Expanded Overview

Auto supplier M&A activity continued at a robust pace in the first half of 2018, although down modestly in the number of deals closed during the period versus the same period in 2017. This is a continuation of a trend we saw during the first quarter of the year. Trends impacting the appetite for M&A opportunities are generally segmented according to tailwinds and headwinds. Among the tailwinds are the following:

  • Supportive economic underpinnings – low unemployment, rising housing starts, relatively low interest rates (although headed up), consumer confidence tracking at historically high levels, and rising levels of disposable income per capita characterize an economic picture of relative strength in spite of the consensus view that we are very late in the current positive economic cycle
  • Tax reform – passage of The Tax Cut and Jobs Act, with the stimulative impact of lower rates offsetting restrictive elements such as limits on interest and NOL deductibility
  • Demand/supply imbalance – for several years now, the demand for high-quality acquisition targets has significantly exceeded the supply of those assets available to be acquired, hence ever-escalating valuation multiples. Corporate buyers are leveraging strong balance sheets while financial buyers continue to experience unprecedented levels of fund-raising success, creating a competitive deal market which favors the well-positioned seller

Headwinds to M&A activity include:

  • Declining vehicle sales volumes – having peaked in 2016 at approximately 17.5 million units, sales of light vehicles in the U.S. are expected to decline steadily through 2021, with the trough occurring somewhere between 16.5 million units (a 6% decline from peak) and 13 million units (a 25% decline from peak), depending on which analyst you believe
  • Shifting macro factors – escalating gas prices, tightening monetary policy (i.e., rising rates), rising raw material costs, and shifts toward more restrictive trade policies (including tariffs) create an environment of increasing uncertainty within a complex, global automotive value chain

Against this backdrop of shifting forces impacting auto suppliers, there are a number of prevalent trends which are driving M&A activity and will continue to do so into the foreseeable future. These include:

  • Technology advancements – the growing emphasis on automated, connected, electric and sharing (ACES) vehicle technologies is increasingly driving M&A activity as both OEMs and suppliers search for differentiated and proven technological advancements that exceed those obtained from in-house R&D efforts
  • Globalization and vehicle lightweighting trends – pressure by OEMs for suppliers to be able to efficiently support global vehicle platforms is not a new dynamic within the supply chain, but one which continues to influence M&A activity nonetheless. Likewise, regulatory policies mandating escalating fuel efficiency targets continue to drive acquisition activity as suppliers search for technologies that will enable lighter vehicles, particularly in light of driver-assist and communication products that add to a vehicle’s weight
  • Evolving product portfolios produce more spin-offs – as suppliers shift resources to support product portfolios more reflective of ACES technologies, we are increasing seeing those companies spin-off business units containing more traditional mechanical, non-core products

For the remainder of 2018, we believe we will see a continuation of the healthy M&A momentum experienced in 2017 and through the first half of 2018. Well-capitalized suppliers and private equity buyers with deep pockets will (i) increasingly seek ACES technologies that leap frog those of competitors, (ii) look to enhance their global supply capabilities, (iii) pursue lightweighting technologies that assist OEMs to achieve tightening emissions standards, and (iv) spin-off business units that fail to contribute to long term strategic objectives, all while being mindful of shifting economic and geopolitical forces beyond their control.

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Explore the insights and news from our Restructuring Advisory practice in our new Restructuring Quarterly.

Highlights from Q1 2018 include:

• Practice Leader Sheldon Stone on “Predicting the Next Recession”
• Results from our 2018 Lender Outlook Survey
• Details on our upcoming Current Trends in Bankruptcy panel event in Chicago on May 15
• A look back at our recent webinars: Interim CFO and Exploring the Basics of Due Diligence
• Upcoming speaking engagements and other items of interest

Much has been written in recent years about the impact of a burdensome regulatory environment on innovation. The focus more recently has been on the potential impact (positive or negative, depending on the political views of the commentator) of the current U.S. administration’s push to reduce regulatory burden on various industries. With respect to healthcare, the regulatory environment is pervasive, encompassing life sciences, medical technology, and healthcare services. However, given the industry’s ultimate goal of preserving and enhancing human life, people seem to be generally more favorably disposed toward regulation in healthcare than in other sectors of business.

