M&A Activity In 2016: What It Tells Us About The Economy For 2017
Summary:
Takeover activity in 2016 was the third highest on record, falling only behind 2015 and 2007.
The economic environment was not that strong and executive attention was focused more upon the returns from financial engineering and not those from business capital expenditures.
The first look of analysts for M&A activity in 2017 is strong as the economic environment is expected to remain about the same except for a reduction in regulatory oversight.
The year 2016 turned into the third most active year in takeovers, with $3.7 trillion in transactions, down from the record setting year, 2015, when there were $4.4 trillion.
Furthermore, in 2016, there was a surge in deals that did not make it through to completion.
Last month I wrote that 2016 "was the biggest in terms of volume for busted transactions-those withdrawn after being announced-since the depths of the financial crisis eight year ago…."
"Some 1,009 takeovers worth $797.2 have been scrapped this year as of last Tuesday, according to Thomson Reuters, a volume that had not been seen since 2007 and 2008."
The surge in deals, whether or not they were completed, seems to be related to the need corporate executives have felt to grow their organizations, especially when the economy has not been growing?
Well, according to many reports, one of the major factors going on in the corporate world was the search for growth. As quoted in the cited Financial Times article, "Takeover activity has been fuelled by the search for growth by companies in consolidating sectors and the availability of borrowing at attractive rates."
In addition, in another Financial Times piece, "Many companies face poor organic growth prospects, forcing them to consider buying rivals or expanding in new territory."
In other words, the economy was not growing fast enough to achieve "organic growth," hence giving us a reason why business capital expenditures were as low as they were, and so, to achieve the growth they wanted, corporate executives opted to push the edge and create growth for their companies through corporate combinations.
Many of the deals that fell apart were a result of trying to stretch too far, creating either regulatory problems because of the market concentration that would result from the transaction, or, because the combining organizations just were not compatible.
One of the things that I draw from this picture is that the economy was weak enough that corporations could not generate desirable growth rates and so they turned more and more to financial engineering to keep them busy and attempt to create excitement around their stocks.
In terms of financial engineering, the past seven years has garnered a lot of attention because of the use corporations have made of stock buybacks and dividend increases.
Product markets have not expanded as rapidly as executives would have liked. This is because the economic growth of the United States has been very, very disappointing…except when compared with other major countries around the world.
It is interesting to note that economic growth in 2016 came in, year-over-year, at less than 2.0 percent, which was also the case in 2015.
One has to go back to 2007 to find the second most active year for M&A, a year that included the collapse in the financial sector and the start of the Great Recession.
The compound rate of growth of the economy has only been 2.1 percent per year for the seven and one-half years of the current recovery. The growth of labor productivity has been just a little above zero. The rate of capacity utilization in industry has cradled around 75.0 percent during the current recovery where it was around 81.0 percent during the previous time of economic expansion.
There just has been little within the economic environment to drive "organic growth" within the corporate world and not putting money into physical capital expenditures has just exacerbated the slowdown.
As a consequence, the corporate world has turned more and more to financial engineering to drive results.
Many analysts are looking at 2017 as another banner year for M&A activity. Two things seems to be driving this belief: first, more emphasis upon fiscal stimulus; and, two, a reduction in regulation. In other words, it is expected that the Trump administration will create a favorable environment for takeover transactions…and corporations will respond.
The picture this is building, however, is that the environment that the Trump administration will be creating is one that is very attractive to further efforts at deal-making, at more and more financial engineering. However, this picture does not include much for faster economic growth, at least not in the first couple of years.
Thus, the conclusion one can draw from this discussion is that limited economic growth has created an environment where more corporate energy has gone into financial maneuvering rather than into building "organic growth" and that this condition will continue on into, at least, the first couple of years of the new administration.
Should be a good time for investment bankers.
