The combination of low interest rates and historically high levels of cash on corporate balance sheets has helped whet the appetites for merger and acquisition (M&A) activity on the part of both strategic (i.e., corporate) and financial (i.e., private equity) buyers. According to data from Bloomberg, global M&A activity reached $ 3. 8 trillion in 2015 , surpassing the previous record from 2007 prior to the onset of the Great Recession.
Echoing this pattern, the 92 M&A transactions involving North American staffing firms announced in 2015 was the highest volume we have recorded since 2007, when 126 deals were publicized. For the year, activity was up 31% from 2014, and the 32 transactions announced in the third quarter of 2015 was the most since the second quarter of 2007. As indicated by the accompanying chart, M&A transaction volume began to decline in 2008, bottomed for the cycle in 2011, and had been fairly stable for the three years preceding the growth exhibited in 2015.
The IT staffing segment was most heavily targeted for acquisition last year, accounting for one-quarter of all deal volume — 23 transactions, and nearly doubling the 12 IT staffing firm acquisitions noted the prior year. The healthcare staffing segment was nearly as active as IT, with 22 firms acquired, up from 16 in 2014. Rounding out the list of most-targeted segments were light industrial (12) and professional (those firms doing substantial business across more than one professional segment, 11), which combined to represent another quarter of all staffing deals.
What Drives M&A?
Financial buyers have just one motivating factor to engage in M&A: profit. Private equity firms typically seek to identify companies that appear undervalued or are otherwise lagging competitors, acquire them, then set about the business of cutting costs and enhancing revenue opportunities, often initiated with the installation of a new management team. Private equity firms may also acquire companies that are complementary to one(s) already in their portfolio with the intention of integrating the entities to create a more robust combined organization. The desired end result is that the acquired business(es) can be turned around and sold — often in a public stock offering or to another corporation — for a return above what the firm outlaid in their acquisition and reorganization.
The specific priorities that a given staffing firm may have in pursuing an acquisition are manifold, but in any case such an initiative signals that company management perceives a better potential return by deploying capital outwardly than by reinvesting in the business. In contrast to most other industries, intellectual property and physical assets such as production facilities and equipment are not significant determinants of competitive advantage in the staffing world, and thus do not play a primary role in the M&A decision process.
In evaluating potential acquisition targets, a staffing firm typically seeks to offset weaknesses in its current operations, or tap into the growth potential of a market in which it has not been a significant player. This may mean looking to buy a firm that is a leader in supplying an emerging skill set where the acquirer was not positioned to benefit from the rising demand. An additional priority could be to expand its presence into a new geographic area.
Implications
Rising deal volumes can be a signal that we are approaching the end of an economic expansion, as coincided with the 2007 and 2000 levels. But does last year’s upswing in transaction volume portend negative implications for economic growth going forward? Not necessarily.
One byproduct of an expanding US economy is the increased likelihood of benchmark interest rates being raised by the Federal Reserve. This increases the cost of capital, which requires a commensurate increase in the potential return on investment from any M&A transaction in order for the deal to make sense. The first such move by the Fed came in December, with more anticipated during the remainder of this year. The rise in interest rates was among the headwinds for overall M&A activity in the first quarter of 2016, when the value of global transactions declined 11% from the same period last year.
Whether 2016 shows further M&A growth — revealing that 2015 was only the first year in a sustained increase — or returns to the more muted levels of the preceding years, we would caution against reading too much into the short-term trend.
