Ken Hirsch
Following the torrid pace of deal activity in the last quarter of 2021, we expected a brief lull in activity in the first quarter of 2022. The lull lasted about two weeks! Deals that carried over from 2021 and companies that were prepped for market but avoided the year-end crush quickly filled the calendar and deal flow remains unabated.
Of course, recent events in Ukraine have injected a degree of uncertainty in financial markets and heightened uncertainty usually leads to a slowdown in new deal activity, as buyers and sellers assess the impact of events on their investment and business strategies.
However, the extent to whether the situation in Ukraine leads to a slower deal volume or an actual decline in deal activity remains unclear. Importantly, there is a significant amount of dry powder to be deployed in M&A activity; most investors are making long term investment decisions; and actions taken to sanction Russia are not expected to have a significant impact (i.e., contagion to the financial system) on the global economy.
This is not to say that investors are not closely watching as the situation unfolds. As an example, we know that companies whose cost structure is tied to hydrocarbons have already begun to experience higher costs and supply bottlenecks, which will impact short term earnings, and therefore potentially impacting valuations.
Despite this uncertainty, because of the mitigating factors we outlined above, tailwinds remain strong for M&A activity as we head into the second half of the year, though they have abated somewhat from the phenomenal growth experienced in 2021.
Consensus Around the Strength of the Global Economy
The global economies are expected to continue a robust growth trajectory post-Covid, though not as strong as 2021. For example, the International Monetary Fund projects that the global GDP will be 4.4 percent in 2022, down from 5.9 percent last year. Specifically, U.S. GDP is expected to grow by 4.0 percent in 2022, down from 5.6 percent in 2021, according to the IMF.
Though economic growth is expected to slow in 2022, the projected rate of growth remains above historical averages. For example, the average annual growth of the global GDP since 1961 is 3.4 percent, per the IMF. Above average growth is expected for the rest of this year, unless the situation in Ukraine escalates into a full-scale war involving many nations.
Record Buyer Purchasing Power
Despite record levels of deployment of new cash in deals through Q4 2021, the private capital markets remain in a state of excess liquidity. Private equity funds have approximately $1.4 billion of dry powder on hand representing approximately $3.0 billion of purchasing power.
Credit funds, such as business development companies (BDCs), have become an important source of financing for middle-market companies and private equity groups. According to Preqin, “Almost 60 percent of dry powder in direct lending is allocated to senior debt, with $103.9 billion available for investment worldwide as of October 2021. The majority of this, $73.8 billion, is with North America-based fund managers.”
This increase in the amount of cash seeking M&A deals is also being fueled by new sources of capital entering the market, such as family offices, control investors opportunistically seeking attractive investment strategies and opportunistic funds.
Seller Engagement
Demographics continues to be the main driver in the sale of businesses as the Baby Boomers who own many businesses are getting to the age when they want to sell and retire. This is a trend we expect to continue for several years, as we are right in the middle the Baby Boomer retirement bulge. The average Baby Boomer is 67 years old this year.
While valuations have generally leveled off over the past 18 months, they remain frothy, bringing more sellers into the market. Valuations in Q4 2021 averaged 7.5x Ebitda for middle-market companies –the highest quarterly mark in over 15 years.
The overall business environment has become more challenging for the owners of middle market companies; labor shortages, supply chain disruptions and Covid have impacted owners’ view on their business and personal financial plans – pushing them toward a decision to sell.
Given these market dynamics, global M&A activity continued at a frenzied pace, with over 30,000 deals closed for a combined $4.5 trillion in 2021. In North America, over 18,500 deals closed for a combined $2.8 trillion. While multi-billion dollar transactions grab the headlines, deals of $500 million and below represented 94 percent of deal volume last year.
Forces Countering M&A Growth in 2022
While the tailwinds are strong there are headwinds that we are watching as we as we head into the second half of the year. Namely:
- As we noted, geo-politics have been upended with the Russian invasion of Ukraine creating uncertainty for lenders, investors and businesses.
- The Fed and global central banks will be unwinding unprecedented monetary policy; the market is currently anticipating up to seven interest rate increases this year. Higher borrowing rates may slow down deal activity and, at a minimum, cause buyers to manage leverage more conservatively. In slowing inflation, tighter monetary policy will slow the economy, impacting financial forecasts.
- Rapid demand increases coinciding with economic recovery is pushing up prices for key commodities such as oil, metals and food while at the same time, shipping costs have increased sharply. Oil markets are being hit especially hard by the conflict in Ukraine.
- Worker shortages continue to exacerbate supply chain woes.
Key M&A Trends to Look for in the Second Half of 2022
The second half of 2022 presents great opportunity but less visibility. Areas we see of greatest focus include:
- Strong activity continues in the technology sector, capturing a record portion of global deal value and count in 2021 at over 20 percent. Demand for large deals continues, despite elevated antitrust, data and privacy concerns. “Big Tech” faces increased scrutiny amid consolidation plays.
- We also foresee an uptick in deal activity around the convergence of healthcare and technology. Healthcare IT companies are taking advantage of elevated demand to build multifunctional digital platforms through M&A.
- Business products and services continues to see strong M&A activity, with 10,703 deals closing in 2021 for a combined value of $1.26 trillion – and this sector is expected to continue doing well in the second half of 2022.
- Despite supply chain disruption and a global microchip shortage, the automotive sector is seeing a flurry of deal activity resulting from a push for electric vehicles and autonomous driving.
Competition for Attractive Deals Will Remain Strong in 2022
We expect M&A activity in 2022 to remain strong, with caveats around increased economic and geopolitical risk, as seller engagement remains high and investors and lenders have plenty of capital to deploy.
