From the recent challenges surrounding the financing of deals to the growing influence of regulatory bodies and increasing focus on sustainable practices, we explore how these dynamics are shaping M&A transactions. We also examine the repercussions of recent legislative changes and the surge of digital transformation.
We look at the re-emergence of cross-border activity, and the rise of renewable energy and ESG integration as key in shaping the future M&A outlook.
Mergers & Acquisitions Trends 2023
Turning the Volume Down
During the Q1 of 2023, M&A transaction volume reached its lowest point in ten years, totaling just $571.34 billion. As a result Investment bankers experienced a 37% decline in global revenue from providing advisory services in the first half of this year. According to Refinitiv data, global M&A deals fell to a three year low in the first half of 2023 compared to the second half of 2022 (and that period itself was a relatively slow six months).
This downturn was largely a result of macroeconomic factors such as high inflation, and a loss of confidence following the mini-banking crises at the start of the year involving Silicon Valley Bank and the Credit Suisse Group, as well as ongoing geopolitical instability.
Impact of High Interest Rates
High interest rates create challenging circumstances for companies looking to expand. The U.S. Federal Reserve (Fed) has raised the interest rate to 5.5%, the highest in 22 years, meaning higher borrowing costs. Companies often rely on debt to finance expansion and acquisitions, as it allows them to leverage their existing resources to achieve growth. With higher interest rates, the cost of servicing debt rises, leading to higher interest payments on loans. As borrowing costs rise, the discounted cash flow projections used in valuation models may result in lower valuations.
Increased borrowing costs and reduced purchasing power have meant limited access to traditional funding sources.
In response to these challenges, one notable trend is the use sustainable financing, which includes strategies such as Environmental, Social, and Governance (ESG)-linked loans to make best use of available tax credits. These mechanisms attract favorable terms and interest rates for companies committed to sets of sustainability performance targets.
Among those capitalizing on the lack of well-financed competition are established corporations with robust financial positions. Companies with substantial cash reserves and high credit ratings have been able to leverage their financial strength to engage in strategic acquisitions. This advantage enables them to navigate the challenges posed by economic volatility and outmaneuver competitors struggling to secure financing.
The CHIPs and Science Act and the Inflation Reduction Act are both expected to give impetus to M&A transactions. The CHIPs Act provides $52 billion in subsidies to support investment in semiconductor manufacturing, assembly, test, packaging and R&D capabilities in the US. This is expected to create M&A activity in the semiconductor industry, as companies look to acquire or partner with other companies to gain access to new technology, increase manufacturing capacity, and integrate their supply chain.
The Inflation Reduction Act includes a number of tax breaks designed to encourage companies to invest in clean energy technologies. These tax breaks are expected to make it more attractive for companies to acquire or partner with other companies in the clean energy sector.
Private equity (PE) plays a pivotal role in global mergers and acquisitions (M&A) transactions, with access to capital driving business growth and reshaping industries. However, recent data indicates a notable shift in PE-backed deal activity. Between 2021 and 2022, there was a significant 40% reduction in PE-backed deal value, signaling a temporary slowdown in this sector’s traditional robust performance.
Bloomberg reported that in Q1 of 2023, out of the $559 billion spent in M&A transactions only $182 billion stemmed from private equity firms, a massive drop from the $439 billion invested in Q1 of 2022.
Nevertheless, the potential of private equity remains substantial. Bain & Company’s estimation of $3.7 trillion in dry powder – uninvested capital – underscores the industry’s capability for substantial impact when unleashed. This significant reservoir of funds has yet to be deployed in meaningful ways due to various market factors, such as the inflationary pressures in the economy discussed above.
The Inflation Reduction Act aims to stimulate the utilization of this substantial dry powder within private equity funds in the US. By introducing measures that encourage investment and innovation, the Act seeks to address inflationary pressures and bolster economic growth. It will be interesting to see whether this will be enough of an incentive to catalyze new M&A market trends within PE in the next few years.
