levels of exits and distributions from funds back to LPs, and a lot of that capital is being reinvested back into the asset class. GPs have successfully raised new funds to a point where PE firms globally have about US$470b in dry powder.⁴ That's just shy of what they held at the height of the market in 2007. Factoring in the addition of co- investment capital, we are experiencing an all-time high of available dry powder; a lack of sufficient deal flow, however, has resulted in a challenging investment environment. GPs are experiencing some pressure to invest with the increased level of dry powder. Financing is still readily available at historically low borrowing rates and attractive terms. As a result we expected to see larger buyouts increase in number, although thru the first half of the year we have observed a reduction in the number of large buy-outs (deals in excess of $5 billion). In our view this is not because GP's aren't focused on the larger end of the market, but instead there has been a lack of target companies in this price range, impacted by the timing of large corporate carve-outs and the re-emergence of aggressive corporate acquirers. While some GP's are looking to the emerging markets to invest, the US remains the most attractive investment market.

Apart from high seller expectations, regulatory factors continue to threaten future PE activity. US regulators' leveraged lending guidelines are limiting the amount of debt that PE firms can access, especially for some of the more aggressive structures. While these guidelines have impacted the financing packages of some deals, they have not drastically impacted the ability of GPs to raise financing associated with buy-out transactions. However, the situation does bear watching for the remainder of 2015.

From a sector perspective, the financial space has been the most active for PE investment so far this year. The sector has pulled in over US$15b for US deals; or nearly 30% or the total investment made by PE firms in the first half of 2015.⁵ There have been 29 transactions this year to date, which represents 8% of total deal volume.⁶ Technology is the current leader based on deal count; the sector has accounted for 26% of all PE deals.⁷ "The convergence of the financial and technology spaces will continue to attract PE investment in tech-based growth spaces such as big data, mobile devices, and other niche areas," said Bunder. "Beyond that, PE firms, especially in the US, are seeing a wide range of opportunities in healthcare. The industry is in the midst of significant transformation and is looking for new approaches as providers and end-users look to control costs and convert to an outcomes based model."

"Over the past year we've witnessed more capital being deployed in growth equity and minority investments, which merits further study. GP's are increasingly taking a more flexible approach to investing, deviating from the traditional controlled leveraged buyout model. While we do not expect all PE's to embrace this type of investment model, we do expect to see an increase due to the competitive environment and the desire of some sellers to retain control while attracting smart capital to assist in growing businesses beyond their current perimeter," said Bunder.

Sectors to watch in the second half of 2015
Technology and life sciences space saw the largest increases in deal volume in the first six months of the year. The sectors that are going to be the most interesting to watch in the remainder of 2015 will be healthcare and life sciences, financial services, technology, and oil & gas.

Life Sciences and healthcare

The life sciences and healthcare industries continue to abound with transformative deals driven by a push for consolidation and convergence. As both sectors face increased competition in a customer-driven marketplace, life sciences and healthcare companies alike will seek to strengthen their positions and grow through M&A.

The life sciences sector has seen its two year streak of active dealmaking continue as US transaction volume is up 22% from this time last year and deal value is up 45.2% to $236.1 billion through the first half of the year of 2015, compared to $162.6 billion from the same period last year.⁸ Four of the ten largest US deals were in the life sciences space. Many pharmaceutical and medical technology companies are growing slower than the industry overall and risk being left behind; the last two years have shown that one of the most effective ways to keep pace is through M&A.

M&A and divestiture transactions are being driven by the growth imperative, the need for scale, and an increasing strategic focus "The pressure to reduce pricing across the board is a primary impetus spurring this increase in dealmaking that we're seeing," said Jeff Greene, EY Global Life Sciences Transaction Advisory Services Leader. "In today's life sciences industry it's nearly impossible for one company to be diversified across a broad array of businesses or therapeutic areas, and perform at a world class level in each. The industry has seen a return to companies narrowing their portfolio and divesting ancillary components in an effort to stay lean and focused."

The life sciences space will also likely become a ripe sector for shareholder activists over the next year. As investors push for portfolio optimization and streamlined cost structures, the industry will be increasingly vulnerable to outside activism.

The healthcare space has seen a takeoff in deal activity over the last six months as health plans and services along the provider care delivery chain continue to both consolidate and converge. Provider care deal value is relatively flat, down just 3.3% to $15.7 billion in the first half of 2015 compared to $16.2 billion over the same period in 2014.⁹ Volume, however, has risen 5.3% to 240 deals, up from 228 deals at this time last year.¹⁰ This pickup in deal value is largely being driven by increased competition in the industry as healthcare companies look to deals of scale, either nationally or on a local basis, as a means to solidify positioning in a rapidly changing industry.

"This is without a doubt the most exciting time in the last 25 years of healthcare M&A," said Greg Park, US Healthcare Sector Leader for Ernst & Young Capital Advisors, LLC. "So far this year, we've seen a high amount of activity in the middle market as the healthcare value chain continues to shorten in order to capture more of the healthcare dollars and provide the customer with more bang for the buck. In the midst of all this M&A growth activity, healthcare companies will continue to refine their strategy and focus, and we'll see an uptick in divestitures and carve outs. Headline M&A activity that drives costs down and offers more value to the consumer will be the norm."

