AT&T cliffhanger adds uncertainty into otherwise favorable year for global M&A

  • The outlook for global M&A remains strong in 2018, despite recent stock market volatility.
  • Still, there is regulatory uncertainty regarding the AT&T/Time Warner deal.
  • Deal valuations are also at their peak, squeezing some potential buyers out of the mix.
  • The Justice Department has taken a harder line on cross-border Chinese deals.
Michael Nagle | Bloomberg | Getty Images

The most important deal of 2018 was announced more than a year ago.

AT&T and Time Warner are headed to court next month to defend their $85 billion deal, announced in 2016. The last time the government won a case challenging a vertically integrated merger, the purchase of a supplier rather than a competitor, was during the Nixon administration.

While dealmakers have plenty to be optimistic about — low interest rates, rapid transformation across all industries, tax code clarity — the case will set the tone on the Trump administration's tolerance for megadeals.

So far, advisors are progressing as if under the status quo.

"I don't think it's become clear enough as to what the hot button issues are. People seem to be operating under what have been the historic norms," said Robin Rankin, co-head of mergers and acquisitions at Credit Suisse.

If the administration breaks with a more than three-decade trend of approving vertical deals, it would force advisors to reassess all that they had previously accepted as certain. It would mean deals they previously viewed as sure to be approved could face hurdles anew.

This uncertainty would extend to Disney's proposed acquisition of $52.4 billion worth of assets from 21st Century Fox, which, though not vertical, will test the Trump administration's attitude toward movie studio combinations.

Meantime, the Trump administration has been scrutinizing other deal approvals. On Feb. 1 the Justice Department requested more information on CVS Health's plan to acquire Aetna. It has taken a harder line on deals with Chinese acquires, blocking the sale of semiconductor Latttice to Canyon Bridge Capital Partners, a private equity firm funded by the Chinese government.

"Many of us are surprised at how unpredictable the attitude toward antitrust has been under President Trump. We expected more of a Reagan approach, and what we've seen is populist. Deals people thought would sail through have attracted higher scrutiny," said Melissa Sawyer, a partner in Sullivan & Cromwell's Mergers & Acquisitions Group.

Time Warner CEO Jeffrey Bewkes (right), and AT&T CEO Randall Stephenson listen to testimony during a Senate Judiciary Subcommittee hearing on Capitol Hill, December 7, 2016, in Washington, DC. The subcommittee heard testimony regarding a proposed merger between AT&T and Time Warner.
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Time Warner CEO Jeffrey Bewkes (right), and AT&T CEO Randall Stephenson listen to testimony during a Senate Judiciary Subcommittee hearing on Capitol Hill, December 7, 2016, in Washington, DC. The subcommittee heard testimony regarding a proposed merger between AT&T and Time Warner.

Pay up

As the investors and companies await more clarity on the Trump's approach to regulation, the stock market has been ticking further and further up to record highs. (Last week's gyrations aside.)

So far, M&A dealmakers have shrugged off the wild market swings.

Stocks reached a post-crisis peak in 2017, according to a report by Citi's Financial Strategy and Solutions Group. Deal valuations, meantime, are averaging 19 times equity value to earnings before interest tax depreciation and amortization (EBITDA), their highest since 2014, according to Dealogic.

"At least a few days ago, valuations were very high. That means deals are more expensive and, for some, prohibitively so," James W. Woodall, CFO of Fidelity National Information Services, told analysts last week.

"If we don't have deals that fit strategically, or action where we don't meet our valuation screens, we'll certainly buy back shares."

So far this year, the value of deals has surged to $398 billion, according to Dealogic, the greatest since 2000. At the same time, the number of deals to date is at its lowest worldwide since 2005. While one month is by no means indicative of a broader year, the numbers demonstrate that fewer companies are partaking in the M&A frenzy.

Stock buybacks, meantime, have totaled $86 billion since Jan. 1, according to Birinyi Associates, double the level of the same period last year.

"I think it's fair to say 2017's record valuation multiples have dragged on M&A somewhat," said Russell Thomson, managing partner of Deloitte's US M&A practice.

Drive for deals

Still, corporate drivers for M&A remain strong. There is clarity on the new tax code and, on a relative basis, low interest rates, even with recent bond volatility. If last week's stock roller coaster ultimately ends with lower, stabilized stock prices, it may put more deals within reach.

"If the economic outlook remains largely unchanged, any downward pressure on valuations can be expected to motivate buyers that might be on the sidelines, said Cary Kochman, a co-head of global M&A at Citi.

"However, price stability is one of the key pillars of support for robust M&A activity. So any protracted period of volatility can correspondingly be expected to slow M&A activity."

One of the biggest drivers likely to push companies forward with dealmaking is the technological proliferation across all industries: aerospace, retail, health care. As the pace of adaptation spikes, companies have less time to develop capabilities by building it on their own.

"In every industry, there is an aspect of technological disruption that is happening or will happen. What we're seeing that's different now is more companies are willing to address that through M&A," said Anu Aiyengar, head of mergers and acquisitions for North America at J.P. Morgan.

Companies looking to make the jump in 2018 will follow a path paved by some of their respective industry leaders: CVS Health last year announced its $69 billion purchase of Aetna, and United Technologies its $30 billion purchase of Rockwell Collins.