Credit: Eric Westbrook

After mergers and acquisitions activity boomed in 2018 to the tune of $3.53 trillion in total deals, nearly half of which were credited to the United States alone ($1.5 trillion), market watchers could fairly place big expectations on this year’s output. Not only was last year an unqualified success, but it came on the heels of a strong 2017 ($1.3 trillion in U.S. M&A), and not long after the biggest year on record (2015’s total was nearly $1.8 trillion).

But optimism must still be guarded. A number of adverse market trends and developments could put a damper on M&A activity in 2019 and beyond.

“M&A loves certainty, and there are a lot of macro factors out there that are leading to a lack of confidence and to uncertainty,” David Gibbons, a partner at Hogan Lovells, says.

Brexit Woes

As negotiations over Brexit’s ultimate form dragged on with a late-March deadline approaching, there was no doubt about the impact of all the uncertainty on deal-making. In the United Kingdom, total deal value plummeted by at least one-third in 2018, Mark Thierfelder, chair of the corporate and securities and private equity practices at global law firm Dechert, says.

“Given the increasing uncertainty around Brexit, deal volume is going to continue to be very slow until at least the end of March and potentially for the rest of 2019 if there’s no deal,” Thierfelder says.

Europe is anticipating a slowdown brought on by macroeconomic factors, he says, though it’s not likely to be as drastic as the short-term slide in the U.K.

China and the U.S.

The unresolved tensions and trade war with China are a major impediment to doing deals, not least because of an ancillary effect of this conflict—the heightened role of the Committee on Foreign Investment in the United States (CFIUS) as a monitor and regulator.

David Gibbons of Hogan Lovells.

“The U.S.-China trade war and enhanced regulatory scrutiny of deals, particularly in the technology sector, have slowed down deal-making activity,” Gibbons says.

The vigilance of CFIUS is not the only factor at work here. On the Chinese side, regulators have made it harder for money to leave the country, partly out of concern about deal-makers parking vast amounts of money in offshore funds.

The turbulent relations between the great powers made Chinese purchases of U.S. companies in 2018 fall an astonishing 94.6 percent, to just under $3 billion, according to Mergermarket’s report on 2018 M&A. The report noted that the largest Chinese bid for a U.S. company last year—Bison Capital’s $450 million offer for biopharmaceutical firm Xynomic Pharmaceuticals—didn’t even break the billion-dollar mark.

“Deal flow from China fell way off the table last year, and there is no reason to think it will come back this year,” David Shine, a partner at Paul Hastings, says.

Big Shoes to Fill?

Any prognostications about 2019 must take into account the nuanced reality of 2018, in which the biggest deals were not at all evenly distributed throughout the year.

It was really a tale of two halves, says Gibbons, who cites JPMorgan’s report on the 2019 M&A outlook. In the first six months of 2018, the report notes, some 30 “mega deals” over $10 billion in value were announced, but only 14 such deals were announced in the second half.

“If you look at 2018, it was certainly a very strong year. But most of the data out there indicate that the first five months were far stronger from a value perspective than the last seven months,” Thierfelder says.

Dry Powder

For all the uncertainty, a number of powerful forces point unmistakably to the likelihood of 2019 being another record year right up alongside 2015 and 2018, or even surpassing those years.

Corporations and private equity shops that have benefited from a surging economy are not likely to sit on the cash that has accrued on their balance sheets since the financial crisis.

Thierfelder expects U.S. economic and regulatory trends will encourage deal-making this year.

“Corporations, coming off a 10-year economic expansion, have been relatively flush with cash. With the tax reform last year, they have more free cash on their balance sheet,” Thierfelder says. “To the extent they’re not using it to buy back stocks, one of the likely uses will be to reinvest cash in M&A activity.”

The role of private equity will be particularly significant. Indeed, one of the most propitious signs for M&A in 2019 and beyond is the massive amount of dry powder that private equity shops have set aside and are ready to put to use, Thierfelder says.

