After a banner year for mergers and acquisitions in 2015 and a choppy but overall good market in 2016, a solid majority of respondents to Dykema Gossett’s annual M&A outlook survey don’t expect the market to strengthen next year.
Just 33% of the 74 M&A professionals, advisers, and corporate executives who participated in the survey said they anticipated higher deal activity next year, while 47% thought there wouldn’t be significant change in 2017 — and no change is still a pretty good outlook, all things considered. Indeed, many of the factors that influenced the market in 2016 will continue to drive the market in the coming year.
Smaller deals and those by privately held firms will lead the way. Almost three-quarters of the respondents (72%) thought deals with a value of less than $50 million would increase in 2017, and 68% expected that M&A activity would increase among privately held businesses.
In support of those expectations, respondents cited some of the same factors represented in last year’s survey, including aging business owners looking to sell and concerns that the selling window — propped open by low interest rates and the availability of capital — might close in 2017. Some sellers may look to complete deals they’ve been working on by year-end, also in part over concerns that there could be an increase in the capital gains tax in 2017. Others may wait, as earnings have stabilized for some businesses, potentially decreasing the pressure to sell right away.
Availability of capital and low interest rates continue to drive M&A activity. For the third straight year, survey takers said availability of capital will be the primary driver of M&A activity, including cash on strategic buyers’ balance sheets, undeployed capital at private equity funds, and readily available debt financing.
One quarter of survey respondents cited interest rates as the most significant factor expected to drive M&A activity in the United States next year. While it’s expected that the Federal Reserve will raise rates in December for the second straight year, the increase likely won’t be substantial enough to impact buying decisions.
Obstacles to M&A transactions remain the same, with a twist. The most common roadblocks to dealmaking will again be valuation, availability of quality targets, buyer competition and due diligence. Respondents to the survey, which was conducted before the presidential election, also expressed concern that there might be corporate tax increases next year. However, with the election of Donald Trump, we expect corporate tax rates may actually decrease rather than increase. At the same time, President-elect Trump has hinted at increasing taxes on carried interest.
Hot industry sectors remain the same. The energy, health care, and technology industries are expected to see the most activity for the third year in a row. Energy took the top spot this year, likely due to over-leveraged companies in the oil and gas sector seeking buyers, but that might be fading after a number of bankruptcies in 2016. Private equity has started to invest more in oil and gas exploration and production, a sign of increasing health in that sector.
Financial buyers will top strategic buyers. Survey respondents said they expect financial buyers — those looking for solid, well-managed companies — to have more influence than strategic buyers — of competitors, suppliers, or customers — for the first time since 2008. The former have been gaining ground over the past 12 months due to increased interest from private equity firms in deals worth $5 million or less.
That said, the distinctions between the two types of buyers have become blurred, as financial buyers, like private equity firms, make acquisitions in spaces where they already own businesses, effectively acting like strategic buyers.
The U.S. economy. There was a notable decline in the percentage of respondents in this year’s survey who reported a positive outlook on the U.S. economy as a whole. Last year, 48% were positive and 37% neutral, while this year only 28% were optimistic and 54% were neutral. As we’ve been in an upward cycle — both for M&A and the economy — for some time, it’s not surprising that some people believe the cycle will end. Still, most don’t think the sky is falling, and nothing suggests that it will a year from now, either.
Political issues. Intense political discourse in recent years and the 2016 presidential election cycle have undoubtedly created much anxiety and uncertainty among individuals, but results of the Dykema survey suggest that political issues may have little effect on the M&A market in 2017.
Four in five respondents thought that health-care reform, Brexit, financial-institution regulatory reform, overtime regulations, and antitrust enforcement would have no impact on dealmaking. Half of survey-takers thought the outcome of the presidential election would have a neutral effect on the M&A market.
That said, respondents’ biggest concerns for the market in 2017 related to federal regulation of business, the minimum wage, federal deficit spending, and taxation of carried interests.
While Trump’s public statements regarding the latter two items may justify some concern, an overwhelming number of respondents felt his policies would be generally favorable toward business. Given his pro-business stance, antitrust review may become less restrictive, as he has previously been on the opposite side of the Federal Trade Commission and Department of Justice in trying to build his own financial empire.
Still, he has expressed certain antitrust concerns, and only time will tell which way his administration might lean.
All things considered, it looks like we are poised for another good year of M&A, especially in the market for small and privately held businesses. Availability of capital and low interest rates will continue to drive M&A activity, and what were previously projected to be obstacles to dealmaking in 2017 may look less like obstacles under a Trump presidency.
That said, the information gathered from respondents to the Dykema survey over the past couple of years suggests that it is unclear how long the window for dealmaking will remain open. We recommend that dealmakers contemplating an M&A transaction in the near future take a hard look at doing the deal in 2017 while conditions remain favorable.
John Pray III is an associate in the corporate finance group in the San Antonio office of Dykema Gossett. Jeff Gifford is co-leader of both the firm’s mergers and acquisitions subgroup and family business transition team.