Corporations are finding it increasingly difficult to grow in today’s slow-growth economy. But money is cheap and balance sheets are flush with cash, which has led several major players to combine forces and reap the benefits of their resulting size and efficiencies.
In 2015 alone, the Milwaukee area saw the announcement or completion of some of the biggest deals in recent memory, including: Glendale-based global multi-industrial firm Johnson Controls Inc.’s pending merger with Ireland fire protection and security solutions company Tyco International plc; Milwaukee-based utility Wisconsin Energy Corp.’s $9 billion acquisition of Chicago-based Integrys Energy Group; McLean, Va.-based USA Today publisher Gannett Co. Inc.’s $297 million acquisition of Milwaukee Journal Sentinel parent Journal Media Group; London-based megabrewer SABMiller’s plan to sell its 58 percent stake in the MillerCoors joint venture to Denver-based brewer Molson Coors for $12 billion; Cincinnati-based grocery giant The Kroger Co.’s $824 million acquisition of Milwaukee-based Pick ’n Save parent Roundy’s Inc.; and St. Louis-based Columbia St. Mary’s parent Ascension’s acquisition of Wheaton Franciscan Healthcare’s southeast Wisconsin facilities.
This follows a national trend toward consolidation which helped advance M&A activity to record levels last year. Global announced M&A volume surpassed $5 trillion for the first time in 2015, according to Dealogic, which provides analytics to investment banks. There were 10 deals of greater than $50 billion announced last year, one of which is the Anheuser-Busch InBev bid for SABMiller that is expected to result in the MillerCoors spinoff.
Most companies that weathered the Great Recession have already right-sized their workforce. Balance sheets are generally very strong in the post-recession economy, with debt capacity or cash available in spades, said Steven Barth, a partner and co-chair of the Transactional & Securities Practice at Foley & Lardner LLP in Milwaukee. At the same time, interest rates are very low and money is relatively easy to borrow.
“As companies continue to deal with what I would call the new normal economy…companies have to look for acquisitions for a very significant part of their growth,” Barth said. “Growing organically is so difficult to do, especially if you’re a very big company. Really the only way to have an impact on your growth curve and to have a substantial impact is acquisitions.”
“Given the nature of our practice, we’re very excited about all this activity,” said Chris Smyth, transaction advisory services leader for professional services firm EY’s central region, which includes Milwaukee. “Our outlook for 2016 is positive as it relates to M&A.”
According to EY’s global Capital Confidence Barometer survey in October, 59 percent of companies surveyed expected to pursue an acquisition in the next 12 months, which is the highest appetite for deal-making measured by the survey in six years. The Barometer, which included 1,600 executives in 53 countries, also indicates that most M&A activity is occurring in what EY defines as the medium-sized category, at between $251 million and $1 billion, but megadeals of more than $1 billion are still prominent.
“We’ve gone through a period where most companies have been very focused on the cost and operational efficiency side and now they’re focused on growth,” Smyth said.
“This is an ongoing trend of companies using M&A as a tool to drive growth,” said Joe Packee, managing director and co-head of Global Industrial
Investment Banking at Robert W. Baird & Co. Inc. in Milwaukee. “In the current global economy, organic growth is limited and companies are achieving the growth they need by going out and buying it.”
Activity up across the board
While the national trend is clear, the reasons for the individual transactions are across the board. Depending on the transaction, a company could be making an acquisition to add a new product or technology, expand geographic reach, attain synergies in a supply chain or other operational adjacencies, or to eliminate a competitor and improve market position, Packee said.
And across industries, financial conditions are ripe for mergers. Corporate earnings and stock performance grew quickly post-recovery, from 2011 to 2013, but then stagnated, said Matteo Arena, associate professor of finance at Marquette University in Milwaukee.
“So you see companies that have to figure out how to keep growing and when internal growth opportunities, new investments and earnings are stagnant, then companies will try to increase earnings by acquisitions,” Arena said.
“Many corporations have very strong balance sheets, with plenty of cash to finance these deals,” Packee said. “Where they might need to tap debt financing or where private equity firms may be involved, debt markets have, for the most part, remained incredibly accessible and provided a lot of relatively inexpensive debt.”
“When you combine the stockpile of cash held by companies with the low-cost debt available to finance M&A transactions, that translates to tremendous purchasing power,” said Rob Jansen, managing director at Milwaukee merger and acquisition advisory firm Bridgewood Advisors Inc. “There is significant motivation for companies of all sizes to put idle cash to work in a strategic way.”
“I think it’s happening in every single industry,” Barth said. “Everyone has their own different dynamics and independent industry factors that are impacting one way or another, but there’s no question. I think it’s across the board.”
Wisconsin’s M&A activity has in most ways mirrored the transaction trends across the country and the world.