That said, the cost of dealing with regulations in product development or regarding compliance with mandates associated with the delivery of healthcare services, to name but a few, can significantly reduce returns and make investing in particular businesses or products less attractive. It seems reasonable to assume that, on the margin, the regulatory burden on healthcare has a somewhat depressive effect on innovation; however, the fact remains that with the intellectual horsepower available in this country, incentives in place to reward success and capital to implement, innovation continues to thrive. Much like the flowers beginning to push up through the early spring snow, new products and services, and new ways of attacking long-standing issues seem to shrug off the burdens — justifiable or not — placed on businesses by governments.

Interestingly, with respect to healthcare services, despite the turbulence the industry has been subjected to recently (ACA, transition to value based reimbursement, DOJ opposition to significant M&A transactions, etc.), business leaders continue to explore ways to connect assets in unique ways that address the issues of cost, quality, and patient satisfaction. While it’s unlikely that all of recent transactions in the healthcare sector will fully achieve their stated objectives, progress will be made. There are too many bright people, too much available capital and too much incentive for it not to. The prize is greater access to care, quality, and patient satisfaction, which, when combined with sustainable cost containment, will yield solid financial performance for industry participants able to achieve these broad metrics.

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M&A activity in the food and beverage industry remained robust in Q1 2018, a continuation from a highly active 2017. While Q1 2018 activity was down as compared with Q1 2017 levels, we believe that interest in the sector and current industry trends will result in full year 2018 activity ending up in-line with 2017 levels.

A number of sector trends will continue to drive deal activity in 2018. Primary trends include the emergence of the so called Amazon effect and changing consumer preferences toward (i) healthier, better-for-you alternatives, (ii) local brands/ingredients, and (iii) an increased appetite for snacks and on-the-go consumables.

As large, old-line food and beverage companies (think General Mills and Kellogg) have been caught holding the bag with vast, traditional product portfolios (e.g., sugary cereals), consumers, particularly millennials, have been voting with their wallets and forcing big changes at these companies. Hence the falling stock prices for old liners, including last-twelve-month declines of 10%+ for each of General Mills, Kellogg and Post. Large, old-liners have been prioritizing M&A for on-trend growth as it is often easier to acquire trusted, proven brands than to build them organically. And with on-trend, high-quality businesses of scale in short supply, competition for deals is often price based, with buyers offering significant premiums. For instance, Hershey paid a 70%+ premium for better-for-you snack company Amplify in late 2017.

Food and beverage retailers are also under pressure from the Amazon effect. The monumental impact of Amazon’s acquisition of Whole Foods in mid-2017 illustrates Amazon’s ability to significantly disrupt established industries. Stock price impacts were immediate, with next-day declines of 15%, 12% and 5% for Kroger, Target and Walmart, respectively. This generated an urgent need to develop scalable online grocery/fulfillment strategies among traditional grocers. As they experiment with online order/in-store pick-up, some have leveraged M&A to acquire proven delivery capabilities (e.g., Target’s acquisition of same-day delivery platform Shipt in late 2017), a trend we expect to continue.

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Despite a slight pull-back in 2017, building products sector M&A activity remained strong with 117 transactions, during the year representing approximately $4.9 billion in deal value. Robust acquisition activity has continued into 2018, as the number of transactions in the first quarter increased 8.8% over the same period from a year earlier.

The current favorable M&A environment has been supported by increases in both residential and non-residential construction, as well as increased spending for home repair and remodeling. We expect M&A activity to remain strong through 2018 driven by low interest rates, strong economic fundamentals, healthy levels of corporate cash balances, and access to cap¬ital available through debt and equity markets. Additionally, the enactment of corporate-friendly tax reform is expected to further accelerate acquisition activity.

The building products sector remains a highly competitive marketplace with larger players benefiting from scale. Both strategic and financial buyers are looking to capitalize on expanded economies of scale and expand their scope by filling gaps in existing product offerings. In addition, these firms will continue to search out new geographic market opportunities. As a result, we expect companies with strong brands and a value-added proposition to likely become acquisition candidates.

We’re also continuing to pay close attention to the competitive tension from e-commerce players. Al¬though penetration in building products has lagged consumer categories, the sector is not completely insulated from the so-called Amazon effect. Amazon’s B2B unit currently hosts 13MM home improvement and 3MM building material SKUs. The program, which launched three years ago, has since realized a five-fold increase in its home improvement revenue – by some estimates, Amazon’s home improvement sales could outpace Menards’ in 2018. Additionally, Amazon’s Home Service feature places customers in direct contact with professionals for bulky or behind-the-wall installation projects, and can potentially offset the key advantages of brick-and-mortar competitors. Consequently, residential building products category leaders are racing to get in front of this challenge by investing in downstream e-commerce tools and building out their direct-ship capabilities.

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