Landscape Shifting for M&A in 2016

Low borrowing costs, market stability founded on a strengthening U.S. economy and a gaping tax loophole spurred a record year for mergers and acquisitions in 2015. Those same factors – in reverse – could derail a repeat performance in 2016.

That’s hardly a guarantee, but there are strong indications that the ground is shifting beneath the landscape that last year generated merger and acquisition deals valued at an unprecedented value of more than $5 trillion.

2015 was marked by a handful of megadeals led by drug-maker Pfizer’s (NYSE:PFE) $191 billion takeover of Irish pharmaceutical company Allergan (NYSE:AGN), a marriage designed to dramatically lower Pfizer’s annual tax bills by moving the erstwhile New York-based company’s domicile to Dublin where the corporate taxes are a fraction of what they are in the U.S.

Other prominent deals announced last year include Belgian beer maker Anheuser-Busch InBev’s (NYSE:BUD) $120 billion merger with British counterpart SABMiller; Royal Dutch Shell’s $81 billion acquisition of British energy supplier BG Group; and broadband provider Charter Communications (NASDAQ:CHTR) $78 billion deal with Time Warner Cable (NYSE:TWC).

All of these deals were greased by at least one of the three predominant elements noted above, and all would likely have been harder to complete in 2016 given the shifting financial and political landscape.

Consider the first element: historically low borrowing costs. “With the (Federal Reserve) poised to raise rates, borrowing will become increasingly expensive, making deals relatively expensive,” said Rob Salomon, a finance professor at NYU Stern School of Business.

In a symbolic move away from the easy-money policies initiated in the wake of the 2008 financial crisis, the Fed voted in December to start raising interest rates off the near-zero range where they’d been held for seven years.

Fed policy makers have repeatedly vowed to move rates higher “gradually” and only as justified by incoming economic data, which means rates could stay relatively low for the foreseeable future.  But the writing is on the wall. Just as mortgages and car loans are bound to get more expensive for consumers, so will financing large M&A deals for CEOs.

Second, analysts are predicting that global markets will be more volatile in 2016 than last year. “With greater volatility around the globe, in China and emerging markets, for example, deal volumes will go down as dealmakers go into ‘risk off’ mode,” Salomon predicted.

Last August and then again earlier this month concerns that the Chinese economy, the second largest in the world behind the U.S., was slowing down sent ripples through global markets, not least in the U.S. where stock markets have fallen into correction territory and the price of oil has plunged below $30 a barrel, its lowest level in over a decade.

In other words, a potentially weakening China is cause for a good deal of uncertainty among investors, CEOs and boards of directors, all of whom have to sign on for huge mergers and acquisitions involving giant multi-national companies.

“We live in a global market and what’s happening in China will have an impact around the world,” said David Stowell, professor of finance at Kellogg School of Management at Northwestern University.

In all likelihood, in 2016 there will also be fewer inversions, the tax-motivated deals that led Pfizer to target the much-smaller Allergan because the latter is domiciled outside the U.S. “Though a smaller portion of the story, with the U.S. government looking for ways to legislate away corporate inversions, we will likely see fewer deals in which companies attempt to change their domicile through merger and acquisition activity,” said Salomon.

Indeed, Democratic presidential hopeful Hillary Clinton has specifically targeted inversions as part of her broader platform to reform the U.S. financial system. Late last year, shortly after Pfizer announced its deal with Allergan, Clinton projected that the U.S. will lose $80 billion in tax revenues over the next 10 years if tax loopholes that allow corporations to benefit from inversions aren’t fixed.

Which brings us to the U.S. presidential election, a cause of uncertainty in 2016 perhaps more so than in any recent presidential election cycle.

“The election cycle is on us. That can wreak havoc on M&A markets,” said Northwestern’s Stowell.

Democratic candidates Clinton and Bernie Sanders have promised to increase regulations on the banking industry in an effort to prevent another crisis like the one in 2008 that temporarily crippled the global economy. If banks find it harder to lend under more restrictive regulations, the M&A market will be negatively impacted. In sum, more uncertainty.

Meanwhile, no one knows what a Donald Trump administration might mean to U.S. financial markets.

Just to be clear, there’s also a chance the exact opposite of these arguments will occur: that M&A activity will continue to thrive in 2016 precisely because the conditions that existed in 2015 will extend or barely change into the New Year.

With that in mind, the pace of M&A could actually accelerate as executives rush to complete deals before rates move significantly higher, before the Chinese economy implodes and before a new presidential administration unleashes reams of new regulations.

But that’s not the most likely scenario. “I don’t think 2016 will be as robust in terms of volume as last year,” said Stowell. “It’s more likely than not that those variables (higher interest rates, global instability, political and regulatory uncertainty) will result in a diminished year.”