“The overall trend in these megadeals is industry consolidation, which has been motivated by both cost synergies and growth synergies,” Jansen said. “While the megadeals naturally receive most of the headlines, the same M&A strategies are being employed by middle-market Wisconsin companies, which are using acquisitions to grow market share, expand product lines, add new capabilities and diversify. Our buy-side M&A clients have never been more active.”
But Wisconsin’s megadeals could just be a rare grouping of opportune transactions, said Bradley Raaths, an attorney at DeWitt Ross & Stevens in Madison who focuses on M&A transactions.
“There surely is substance behind the deals,” Raaths said. “I just don’t think that those deals in and of themselves are an indicator of a trend so much as a confluence of deals of a similar timing.”
“There are very solid foundations in Wisconsin for the M&A market,” he said. “You’ve got good performance, you’ve got low unemployment, you’ve got the relative low cost of capital. When you’ve got companies in Wisconsin that are on solid footings, that are doing well…those make good targets. And if they’re not targets, they’ve got the strength of financial resources to undertake deals on their own.”
Of the megadeals that have been completed recently or are in process in the Milwaukee area, four out of six have involved a larger out-of-state company targeting a Wisconsin company.
“Maybe that just points to sort of the hidden gems we have here in the Wisconsin community that are being sought after by the larger companies,” Jansen said.
Searching for growth
Corporations seeking to generate returns in a slow-growth economic environment have few options available.
They can perform some financial engineering, buying back shares to increase shareholder value, for example, Barth said.
“That works, but it doesn’t really grow the top or the bottom line at all, it just enhances earnings per share,” he said. “You could increase the dividend and shareholders love that. But what really excites shareholders is ‘Hey, they’re still growing and they’re growing by very large strategic acquisitions.’”
Strategic acquisitions make sense in the favorable lending environment and considering most companies’ good cash reserves and strong equity, Smyth said.
“Companies are focused on growth and they want to do something material, which is why I think you’re seeing larger transaction values,” he said.
As they take a closer look at their businesses, some leaders are also deciding which areas they want the company to exit, such as with Johnson Controls’ planned spinoff of its automotive seating and interiors business as part of its pending merger.
“We’re seeing more and more companies becoming sophisticated and astute around portfolio management,” Smyth said. “Companies that are doing M&A are being rewarded by the equity markets.”
The rise of investor activism may also be contributing some of the pressure on corporations to create returns for shareholders, whether in response to activists or as a proactive avoidance tactic.
“They’re really forcing the companies to evaluate the businesses that they’re in to drive shareholder returns,” Smyth said. “The result is some of these folks really doing an outstanding analysis of some of these businesses and really taking action at the board level.”
Most public companies, particularly large cap firms, are concerned about the activist investment asset class and the hefty investments it has garnered, as well as the substantial returns some of these firms have generated, Barth said.
“Top of the agenda for almost every public company is ‘How do we anticipate a potential activist and what are we going to do to prevent one from occurring?’” he said.
Pleasing activists could involve either a purchase or a sale, Arena said.
“Definitely there’s more pressure from activist investors in the last few years, but that can go either direction,” he said. “Some activist investors in some companies are asking for acquisitions, but in many cases they are asking for divestitures, spinoffs.”
The threat of activist investors can make leaders more proactive and diligent about cutting fat or adding value, Smyth said. And they’ll need to do their homework to be prepared for the potential activist move.
“If (leaders are) not prepared to answer (activists’) questions, then I think that’s when shareholders would be willing to engage with the activists,” he said.
A continuing trend
Baird doesn’t expect this megadeal trend to die down anytime soon, Packee said.
“2015 was a record in terms of global M&A deal volume, with more than $4 trillion in transactions,” he said. “We may not achieve that same record in 2016, but we expect that it will still be a strong year.”
According to KPMG’s 2016 M&A Outlook Survey, 51 percent of 550 M&A executives surveyed nationally said the biggest driver of M&A is corporations’ and private equity funds’ record cash reserves and commitments. And 58 percent said the current appetite for M&A is best explained by companies’ need to fortify their competitive position in the current market.
The mergers are happening across sectors, from diversified industrials to consumer to life sciences. They’re driven by factors as varied as exposure to stressed oil and gas markets, and sector convergence, Smyth said.
While many of these deals are driven by the low cost of debt at the moment, the Federal Reserve this year is beginning to increase interest rates, albeit at a slow pace, Arena said.
“So companies are saying ‘The interest rates are still low but the window of opportunity is closing, because the interest rates are going up,’ so you see an acceleration of these deals,” he said.
When a deal is valued at more than $78.2 million, it requires federal approval because of antitrust concerns. The Federal Trade Commission and Department of Justice evaluate how the companies’ market is defined and whether the merger would have an adverse impact on their competition. This process usually lasts between six and 18 months, Smyth said.
