January 8, 2019
2018 was a challenging and unusually volatile year for investors in the stock market, leading most to a more cautious view on the environment entering 2019. Reduced regulation, a lower corporate tax rate, tight employment and healthy corporate balance sheets continue to provide a solid foundation for continued domestic growth. However, the potential for slower global growth, compounded by trade and tariff-related concerns and anticipated Fed rate hikes have weighed on investor confidence heading into 2019.
With this as a backdrop, we examine key trends investors and corporate issuers should be watching closely in the new year:
Despite rising interest rates and an uncertain trade environment, the healthy economic backdrop and U.S. tax reform fueled strong M&A activity in 2018, both in terms of deal volume and aggregate transaction value, up 8% and 36% respectively for the first nine months of 2018. Notably, the number of $1B+ deals saw the largest year-over-year increase, up 10.9% since 2017. While optimism remains robust for 2019, there are a few factors at play. Overall, the deal appetite remains strong in the middle market with private equity firms holding record levels of capital available for deployment, while companies continue to sit on significant amounts of cash ready to be put to work in M&A. However, large strategic deals, in particular those with a stock component, may be harder to complete in light of compressed valuations and heightened stock market volatility. Cross-border transactions may also become increasingly more difficult to consummate due to a more stringent CFIUS review process and increased political scrutiny. Lastly, with debt becoming more expensive, financial bidders may be more reluctant to pay the high premiums commanded by sellers, putting further pressure on valuations and hindering sales processes.
The U.S. IPO market was strong in 2018 – marking the best year since 2014 with 190 companies raising $47B during the year. However, the stock market correction in the fourth quarter shelved several IPOs and alarmed private market ‘Unicorns’ that were planning to go public in 2019. Fears of continued volatility in a late-cycle environment and concerns about the window of opportunity closing will likely accelerate 2019 issuances from the likes of Lyft, Uber, Airbnb, and Pinterest. Similar to the trends observed in 2018, technology and biotech companies are expected to continue to dominate the IPO landscape in 2019.
Activists targeted 174 companies in the first nine months of 2018, surpassing 169 targets in 2017, and winning 130 board seats, an increase of 30% year-over-year. As the influence of shareholder activists continues to rise, expect to see campaigns focused on both larger companies and companies based outside of the U.S., a trend that has steadily increased over the past few years and is expected to continue in 2019. While still the principal market for activist investors, the U.S. represented just over 50% of the largest activist campaigns over the last twelve months, a sharp decline compared to almost 70% in 2014. Other countries, such as Canada, the UK, Australia, Japan and China, have seen more companies targeted in the first nine months of 2018 than in all of 2017. Lastly, with one third of newly announced public activist campaigns over the last 18 months primarily driven by mergers and acquisitions, expect M&A to remain at the forefront of activist investors’ agendas going forward.
The U.S. has implemented tariffs on $250 billion of Chinese goods since July 2018 and, in retaliation, China has set tariffs on $110billion worth of American goods. While imported Chinese goods are currently being taxed at 10%, many believe tariff rates will rise to 25% in 2019 despite the current standstill. In addition to providing headwinds to equity markets, the trade war between the U.S. and China will likely continue to put pressure on input costs across supply chains and cause front-running in imports.
Meanwhile, the Federal Reserve has continued its efforts to gradually increase interest rates citing a strong labor market and U.S. economy – raising interest rates four times in 2018 and nine times since it began its normalization process in December 2015. All signs point to two more rate increases in 2019. However, the recent mix of lackluster economic data and earnings results have contributed to the yield curve’s first inversion since 2007, an ominous indicator that has preceded all of the last major recessions, reinforcing investors’ concerns of an economic slowdown in 2019.
Investors will also be eyeing the pending separation of the United Kingdom from the European Union, including the complex and as-yet unknown consequences of Brexit currently scheduled for March 29, 2019.
$23 trillion or more than 25% of all assets under management globally are now invested according to ESG principles, with ESG being integrated into portfolios at an impressive rate of 17% per year. Evidence of the growing focus on ESG criteria to help manage risk can be seen in the increasing support for ESG-focused shareholder proposals – many of which are designed to enhance sustainability disclosure at public companies. From 2016 through the first half of 2018, 165 institutional investors and 54 investment managers collectively controlling nearly $1.8 trillion in assets filed or co-filed shareholder resolutions on ESG issues, indicating investors are attempting to use disclosure around sustainability and governance policies to spur value creation. Furthermore, the first set of industry-specific sustainability accounting standards were published by the Sustainable Accounting Standards Board (SASB) in November 2018. It is clear ESG-related disclosures will remain at the forefront of debate on responsible investment in 2019. The question remains, however: how will ESG as an investment strategy and asset class fare in a bear market?
The corporate access environment has changed rapidly since MiFID II came into effect in January 2018. In Europe, MiFID II has forced investment banks to unbundle research and brokerage services fees to avoid conflicts of interest, a drastic change disrupting the traditional relationship between the sell-side and buy-side. Consequently, investors are scrutinizing the cost of research and placing a greater emphasis on corporate access. Specifically, many asset managers have cut the number of banks they use, which has led to a decline in research and the attrition of sell-side analysts. An increasing number of buy-side investors also favor direct contact with Investor Relations teams. This has resulted in increased pressure on sales and trading to carry the cost of research, which in turn has driven corporate access teams to increasingly focus on the more profitable, high-frequency trading hedge funds. Corporate issuers are bearing the brunt of this cost as the quality of meeting schedules at conferences and non-deal roadshows continues to decline. While MiFID II has not yet formally been adopted in the U.S., the impact is already being felt in the market as banks, particularly ones with global footprints, revise their global policies. Corporate issuers and investors will be forced to continue to adjust to this ever-changing landscape in 2019.
As described in FTI Consulting’s analysis of the current debate regarding disclosure best practices, discussions surrounding reporting requirements of public companies resurfaced in 2018 and will remain a key topic in 2019. With a focus on determining whether quarterly financial reporting encourages management teams to focus on achieving short-term performance targets at the expense of long-term value creation, the Securities and Exchange Commission (SEC) is now requesting public input on the nature and timing of disclosures in 10-Q’s, including how these reports can become more efficient and whether some companies should have flexibility in how often they report.
Recent comments from SEC Commissioner Jay Clayton suggest more change may be in the cards for 2019. Clayton has indicated securities regulators are considering a series of changes to reform the proxy process and curb the outsized power of proxy advisory firms frequently criticized for having too much influence on shareholder votes at public companies. In particular, the SEC has announced it will consider whether to impose new disclosure requirements and stricter regulations to increase transparency on the shareholder voting process.
Lastly, the SEC voted to adopt a controversial two-year “Transaction Fee Pilot” on December 19, 2018 that will observe the impact that price mechanisms have on routing behavior with an emphasis on the maker-taker rebate system. Critics, including the major exchanges, believe that the SEC pilot will interfere with displayed liquidity and stock spreads and ultimately harm investors.
All told, 2019 is shaping up to be a dynamic year. We look forward to collaborating with many of you to help successfully navigate the above-mentioned opportunities and risks, leveraging our unique financial communications capabilities, sector expertise and global network. On behalf of the entire FTI Consulting team, we wish you a prosperous and Happy New Year!
1 – Factset Flashwire US Monthly, US M&A News and Trends, FactSet, (January 2018 & October 2018).
7 – Gail Weinstein, Warren S. de Wied, and Philip Richter, Shareholder Activism: 1H 2018 Developments and Practice Points, Harvard Law School Forum on Corporate Governance and Financial Regulation, (October 14, 2018).