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Part 3 of the PwC series
Winning through M&A in uncertain economic times
The amount and diversity of capital available for business investment going into 2020 may have been unprecedented. It was and still is extraordinary. Corporate cash. Private equity dry powder. Bond issuances. Borrowing capacity, especially at historically low rates in Switzerland, the European Union and the US.
Structural changes in the economy and business behaviour have helped drive capital growth. Saving rates remain high a decade after the last recession—well past the point when they might be expected to fall, based on past cycles. The transition of the Swiss economy from manufacturing to services has resulted in less tangible investment. Companies that may be struggling with an “ideas deficit” are not confident in what they should pursue next, leaving cash largely untouched.
Private investors are also exerting more influence, shifting the capital mix. Private equity firms accounted for less than 10% of total Swiss deal volume in the 1990s. In 2019, that share surged to more than 35%. At the same time, more firms are considering longer holding periods that allow more time to create value and generate higher returns.
At some point, this abundance of capital likely will decline, influenced by short-term economic uncertainties but also longer-term forces. Some of the “savings glut,” for instance, could dwindle as baby boomers who stashed away cash for decades start to spend more in retirement. Yet plenty of funding still could be available for deals by corporate and private investors in a downturn.
More corporate cash goes to M&A
European nonfinancial companies held about USD 1.1 trillion in cash and equivalents in 2018—about three times the amount in 2000. And that does not count cash that companies have invested in longer-term securities, which are not included as cash and equivalents on corporate balance sheets. Companies have generated more cash from operations over the last few years, PwC’s analysis of cash flow statements found, and the cash they have spent on acquisitions has more than doubled during the latest M&A wave. As a result, cash has more closely tracked with deals than in previous cycles.
This cash is not evenly distributed among companies. Novartis, Roche and Nestlé held approximately CHF 32 billion in cash by the end of 2019, which is more than all cash holdings combined of the remaining nonfinancial companies in the Swiss Market Index (SMI).
Private equity takes a bigger share
The capital held by private equity (PE) firms but not yet invested continues to grow, more than doubling in the last seven years, according to data from Preqin. Private investors, including pension funds, family offices, high net worth individuals and others, continue to seek higher returns not afforded in more traditional investment vehicles. They also see benefits to diversification in investments, and are willing to deploy capital to explore it.
As PE firms’ share of total M&A has increased, so has the PE industry. The attraction of PE as an asset class, both in terms of the private nature of the capital and past success, has created momentum behind large PE firms, which are leveraging their scale and resources to capture an increasing share of fundraising.
Some PE firms have attracted other investment partners, like sovereign wealth funds, that add to the capital supply. At the same time, they have diversified their tactics—inserting themselves into different parts of the capital structure—and the tools at their disposal to generate value have become more sophisticated.
Debt options evolve and expand
With historically low central bank rates since the last recession, debt has been plentiful for companies. Lower interest rates after a downturn, especially a historic one, are understandable. But those rates typically rebound in an improving economy. Instead, the slow recovery from the global financial crisis and other concerns, such as the recent trade tensions, have kept rates well below past levels, and it does not seem likely to change soon. Policy rates in Switzerland have been negative since 2015, and central bankers around the world are considering more rate cuts.
Bank financing
The overhaul of government regulations after the global financial crisis included tighter capital requirements for banks. Commercial and industrial loans have increased overall since the last recession, but the largest banks still have to undergo a stress test every year to understand how they would be impacted in a downturn. As bank financing has become tighter compared to previous cycles, the growth in nonfinancial corporate debt has provided alternative sources.
Leveraged loans
Often extended to companies that already have ample debt, leveraged loans typically have higher interest rates and can be more costly than other loans but usually are more flexible than bonds. Since 2015, the European leveraged loan market has doubled. The low rate environment and tighter bank requirements have led more borrowers to leveraged loans, which some companies may find more convenient than public debt markets. As a result, roughly EUR 200 billion in leveraged loans was issued in 2018, of which 59% was in new money compared to 41% in refinancing.
Bonds
The amount of corporate bonds issued by European nonfinancial companies has, in comparison to the pre-crisis average of USD 250 billion average annual issuance, increased by 54% to USD 385 billion in the post-crisis years. And that bond universe has broadened to include more lower-quality bonds. From 2007 to early 2019, the amount of BB-rated bonds—the highest non-investmentgrade bonds—grew by nearly 40%. Not all of this was newly-issued bonds; some came from past rating downgrades, often caused by country rating downgrades experienced by Greece, Portugal, Spain, Italy, Ireland, Belgium and France.
The capital mix for deals going forward
As in past M&A cycles, the various sources of capital available for deals probably will shift as new circumstances unfold.
- Public equity already has become less dominant in acquisitions, and it is likely to become a smaller percentage of overall deals funding, especially if the stock market declines; sellers may be less inclined to accept shares at lower values. Such a decline also could result in fewer IPOs and even longer holding periods for private investments.
- Bond issuances also could be weaker, as the lower–quality bonds that have thrived in the latest M&A wave would see less demand in a worse economy. But some large companies in a more solid financial position still should be able to offer reliable investment-grade bonds.
- Cash will further strengthen those companies’ positions. Joined with the ample private equity dry powder, the capital mix will feature substantial liquidity. And similar to past downturns, we would expect interest rates to remain low to help stimulate the economy. That could make other debt beyond bonds a viable option for many companies.
If businesses have the appetite for M&A, the above sources of capital will provide the means. Before the economy softens, however, corporate and private acquirers need to make sure they are not simply relying on a big bankroll to execute deals. The next part of Winning through M&A in uncertain economic times outlines what businesses should do now and be prepared to do later to capitalise on M&A opportunities.
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Contact us
Claude Fuhrer
Partner, Deals Strategy & Operations Leader, PwC Switzerland
Tel: +41 58 792 14 23
Director, Business Restructuring Services, PwC Switzerland
Tel: +41 58 792 21 60