“The lead time for some of these deals because of the federal approvals is so long that they have a lot of time to plan,” Barth said.
In some cases, regulators may bar a deal unless one of the companies divests a portion of their business.
“When you’re seeing bigger deals, the risk of there being overlap in a particular market or geography, where regulators would look at it and scrutinize it a little more, would be expected,” Smyth said.
According to the FTC, the vast majority of deals it reviews are allowed to proceed after its initial review, but sometimes a second request for information is issued. This occurred in the Gannett/Journal deal, and could have resulted in three possibilities: the investigation closing as usual; the FTC entering into a settlement with both companies; or the FTC taking legal action to block the transaction.
Federal regulations also prohibit merging companies from cooperating on areas that could potentially be seen as competitive, such as pricing or marketing. They must remain completely separate competitors until integration, Barth said.
“They have to be very careful that they don’t work together in connection with their post-merger integration,” he said. “They’re not the same company until they actually are. If you start too early and you get too in-depth and you deal with matters that impact the competitive landscape, you run the risk of what’s called gun-jumping.”
If a megadeal does go through, companies may try to limit the impact of these mergers on the local headquarters or employees, or they may limit the effect to a “slow burn,” Barth said. The integration can often be the most difficult part of a deal.
“To the extent headquarters move, that’s never a good thing, no matter what companies say,” Barth said. “Long term, it does have an impact, because wherever the headquarters is and the CEO, management team is, that makes a difference from a community standpoint.”
Johnson Controls will no longer be headquartered at this Glendale facility when it completes its merger with Tyco. The local impact is expected to be minimal.
The Johnson Controls deal, for example, could have had a more severe impact on local employment if the company had not decided to keep its operational headquarters in the Milwaukee area, he said.
The Johnson Controls-Tyco merger is motivated by the tax and efficiency benefits of locating the merged company’s headquarters in Ireland, which has a more favorable tax code, in a practice known as a tax inversion, Arena said. The companies have said they expect to realize $150 million in annual tax savings from the deal.
A U.S. Treasury tax rule announced April 4 could impact the Johnson Controls-Tyco deal by reducing the potential tax savings. The companies have said they’re reviewing the new regulation.
But the corporate earnings repatriation tax advantage is still available to foreign domiciled corporations, which is likely where the majority of Tyco and Johnson Controls’ tax savings will come from in the transaction, Arena said.
“It’s unlikely that (the merger is) not going to go through, but the possibility that they’re not going to merge is there,” he said.
As for the MillerCoors spinoff, expected to close in the second half of the year, most of the impact may have already been felt in Milwaukee, where the company brews much of its beer, when the joint venture was formed. The companies already announced the MillerCoors Chicago headquarters and name will remain post-sale.
“There’s been some dislocation of certain management team already,” Barth said. “I’m not sure it’s going to get much worse than that.”
“Premium beer has gone up in demand, so brands like Budweiser, Miller, they are not doing as well as they used to,” Arena said. “Their market is shrinking, so the only way they can keep growing, reduce the impact of shift in demand for the product, is by merging together.”
WEC Energy Group is always looking to achieve efficiencies and eliminate redundancies, Barth said. With such a large company and so much institutional knowledge to retain, some employees can likely be reallocated to different positions as the companies integrate.
“(Layoffs are) always more of a concern in any industry of equals or mergers in any industry generally in the same market. I don’t know how you would get around having some adverse employee impact,” Barth said.
WEC completed a 2 percent workforce reduction that eliminated less than 200 jobs and reduced positions in its executive suite during its integration.
There have been an increasing number of health care acquisitions nationally, driven by implementation of the Affordable Care Act, which has also been felt in Milwaukee with the Ascension/Wheaton deal, Arena said.
“That’s because of the health care reform requiring companies…to be more cost efficient,” he said. “If they cannot get more efficient operationally, just internally through management initiatives, they will do it by economies of scale.”
Ascension has not announced its specific plans to generate efficiencies under the combined organization, which now has 11,000 employees and eight hospitals in the Milwaukee area.
The Gannett/Journal Media deal, completed this month, also is expected to result in significant changes. Gannett has said it plans for $10 million in “immediately available synergies” and another $25 million of operating synergies over the following two years as the companies integrate. Journal Media Group has about 3,000 employees nationwide and about 400 employees at its offices in downtown Milwaukee.
Kroger’s acquisition of Roundy’s was a strategic geographic expansion for a large company that didn’t have a foothold in Wisconsin, Arena said.
That transaction has so far not resulted in any significant announced changes to Roundy’s Milwaukee operations, which include 22,000 employees, 151 stores and 101 pharmacies.