Financial Services

The financial services space has seen a boom in deal values over the first six months of 2015, with banking and capital markets M&A deal value spiking to $49.8 billion; up a massive 240% over the deal value total from the first half of 2014.¹¹ While banking and capital markets deal volume dropped off by 5.6%, this precipitous rise in value signals a pickup in the sector that will likely continue through the rest of the year. "The second half of 2014 was rather muted in both deal value and activity, primarily due to regulatory issues that held up both domestic and overseas deals," said Nadine Mirchandani, Americas Financial Services Leader, Transaction Advisory Services for Ernst & Young LLP. "Despite this slowdown in 2014, the first six months of this year have been strong as banks continue their transformation by focusing on a return to their core assets; we foresee this activity continuing through the rest of the year." Dealmaking is being spurred in the banking sub-sector by a push for core transformation as financial institutions seek to redefine their strategy and value chain in the face of disruptive entrants, exits from the banking sector create deal flow and as non-bank lenders entering the field with their own growth and consolidation agenda.

The wealth and asset management space has seen concentrated consolidation in both traditional and alternatives, over the last six months as a method to increase market presence and scale and attract more concentrated institutional capital. The number of wealth and asset management deals ticked up 2.7% to 113 deals, while deal value dropped by 20.4% to $10.3 billion.¹² The wealth management industry is also facing pressure to acquire technology components to augment its services as customers become more familiar with portfolio access technologies and demand additional conveniences and amenities from their brokers.

Meanwhile, the insurance sector is coming off of three years of sustained deal activity. In the current economic environment, acquisitions remain attractive. "With insurers looking to enhance their operational efficiency, meet new regulatory requirements and remain competitive, increasing amounts of M&A activity will be in the form of innovative investment," added Mirchandani. "Meanwhile, reinsurers face pressure to enhance value for investors, leading executives to turn their eyes toward M&A."

Technology

Technology sector M&A has surged in the first half of 2015, setting record highs for both deal volume and value in the post-dotcom-bubble era. Deal value through the first half of the year has risen 64% to $158.4 billion; up from $96.7 billion spent in the first half of 2014.¹³ Deal volume has also risen a respectable 12% to 1,518 deals this year, up from 1,354 deals at this time last year.¹⁴ The first half of 2015 has been marked by a buying spree from non-technology acquirers who are looking to add Internet of Things (IoT) and cloud based technologies to supplement their core businesses. Additionally, the growing necessity of cyber technologies has made an entirely new range of companies and services appealing to potential buyers.

"This whirlwind deal environment is being spurred by readily applicable technology such as IoT, payment tech, smart mobility, and cloud." said Jeff Liu, EY Global Technology Industry Leader, Transaction Advisory Services. "The technology sector will likely keep up the rapid pace of dealmaking that we've seen so far in the first half of the year. As cybersecurity and portfolio optimization continue to be a focal point to investors, tech focused acquisitions will remain on the forefront of the M&A landscape."

Oil & Gas

Dealmaking in oil & gas started out slowly in the first half of 2015 as the price of oil plummeted leading to companies looking internally, focusing on cost management, and refining their strategies, resulting in a value pickup in the second quarter. Deal value spiked in the second quarter, leading to a 119% increase to $128.4 billion in the first six months of 2015, up from $58.5 billion through the first half of 2014.¹⁵ Volume declined 35% to 202 deals in first half of the year compared to 311 in first half of 2014. The last several months demonstrated just how volatile the oil & gas industry can be, but that does not mean that dealmaking has come to a halt.

"Over the last six to twelve months, as oil prices tumbled, major oil players have been carefully managing costs and reviewing their growth strategy, and they are now ready to transact as the new normal for oil prices settles in," said Vance Scott, EY Americans Transaction Advisors Services Oil & Gas Leader. "There are plenty of assets available for both major oil companies and private equity firms alike, now executives need to decide which asset is the right choice for the new oil era in terms of growth potential, equity hydrocarbon stake, technological advances, and the right talent to manage it. The debt and equity markets are open for the right investments, but companies will be cautious when it comes to deal financing and will look at a number of options including partnering, joint ventures, and master limited partnerships to get deals done."

Conclusion

The stage is set for continued M&A activity in 2015 as US businesses are lean and focused, and have plenty of cash in the bank to pursue deals. The strengthening US economy, high consumer confidence, credit availability, and relatively low market risk, are all factors that will catalyze M&A through the rest of the year. The concern however, is that as dealmaking heats up, how will companies outmaneuver the competition to make smart, transformative acquisitions.

"Companies need to gain market share in order to appease shareholders who are growing impatient with slow organic growth. Positive macroeconomic indicators, resurging confidence, shareholder pressure, and cross-border momentum all make the perfect recipe for a strong deal market to continue as companies seek to transform their businesses. For the past several years, we have been waiting for companies to transact in order to beat out the competition and grow, now more than ever it is imperative that companies manage their capital portfolio for growth before the good assets are all gone. The second half of 2015 will be exciting to watch as deal momentum continues," added Jeanneret.

About EY
EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com.

¹ Dealogic as of 30 June 2015, accessed July 2 2015
² Prequin as of 30 June 2015
³ Prequin as of 30 June 2015
⁴ Prequin as of 30 June 2015
⁵ Dealogic as of 30 June 2015, accessed July 2 2015
⁶ Dealogic as of 30 June 2015, accessed July 2 2015
⁷ Dealogic as of 30 June 2015, accessed July 2 2015
⁸ Dealogic as of 30 June 2015, accessed 2 July 2015
⁹ Dealogic as of 30 June 2015, accessed 2 July 2015
¹⁰ Dealogic as of 30 June 2015, accessed 2 July 2015
¹¹ Dealogic as of 30 June 2015, accessed 2 July 2015
¹² Dealogic as of 30 June 2015, accessed 2 July 2015
¹³ Dealogic as of 30 June 2015, accessed 2 July 2015
¹⁴ Dealogic as of 30 June 2015, accessed 2 July 2015
¹⁵ Dealogic as of 30 June 2015, accessed 2 July 2015