Global M&A – The Year Past, The Year Ahead

What happens to mergers and acquisition activity when capital goes from having essentially no cost to having the highest cost attached to it since the 2008/2009 financial crisis? We now know the answer.

A record 2021 leads to a slower start in 2022

A year ago, 2021 had multiple quarters of record m&a activity. Each quarter had over a trillion dollars’ worth of transaction, culminating in a record total of $5.9 trillion in global deal volume for the year, as reported by Reuters. Equity and debt were free-flowing. Interest costs were negligible. SPACs were being formed and raising capital at record levels. Private equity and venture capital funds were receiving commitments for their largest funds ever. Every geography and industry sector had levels of activity never before seen. The only cloud on the horizon seemed to be inflation, which in the autumn of 2021 started to gather steam. Inflation began to reach levels not seen since the early 2000s, prior to the financial crisis. Concern began to be raised that the Federal Reserve and other central banks would need to raise interest rates in 2022.

2022 started with a discernable slowing in announced deals. The first quarter saw concerns about the prospect of rising interest rates lead to a contraction of available credit. The prospect of increased interest rates also led to a sharp decline in equity values, particularly in the technology area. The invasion of Ukraine by Russia created tremendous disruptions in energy markets as well as sanctions on Russian companies and boycotts of Russian goods. The result was a drop of over 30% in m&a volumes in the first quarter from the fourth quarter of 2021.

A brief attempt at a recovery

Bloomberg’s numbers show a spike in the second quarter of 2022 from the prior quarter. A number of deals that had been in process managed to pull together financing and to agree on valuations, despite the increasing turmoil in the equity markets. But despite this spike, m&a volumes were still down over 20% from the comparable quarter in 2021. The Federal Reserve began a series of significant interest rate hikes on a very regular schedule. Inflation proved more stubborn than initially expected. War in Ukraine continued.

Commercial banks withdrew from making non-investment grade acquisition loans, with rare exceptions. However, private equity funds were able to access direct lenders, which are funds established to provide acquisition financing. In addition, other creative financing arrangements were crafted, including seller financing. As a result, private equity transactions reached the highest proportion of the m&a market in history. Several mega-deals were announced by private equity funds during this stretch.

 A short-lived recovery

Any hopes that were raised by the level of second quarter activity were quickly dashed as the summer of ’22 wore on. The third quarter of 2022 had the lowest volume of any quarter in the prior five years to that time, other than the second quarter of 2020, when the world was shut down by Covid. According to Bloomberg, deal volume in the third quarter of 2022 was less than 75% of the level of the second quarter of the year and half of the volume of the third quarter of 2021. Every sector of the m&a market was materially down, although the decline was more notable in the United States than in Europe and Asia.

Private equity activity remained relatively stronger than strategic m&a. But, as direct lenders began to reach the limit of their capacity to provide credit and commercial banks remained absent from the market, prospects for private equity for the remainder of the year were ominous. More interest rate hikes were signaled by the Federal Reserve. The prospect of a recession in early 2023 began to permeate conversations about the economy.

A desultory conclusion to the year

The final results for 2022, according to Reuters, show a decline of almost 40% in global m&a volumes from 2021. The United States had a decline of over 45% from 2021. Even more troubling was that 2022 global m&a volumes ended up being almost 10% lower than 2019 levels. The decline in 2022 actually accelerated in the fourth quarter, with volume down over 50% from the fourth quarter of 2021. The last remaining bulwark of activity, private equity deals, finally gave way, with volumes in the quarter down two-thirds from the year prior.

What next?

My next piece will explore the prospects for 2023 in greater detail. But there are a few essential questions in trying to assess the immediate future. What has to change for equity markets to regain some equilibrium and move past the volatility of the last year? What has to happen for lenders to be willing to provide non-investment grade credit? Why predicates need to exist for sellers to be willing to agree to current valuations? And what has to take place for potential buyers to feel sufficiently confident to re-enter the m&a market?