When corporations have cash on hand, there are a number of things they can do. From a financial standpoint, they can pay a dividend, repurchase their shares, or pay down their debt. That said, if the goal is to generate growth, they can invest it back into the company through traditional capital spending, research and development (R&D), or use it to merge with/acquire another firm. Last year, buybacks were all the rage; this year, the pace of share repurchases has slowed, but the pace of mergers and acquisitions (M&A) has accelerated.
This shift reflects a changing macroeconomic backdrop. Uncertainty has increased on the back of escalating trade tensions, which has made traditional investment spending increasingly unattractive. At the same time, profit growth has slowed, leaving companies with less excess cash relative to the windfall they found themselves with last year on the back to tax reform. However, as some of this uncertainty has waned over the past few weeks, investors have seen a flurry of M&A activity, as bankers and management teams take advantage of subdued equity market volatility to get deals done.
The majority of the deals in the headlines have been between publically-traded companies; however, with more companies staying private (or at a minimum, staying private longer), what does this mean for private investments? Private market exit activity has generally been soft this year, as volatile equity markets have made initial public offerings (IPOs) difficult and the pace of corporate acquisitions has slowed given uncertainty around the trajectory of the business cycle. As a result, the pace of secondary buyouts – when a private equity firm sells a stake in a company to another private equity firm – has accelerated both in terms of the number of deals as well as the dollar value of those deals.
For some time we have been asked whether public markets would eventually instill discipline on private companies. With 2019 nearly behind us this seems to be the case, as just over 50% of this year’s IPOs are trading above their offer price. Furthermore, the increase in secondary buyouts, where valuations and accounting may be under less scrutiny, could reflect the froth that many believe to be present in private markets.
Secondary buyouts have increased as a share of total exits
Percent of exits (#)
Source: Pitchbook, J.P. Morgan Asset Management.
*2019 data is YTD through 9/30/19.
Data are as of November 26, 2019.