A recent analysis by Ernst & Young (EY) of 2,600 executives shows that although 2018 is on track to become a near-record year for the number of global mergers and acquisitions (M&A), corporate acquisition appetite is at a four-year low. How come?

Numbers projected up but M&A interest down

Despite 2018 being on track to become a near-record year for the number of global mergers and acquisitions (M&A), corporate acquisition appetite is at a four-year low, according to the 19th EY Global Capital Confidence Barometer (CCB), a biannual survey of more than 2,600 executives across 45 countries. With rising regulatory uncertainty, and ongoing trade and tariff negotiations, including Brexit talks and the US–China trade disputes, 46% of respondents in the EY analysis cite regulation and political uncertainty as the biggest potential risk to deal-making in the next 12 months. Only 46% are now planning to acquire in the next 12 months, down from 56% a year ago.

Despite the lower interest for M&A, survey respondents are bullish on M&A and macroeconomic fundamentals. Ninety percent of respondents expect the global M&A market to improve and 9% expect it to remain stable in the next 12 months. The majority of executives (85%) believe global economic growth prospects are improving, with only 2% predicting short-term market stability to decline and 2% predicting equity valuations to deteriorate.

“Geopolitical, trade, and tariff uncertainties have finally caused some dealmakers to hit the pause button,” said Steve Krouskos, EY Global Vice Chair, Transaction Advisory Services, in commenting on the study. “Despite stronger-than-anticipated first-half earnings and the undeniable strategic imperative for deals, we can expect this year to finish with much weaker M&A than how it started. The good news is that companies will likely take the break in action as an opportunity to focus on integrating the many deals undertaken over the past 12 months. This is likely to be just a pause, not a complete stop. Fundamentals and the strategic rationale for deals remain strong, and the appetite to acquire will likely grow toward the second half of 2019.” 

The pending withdrawal of the UK from the European Union (i.e., Brexit) and the uncertainty over what a negotiated trade deal will be is having a bearing on executives’ view of M&A. The outcome of Brexit negotiations is a focus for all executives surveyed in the EY study. Forty-one percent say that an Economic Free Trade Agreement similar to Switzerland’s (a bilateral agreement with EU affording UK select access toa single market for goods but not services; UK must accept free movement of people and make specific EU contributions) is their preferred outcome of UK–EU discussions, followed by 22% preferring Canada’s Free-Trade Agreement model (an agreement for tariff-free access for most goods, services not necessarily included, but custom controls in place; UK does not need to accept free movement of people). Just 5% of executives globally prefer a second referendum of the UK’s EU membership. and only slightly more (6%) favor a World Trade Organization rules-based outcome.

Despite ongoing global trade and tariff uncertainty, many companies are still planning cross-border deals to mitigate the potential impact, with 20% of executives focusing more on international opportunities, including within the UK, which is the number two destination of M&A choice for executives globally, up from the fifth position in EY’s April 2018 survey. Overall, the top five investment destinations for executives surveyed are the US, the UK, Canada, Germany, and France.

“Many companies are looking to M&A to mitigate the potential impact of trade and tariff policies, secure market access, and protect supply chains,” said EY’s Krouskos. “All of the top M&A destinations of choice are countries embroiled in trade uncertainties, suggesting that those companies planning deals are actively looking to get ahead of potential geopolitical disruption.”

Portfolio review increasing

The increasing risk of technological disruption, geopolitical uncertainties, and ever-changing consumer preferences are prompting executives to review their portfolios more frequently, according to the EU study. An increasing number of executives (40%) are reviewing their portfolios every six months compared with a half a year ago (27%). Companies from Japan (62%) and China (61%) cite this frequency more than other countries’ respondents. Just 33% of companies review their portfolios once a year or less, compared with 64% six months ago, with most of those respondents based in the US (58%) and the UK (43%), according to the study.

Interest in divestments on the rise

As a result of portfolio reviews, nearly three-quarters of companies (73%) have identified assets to divest—due to underperformance or risk of disruption—indicating that other assets are coming to market and future buy–sell activity, according to the EY study.

Some divestments could attract private-equity buyers, with 31% of executives citing private-equity buyers as a major acquirer in the next year. Sixty-eight percent believe that the biggest competition they face for assets will come from private capital, including private equity and corporate investment funds. “The rise of private capital, including private equity, super funds, sovereign wealth funds and corporate venture capital, has fundamentally reshaped the funding environment and will help refresh M&A activity in the future,” said Krouskos. “Fund managers are allocating more to private capital than ever before in the history of modern capital markets. Many will use private equity as a vehicle to deliver returns while others will increase direct investing activity.

