'Fasten your seat belt': There's going to be a dealmaking bonanza in 2017

Screen Shot 2017 02 02 at 12.56.08 PMBrad GevurtzBrad Gevurtz, Managing Director, Investment Banking, D.A. Davidson & Co.

It’s amazing how the third best year ever in M&A activity can be viewed as “disappointing.” But that’s just what we’ve been calling 2016.

Yes, 2016’s $3.84 trillion of global M&A was down from the $4.66 trillion in 2015, but historically, 2016 was a very strong year and there were several blockbuster deals announced in the fourth quarter that suggest 2017 could be a banner year ahead. So what do M&A experts think will happen in 2017? Well most of them are optimistic, for the following reasons.

Despite the general view that interest rates will increase, they are still at historic lows, and low interest rates decrease the cost of funding M&A deals. In addition, stock prices, which are at near record highs, give companies the currency to pay higher multiples for targets, the ability to raise capital cheaply, and the confidence to strike deals. Adding fuel to the takeover fire is the record level of cash held by corporations, which could actually grow under the new administration. A proposed change in the tax code could make it easier for US companies to repatriate cash, which could then be used for domestic acquisitions.

The problem is that the returns on cash are historically low. When you add the fact that organic growth in the US economy has been sluggish, CEOs and boards looking at M&A deals start coming to the same conclusion. They look at build-versus-buy scenarios and see that by buying they can accelerate growth and transform low return cash into potentially high return investments. Whereas five to 10 years ago, some of these M&A deals wouldn’t pencil out, today the combination of historically cheap debt, high buyer P/E ratios, and unattractive alternate uses of cash has flipped expected returns from negative to positive.

From a purely financial standpoint, the pump is primed for M&A.

Which leads us to the strategic imperative. Technology is radically changing how companies do business. Just take a look at Amazon’s effect on retail, Uber’s on transportation, and Netflix’s on media. There’s a phrase tech people use to describe this phenomenon, which is “software is eating the world.” If you are a department store or a cab company, my guess is you are experiencing this real time. But what does this mean for M&A? In the past, if you were selling a tech company, there was a list of tech companies you would approach as buyers. That list has expanded. In the past few months Wal-Mart, GM, and Unilever have all made $1 billion plus acquisitions of tech companies. And they did it for defensive reasons (e.g., they don’t want to become the next Blockbuster) as much as for offensive reasons.

I don’t want to end this M&A forecast without discussing my friends at the private equity firms. PE funds are sitting on mounds of cash, they are besieged by lenders who want to extend credit, and their investors want them to buy companies. These funds are run by very smart people, who know how to make acquisitions, close them quickly, and move on to the next deal. Plus, many of them have portfolio companies that allow them to understand the business of the seller and to make money from revenue and expense synergies.

So absent a macro economic shock to the system, an overseas war, or some governmental blunder, where do I think M&A is going in 2017? I think I can sum it up in a few words .. fasten your seat belt.

Brad Gevurtz is a Managing Director of Investment Banking at D.A. Davidson & Co.

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