Earlier this year, I wrote a piece titled 2012: The Perfect Storm, which forecasted a host of reasons that would drive recordsetting merger and acquisition activity in the United States this year. So as 2012 is coming to a close, I thought it only fitting to look back and take stock of what actually happened, along with what’s likely to be in store for the immediate future.
First, let’s step back and revisit some of the forces I felt would create this Perfect Storm. Entering 2012, and for some time prior, large corporations and investment funds were sitting on unprecedented levels of cash. These cash balances have only grown since, largely because these beneficiaries are challenged as to what to do with this cash in order to generate reasonable returns without incurring unreasonable risks. Despite these challenges, however, these cash holders were, and continue to be, under mounting pressure to put it to work. In the midst of what continues to be a difficult and uncertain economy for generating organic business growth, businesses remained slow to hire, not convinced that the added personnel would yield additional revenues and profits. Yet simultaneously, the pressures were also mounting on these businesses to grow revenues and profits. These collective factors, I hypothesized, would motivate particularly large businesses and investment funds to look towards acquisitions as a means to deploy cash and generate growth.
At the same time, there were several forces that I felt would drive an unusually large number of business owners to contemplate selling their business. Most notably, the Bush Tax Cuts are due to expire at the end of 2012, effectively raising the federal capital gains tax rate from 15 percent to as high as nearly 24 percent, an increase of close to 60 percent. For a business owner considering the sale of a $5 million business, this could mean nearly $500,000 in additional taxes taken out of the consideration they would receive. Viewed another way, if the tax cuts expire, to achieve the same net proceeds after 2012, that same business owner would effectively have to sell their business for roughly $5.6 million. You simply can’t make up in value what you’ll lose in additional taxes in that short of time. Beyond tax incentives, our country’s population demographics continue to contribute to rising M&A activity. Baby Boomers make up a large share of this country’s business owner population, and as they reach their 60s and 70s, particularly those that don’t have children to take over their company, a meaningful number of them will be selling their businesses.
Predictions Come True
The collision of these factors driving both buyers and sellers to come together, I predicted, were destined to create a Perfect Storm that would result in significantly heightened mergers and acquisitions across most industries. By nearly all accounts, even with the year still not complete, this has been the case. Punch in an online search for merger and acquisition activity in 2012, and you’ll find posts regarding numerous industries that have seen major increases in deal volume this year. Further, it is expected that an overwhelming amount of this volume pick-up will actually take place in these last few months of the year. Most of us, by nature, are procrastinators, and that combined with the fact that it’s very difficult to predict how much time it will take to complete one of these deals, will likely result in a frenzy of transactions that will be pushed to close right up to the end of the year.
So this year has played out as many expected. Cash reserves continue to be an obvious driver to this activity. In fact, there remains more cash at the disposal of corporations and investors than there are quality companies to deploy it to. Given this supply and demand imbalance, and the fact that these investors don’t typically resort to buying lesser quality companies, the result has been that they’re paying more for quality companies.
It also remains costly to hold cash in this environment. Given the rate of inflation, holders of cash are generating net wealth decreases. And there is not an end in sight to the depressing returns for which our cash currently generates. For large companies wishing to grow their value, this has meant they must spend, and to a large degree they have in 2012. Moralistically, many argue that this cash should be spent on adding jobs, and it does appear that overall, jobs have been added. But not by much. That’s because, as predicted, there has remained too much economic uncertainty. Executives leading these companies aren’t yet convinced that consumers are prepared to buy again in a big way. And as long as they remain unconvinced, they will not hire in mass.
Yet the flip side to this is that these large businesses have to grow revenues. The pressures to do so are unreal. People and institutions that invest money on a large scale, simply don’t tolerate wealth stagnation. They mandate that their wealth grows, and if you can’t do it for them, they’ll find someone else who can. Given the above-mentioned constraints, corporations and investment funds have turned to acquisitions in a big way. If they do this properly, they generate revenue growth and earnings synergies that lead to value accretion and, of course, gains in investor wealth.
On the other side of the table, as if they needed extra incentives to consider a sale of their company, business owners have taken notice. Regardless of age, these owners are being solicited hard by various business buyers, and they are doing the math that results when you combine premium valuations with preferable, yet possibly increasing, tax rates. The result has been at least enough sellers to fuel the other side necessary to make for this Perfect Storm.
2013 and Beyond
From a deal perspective, 2012 is pretty much in the books. By that I mean transactions that will close in 2012 are already underway. For the most part, there’s just not enough time to start the process of selling a company in mid-fall and get the transaction completed by year’s end. So what can we expect for 2013 and beyond? Unfortunately, probably the only sure thing is more uncertainty. We have a huge election coming in November, and the global economy remains nebulous. I think that much of what happens in 2013, at least the extent to which it happens, will depend on the upcoming election.
For instance, if the tax cuts are not extended, I believe we will see a slowdown in mergers and acquisitions. That said, I also believe that many of the drivers that contributed to 2012’s Perfect Storm will continue to be seen in 2013 and possibly far beyond. I see cash supplies remaining high, and due to the aforementioned challenges that come with large cash reserves, along with other economic factors, I believe buyers will remain in strong supply. And none of us are getting younger, which means that more Baby Boomers will become sellers as time goes by.
On the other hand, if by chance the tax cuts are extended, does this mean the Perfect Storm survives another year? Perhaps. Either way, Perfect Storm or not, I do predict a steady volume of mergers and acquisitions for 2013. So if you didn’t act in 2012, your time may not have run out yet.
Lance R. Tullius is Managing Partner of Tullius Partners, an investment banking firm that specializes in providing merger and acquisition and financial/strategic advisory services to companies operating in select industries.