Looking ahead globally

While current issues are slowing possible M&A in 2018, the level of M&A is expected to rebound in 2019. “Uncertainty is giving some executives pause for M&A thought—and that will likely result in a fall from current deal highs in the next 12 months,” said EY’s Krouskos. “However, we can expect higher M&A activity into next year. Portfolio reviews today will yield asset sales in due course. Getting ahead of technological disruption and navigating geopolitical shifts will require M&A. And with growing competition for assets among private equity and other private capital, those corporate executives who are opting to wait on the sidelines will likely find they are compelled to return to the deal table in 12–18 months’ time.”

M&A trends in the US

Encouraged by strong economic conditions in the US, but cognizant of a changing global business and political landscape, 51% of US business executives intend to pursue M&A over the next 12 months while 54% expect an increase in their deal pipelines over the same time period, according to the EY analysis.

“We saw a booming US economy in the first half of 2018, which helped spur record levels of domestic M&A activity across sectors,” said Bill Casey, EY Americas Vice Chair, Transaction Advisory Services, in commenting on the study. “The economic outlook in the US remains positive overall, with strong corporate earnings and low volatility—but executives are pursuing M&A carefully in the face of geopolitical uncertainty, frothy equity markets, and a near-decade-long bull run. These conditions haven’t dissuaded companies from pursuing mergers, but they heighten the importance of due diligence as companies continue to trade at high multiples.”

Amid growing uncertainty over the fate of multilateral institutions, 38% of US executives cited regulation and government intervention, including trade policy and tariffs, as the biggest potential risks to near-term deal-making. Difficulty in identifying high-quality assets was the second most-cited risk for near-term M&A (26%).

Private equity a key factor in US deal-making

As with executives on a global basis, US executives see private equity playing an important role in future deal-making. Fifty-six percent of US executives expect to see more asset competition in the next 12 months, and 52% say private-equity funds will be a direct source. On a macro level, executives said they expect an increase in private-equity acquisitions to be a top theme in M&A over the next 12 months.

The growth of private buy-side capital has coincided with US executives’ increasing focus on divestitures, according to the EY analysis. The overwhelming majority of US executives (92%) say the top result of their most recent portfolio review was divesting an asset identified as underperforming or at risk for disruption. This echoes the recent sentiments in the EY Global Corporate Divestment Study, in which 87% of corporate executives surveyed said they intended to divest within the next two years. “Investor pressure on companies to either maintain or improve both margins and payouts has only intensified,” EY’s Casey said. “Investors, both activist and institutional, have heightened expectations during this sustained period of record profitability and corporate earnings growth. Private equity, which continues to expand and invest over the medium- and long-term, is a natural acquirer of and steward for those divested assets. Carve-outs and buy-and-builds present an attractive opportunity for private capital in an environment where rates are still low.”

Post M&A integration and talent retention

The EY study notes that M&A integration strategies continue to evolve as acquirers seek to capture synergies between cross-sector workforces and diverse enterprise technologies. Sixty-two percent of executives achieved lower synergies than expected in their most recent transaction, and a majority (56%) say they are starting integration earlier in the M&A process.

“Competition for assets and the subsequent high valuations for acquisitions underline the need for companies to maximize the synergies they capture when integrating a newly acquired business,” said Brian Salsberg, EY Global Buy & Integrate Leader, in commenting on the study. “As companies make acquisitions outside of their typical comfort zone in order to meet rapidly changing customer demands, they need to throw out the old playbook and tailor their integration approach to each deal.”

The oft-discussed “war for talent” is a key factor in the integration process. US executives identified the onboarding and retaining of talent as the number one challenge they face when integrating an acquired company. Dealmakers’ concerns with talent reflect the business community’s broader concern with workforce issues amid full employment in the US. Seventy-five percent of US executives say their most significant workforce challenge is either retaining existing workers or identifying and hiring people with the right skill sets.

“The tight labor market presents its own set of challenges for businesses around talent acquisition and retention, particularly as technology redefines traditional roles in the workplace,” said Casey. “In particular, US executives are conscious of how their workforces respond to and are affected by mergers because they know that high employee satisfaction and good governance are linchpins of today’s favored corporate culture and thus integral to long-term talent acquisition, development, and retention strategy.”

US: a target for M&A among US executives

Nearly all respondents among US executives report a primary focus on domestic transactions—however, they say an increased focus on cross-border opportunities would be a possible outgrowth of trade and tariff policy developments. US executives identified Canada, Brazil, and Mexico as their top deal destinations outside of the US with the UK dropping out of the top five ranking.

“Latin America may present an opportunity for US businesses looking to deploy capital, boost their inorganic growth strategies, and take advantage of the privatization of key industries and other pro-business policies throughout the region,” said Casey. “The influence of geographic and cultural proximity is underscored by Canada being selected as one of the top investment destinations abroad for US businesses despite ongoing trade disputes. US executives’ attitudes toward Canada remain positive, a sentiment that looks set to improve further after recent progress on NAFTA renegotiations/trade talks.”