M&A Activity Leverages Economic Upturn
2016 was a year of upheaval. The drop in oil prices, the volatility of the American stock exchanges, the change in the Chinese economic model, along with several surprising election results, worked together to keep us in suspense. Nevertheless, transactions reached some notable highs: 17,000 transactions were executed for a total of USD 3 trillion. We expect business will continue to be brisk and that transactions in Continental Europe will rise from USD 319 billion to USD 459 billion. Europe is recovering its growth and Spain's momentum continues: transactional activity will register an increase of about 48% by 2018. However, the perspectives are less optimistic for the UK, where operations are expected to suffer a decrease.
Trump, China and the Brexit are three elements that are going to determine the rate of recovery and the investors' appetite for transactions. There are various possibilities on the table: the U.S. may adopt protectionist commercial policies, throw away its tax incentive plan or implement a migratory policy change that affects professionals' availability. This might weaken the country with the highest GDP in the world, significantly dampening mergers and acquisitions. Furthermore, the demands of the Trump administration for a strong yuan, and the risk that custom duties may increase, are factors that could limit China's capacity to pilot a difficult economic landing. As to the Brexit, we are optimistic about negotiations and trust both parties will reach agreements that do not pose major obstacles to investment. A close eye will have to be kept on the ups and downs of Italian and German politics, as well as the delicate Greek situation in the EZ. Finally, the national regulations and the restriction of transactional activity must also be considered. Regulations are becoming increasingly more complex and focused on national interests, fact that has triggered debate regarding controls and restrictions on FDI in some relevant countries; as well as initiatives coming from countries like China.
Once the phase of austerity and cuts in government spending in Europe and the U.S. is over, it is urgent that the investments in infrastructures and other areas are accelerated. If the European and American governments take advantage of the low interest rates to promote large projects, it will benefit employment, transactions, and other countries where the products or services necessary to execute such projects are produced. Another contributing factor will be the large cash balances currently held by European and U.S. companies. Venture capital firms and other funds are holding extraordinary amounts of capital and many have reduced their debt and increased their cash, ready for new acquisitions. Thus, we have seen an surge in investors' interest and their search for suitable targets that fit well with the objective of disinvesting in different business units or assets from firms looking to focus on their core business. Other reasons why we expect transactional business to grow are: boards' and managers' rising faith in economic recovery, the increased availability of affordable credit, and the fact that enterprises still find it difficult to grow organically, something that turns the tide towards acquisitions versus slow internal expansion initiatives.
The high valuation of certain target companies in capital markets raises questions. EBITDA multiples have reached the highest levels since 2007. According to Bloomberg, in the United States the median multiple for 2016 sit at 15.7 times EBITDA. It is an incipient trend but it does not necessarily point to a full turn towards higher multiples in all areas, just in certain sectors (such as high tech, telecommunications, consumer products and retail, pharma/healthcare and industrials). It would not be surprising to see the prices of high quality targets rise, to the extent that strategic purchasers or private equity companies continue to seek growth opportunities and high returns in areas like pharma or technology. Nevertheless, the high valuation found in different sectors and geographical areas, added to the withdrawal of monetary incentives in the U.S., could put a good number of corporate transactions on hold. Precisely to face sellers' expectations of high target prices, in 2016 and 2017 we have seen an increase in the use of purchase price adjustment mechanisms: locked box, dollar-for-dollar, De Minimis, Capped and earn-out clauses. While the period used to calculate an earn-out in the past used to be two or three years, currently it is not unusual to find periods of up to five years.
In 2016 the pharma and healthcare sector was one of the most active, with transactions amounting to USD 220 billion and, in the mid-term, it is likely that certain structural trends (further public-private collaboration, major demographic changes, etc.) will make it even more dynamic.
Transactions in the financial sector have traditionally led M&A (in the period of 2010 to 2016, 20% of all transactions were financial operations, and in the five years prior to the crisis, they represented 25% of the total). Such transactions normally grow or shrink in accordance with the general trend. Over the next few years, the consolidation of the European banking system will continue and important acquisitions will emerge as increasing regulations and capital requirements will force the banking sector to get rid of those non-core businesses. The technological changes that threaten traditional banking will cause most of the transactional activity in the sector, mainly the purchase of small commercial banks that operate in the internet or exclusively via apps, as well as acquisitions of purely technological companies, which will become very attractive targets.
Regarding technological business transactions, it will be the new firms and start-ups that will draw most of the attention. Purchasers from every sector are growing inorganically and betting on the success of innovation, digitalization, the collaborative economy and the internet of things. Data protection, cybersecurity, data analytics, the convergence of telephone services with television providers, and the innovation in payment platforms are the incentive behind an array of transactions.
I would like to highlight the international interest in Chinese investment appetite. In 2016, Chinese FDI reached all-time highs; year-on-year investment tripled in North America and doubled in Europe, coming to a total of USD 94.2 billion (in comparison to their annual average of less than USD 1 billion prior to 2008). Previously, Chinese investment abroad was traditionally carried out by large state-owned enterprises. However, in recent years new actors (private companies and equity funds) have set their sights on new sectors. Spain is no exception with regard to this trend (Chinese investment reached USD 1.8 billion versus the USD 470 million of the prior year), with infrastructures, leisure and the agro-food business being the most attractive industries. In this context of China's turn towards a more modern economic model based on the growth of internal demand, the Chinese government is encouraging outward FDI particularly in advanced technology, R+D, distribution, natural resources, haven assets, and sources of know-how.
For Latin America, we don't foresee economic perspectives to improve significantly until 2018 and 2019. The region is facing slow growth, low commodity prices and systemic political instability. Over the past five years, with 77 transactions recorded, Spain has been the preferred target for Latin American investors. During the difficult years of the economic crisis these investors mitigated its negative effects in Spain and when dynamism picks up again, multinational Latin American companies will continue to invest here, given its strategic position as gateway to the European market. Over the past few years the financial, food, distribution, construction and cement sectors were the most attractive sectors for Latin American investment.
We feel that international investment believes in our country. During the crisis, Spain was excluded from the investment plans of many multinational firms and received the opportunistic investment in financial assets and real estate. But this coincided with our companies consolidating their global footprint, by executing productive investments and seeking access to new markets, in light of the weak domestic environment. Overall, Spanish companies achieved an extraordinary level of internationalization and leadership, making them very attractive targets. We have observed an increase of foreign investment in purely industrial assets and believe this trend will continue in 2017.