“We’re seeing a continuing evolution of the market and the entry of new buyers into the game,” he says. “We’re going to see private transactions coming to represent an increasingly mainstream portion of M&A.”

Related factors include the growing role of family offices and permanent capital vehicles, longer-term private funds making investments in a variety of industries and sectors, and growing activity on the part of sovereign wealth funds, Thierfelder notes.

Private Equity Surging

Jane Goldstein of Ropes & Gray. Jane Goldstein of Ropes & Gray.

Even early in the new year, there is little doubt that private equity firms are ready to jump in and do M&A deals, says Jane Goldstein, co-head of the M&A practice at Ropes & Gray and a co-managing partner of the firm’s Boston office. One index of the firms’ strength lies in the capital markets, where private equity has been particularly active despite the government shutdown.

For all the sound and fury of the strategic deals in the opening weeks of 2019, such as Bristol-Myers Squibb’s $74 billion acquisition of Celgene Corp. and Fiserv’s $22 billion acquisition of First Data Corp., the massive corporations of the world do not have anything resembling a monopoly on M&A.

“There’s lots of money in the private equity funds and they are now able, in ways they weren’t before, to compete with the strategics,” Goldstein says. “Depending on what happens in the debt markets, that may change, but the funds are now either partnering up with the strategics or are able to win auctions because of their alacrity in doing deals.”

Alternative sources of capital will have a major impact on M&A deal flow in 2019 and beyond, Gibbons predicts.

“It’s no longer just the big buyout funds that are active. We see more activity on the part of sovereign wealth funds, Canadian pension funds, family offices and other alternative sources,” Gibbons says. “There’s been a big uptick in some of the corporate venture capital that is being deployed, and that tends to push or be a precursor to additional M&A activity.”

Speed and Skill

Many of the biggest and most transformative deals are predicated on complex financing arrangements, and indeed are often impossible without them. Rather than being a hindrance to private equity players, this is precisely what gives them an edge in 2019.

“We’ve been seeing situations where the private equity buyers, if they are really interested in an asset, can pre-empt the process and get to the finish line quickly,” Goldstein says.

In one example of such a scenario, a private equity buyer that may be considering using leverage to acquire a given asset will nevertheless tell the seller that the buyer is ready to pay all in cash, with no financing involved. The buyer may go ahead and write a check for the full amount, and then, after the deal closes, obtain financing from a lender.

“The buyer is always talking to its lender—it’s not knocking on the door of an unknown lender,” Goldstein explains. “It may be that the lender knew about the deal all along, but couldn’t move as quickly as the situation required. In some cases, even if the buyer pays all in cash, it may be able to get financing before the close.”

All the forces propelling private equity to the forefront of M&A are a strong reason to be bullish about 2019’s potential to be another record-breaking year.

Encouraging Signs

This year’s M&A action got off to a spectacular start, with Bristol-Myers’ acquisition of Celgene—one of the biggest biopharma deals of all time—announced in the first week of January.

Gibbons expects much of the action this year to be in the technology sector, as automobile manufacturers and companies like Lyft and Uber race to acquire technologies to augment the mobility of driverless cars.

“Fintech was increasingly active last year and will continue to be,” Gibbons predicts.

Indeed, while strategic and transformative acquisitions with billion-dollar price tags are likely to continue this year, Dechert’s Thierfelder expects that M&A will increasingly be used as a tool in the acquisition of products and technologies and the reshaping of industries striving to incorporate robotics and artificial intelligence.

“The middle market is going to continue to be very active,” Thierfelder says. “I think we’ll continue to see increasing amounts of consortium transactions, with a number of different investors coming together to purchase assets.”

There are plenty of positive signs, and not even the possibility of an economic downturn in the next few years is reason to be pessimistic about M&A. To the contrary, Thierfelder says, “I’ve heard from clients that if we head into a recession in the next year or two it may increase their appetite for M&A transactions.”