Goldman Sachs analysts Robert D. Boroujerdi, Michael Chanin, Deep Mehta, and Christopher Wolf present their case for a likely pickup in U.S. M&A activity and their strategic M&A ideas.

M&A

M&A: Current trends

Into 3Q2013, global M&A dollar volumes are up 13% y-on-y and 22% q-on-q.

U.S. M&A activity is also robust. 3QTD13 is the best quarter since 2Q2007 (data through September 24, 2013). YTD dollar volume is up by 28% y-on-y, though this may have been somewhat skewed by large ticket deals, e.g. Verizon Communications Inc. (NYSE:VZ).

In terms of number of deals, the most active industries were Computers & Electronics, Professional Services and Healthcare. In dollar terms, Telecom, Computers & Electronics, Real Estate and Healthcare saw the most activity.

1-us-ma-trends

M&A: Outlook

Though the above performance appears encouraging, the level of activity is actually below the normalized levels when examined as a percent of equity market capitalization. Currently at 5.1%, this is about 150bp lower than the normalized levels derived from a 1995-2013 average, and the analysts estimate that M&A would have to rise by approximately $300B during the rest of 2013 to reach the normalized level.

Factors favoring M&A activity

U.S. corporates are sitting on much higher cash levels – up 65% since 2007, as seen in the graph below. Further ammunition is available in the form of ~400B of unleveraged private equity ‘dry powder.’

1a-cash levels

Secondly, this cash pile could be used to make acquisitions to drive inorganic growth as well as diversify revenue sources, especially considering sales growth is slowing down and operating margins are at very high levels.

With GDP growth likely to expand, and market sentiment at bullish levels considering the S&P 500 is near its highs, there is increasing potential for M&A activity.

Lastly, policy uncertainty, a key factor that impacts M&A activity, is declining, and is one of the reasons that drove the recent acceleration in deal-making. This factor is quantified by the U.S. Economic Policy Uncertainty Index, which has reverted to long-term averages as per the graph below.

2-policy-uncertainty-average

Riding M&A activity: Goldman Sachs’ basket of potential candidates  (GSRHACQN)

GSRHACQN is a Bloomberg-trackable basket of about 175 stocks that analysts at Goldman Sachs Group inc (NYSE:GS) rate as having a minimum 15% probability of strategic M&A in the next 12 months. This basket is refreshed from time to time, and since its inception in 2009, has outperformed the S&P 500 (INDEXSP:.INX) by 46 points.

3-ma-candidatebasket

M&A activity in the next 12 months

Here are some of the candidates mentioned in the report which have a high chance (30-50%) of strategic M&A.

Fusion-IO, Inc. (NYSE:FIO)

Higher One Holdings, Inc (NYSE:ONE)

DISH Network Corp (NASDAQ:DISH)

Time Warner Cable Inc (NYSE:TWC)

T MOBILE US INC (NYSE:TMUS)

STR Holdings, Inc. (NYSE:STRI)

SunPower Corporation (NASDAQ:SPWR)

Cabot Oil & Gas Corporation (NYSE:COG)

The Wendy’s Co (NASDAQ:WEN)

Forest Laboratories, Inc. (NYSE:FRX)

WisdomTree Investments, Inc. (NASDAQ:WETF)