The trends in M&A to achieve digital transformation and leverage emerging technologies are shaped by the evolving landscape of the technology services industry. Competitive differentiation remains paramount, prompting a shift from merely spanning tech horizontals, verticals, and delivery models to a focus on deals that deliver depth and specialization.
Businesses are seeking assets with differentiated offerings, whether through in-depth tech stack expertise in areas like data engineering, AI/ML, and hyper-automation. For example, Hewlett Packard Enterprise recently acquired ML pipeline startup Pachyderm to bolster its AI portfolio.
Recently, there has been a more interventionist approach from regulatory bodies. The landscape of M&A in European markets is undergoing a shift, introducing new uncertainties for dealmakers. The UK’s Competition and Markets Authority (CMA) now wields increased influence over major transactions. Companies must now navigate the CMA’s perspective on competition concerns, potentially differing from the EU’s stance.
Recent instances, such as the CMA blocking the Microsoft-Activision deal while the EU approved it, highlight this divergence and create unpredictability in deal outcomes. Additionally, the CMA’s expanded authority to scrutinize tech mergers, regardless of minimal UK sales by the target company, adds further complexity for tech firms seeking deals in the UK.
This also has a knock-on impact for the global M&A landscape as multinational companies seeking large cross-border deals must undergo the scrutiny of more increasingly active antitrust bodies.
In July 2023 the USA’s Federal Trade Commission (FTC) and the Department of Justice (DoJ) brought forward proposals for tougher merger guidelines aimed at the Private Equity and Technology sector.
After a downturn in cross-border M&A deals due to volatile geopolitical conditions, there has been a recent pivot towards overseas expansion. Cross-border transactions allow companies to strengthen global supply chains and venture into new markets, ensuring both resilience and fresh opportunities. Navigating foreign direct investment limits and diverse regulatory environments has been key to ensuring success in these types of transactions.
Looking at global M&A trends, Technology, Media & Telecommunications (TMT) stands out as the current sector of choice in cross-border transactions, offering innovation, synergies, and enhanced market penetration. In addition, tapping into the growth potential of overseas markets by fast-tracking digital transformation through acquisitions has incentivised investment.
The landscape of future M&A trends is poised for dynamic shifts, with several factors shaping the trajectory.
The increasing focus on Environmental, Social, and Governance (ESG) considerations in transactions. As society’s emphasis on sustainability heightens, companies are under greater shareholder pressure to invest in ESG-ready entities. M&A professionals must also become familiar with how ESG emerges operationally in the M&A process.
In addition, the movement towards greener energy solutions is set to receive further impetus through government incentives like the Inflation Reduction Act, which could catalyze a wave of deals aimed at transitioning to eco-friendly practices.
A notable surge in private equity (PE) backed deal-making is anticipated, with substantial dry powder awaiting ignition. The injection of capital from PE firms could reignite the M&A landscape, driving innovative transactions and restructuring across sectors.
The increasing influence of technology is inevitable. The deal-making process itself is likely to undergo transformation, with technology streamlining due diligence processes and reducing timeframes. This efficiency could accelerate deal closures, shifting market dynamics and increasing deal volume.
Vertical integration is set to be another focus of future M&A activity. With supply chain challenges accentuated by global disruptions and potential geopolitical instability, companies are likely to pursue vertical integration in response.
M&A’s trajectory will continue to be shaped by a diverse range of factors, including regulatory dynamics, economic influences, technological advancements, and shifting market sentiments. The recent economic challenges, underscored by the lowest M&A transaction volume in a decade, reflect the impacts of macroeconomic factors and geopolitical uncertainties. Taking on the services of an experienced M&A Advisor with an awareness of the latest M&A trends is key to any successful deal.
The potential to unleash private equity’s dry powder when macroeconomic conditions stabilize and the continuing adoption of sustainable financing strategies to achieve better deal terms will contribute to a future revival in deal activity.
ESG considerations and the move towards sustainable practices are becoming more important driving forces behind M&A decisions, further incentivized by shareholder pressure and government schemes.