Although the record-breaking deal activity of 2021 spilled over into 2022, headwinds in the first quarter developed into a significant slowdown during the rest of 2022, with an expectation of continued slowness as we enter 2023
This time last year, the US M&A market continued to be busy with deals in the pipeline from 2021, both deals proceeding to signing, and signed deals in the process of moving to closing.
However, it was evident from early in 2022 that new M&A activity was going to be down significantly from 2021. Cracks were already beginning to show the year before, as the Federal Reserve's language took a more hawkish turn. Talk of inflation being "transitory" shifted. By March, the Fed had made its first interest rate hike in four years. By mid-year, the S&P 500 had entered a bear market.
Since first tightening its monetary policy, the central bank has raised the federal funds target rate by a full 425 basis points (bps). This is the fastest pace of change in modern history. By December 2022, the brakes were being pumped a little less, rounding off the year with a 50 bps increase.
Nevertheless, Fed chair Jerome Powell's language remained resolute at a December 14 press conference announcing the increase: "We have covered a lot of ground, and the full effects of our rapid tightening so far are yet to be felt. Even so, we have more work to do."
Officials forecast up to a total three-quarter point more in interest rate increases this year—the Fed's policy extending longer than many had anticipated. Some are still hopeful that a pivot is not far away. Bond markets have been calling the Fed’s bluff with two-year US Treasury yields peaking in November and dipping below the federal funds rate.
As inflation shows signs of rolling over and economic growth stalls, opinion is divided over what 2023 holds in store—a soft landing or a hard landing. Even if the Fed eventually walks back its recent comments with a course correction, that would suggest that it has overshot the mark.
What is clear is that the first half of 2023 will not carry with it the spillover momentum seen in early 2022, and some investors are bearish on how 2023 will fare. Nevertheless, another camp remains cautiously optimistic. Taken as a whole, 2022 put in a solid performance as compared to historic performance. The real story, however, is that deal activity trended down with each successive quarter as valuations fell, corporate equity issuances became less attractive and debt financing was increasingly costly and less accessible.
As the articles in this report demonstrate, we do not see an early return to a busy M&A market. Opportunistic strategic M&A will dominate until questions regarding a recession are answered and confidence in the stock market returns.
US M&A in review: Momentum can only take you so far
M&A started strong in 2022 with robust deal activity and megadeals dominating the landscape that was largely the result of unprecedented spillover from 2021. But then, things took a turn and deals stalled in the second half of the year, as shifting macro-economic conditions began to take hold.
The US private equity (PE) market in 2022 aligned overall with the broader M&A trend—activity eased off considerably, year-on-year, but remained above historic levels—and like the M&A market at large, it tailed off as the year progressed, but what does this mean for the year ahead?
With some rare exceptions—namely in the oil & gas and energy sectors—deal activity was down in 2022 as a sense of fatigue set in following a prolonged period of high deal activity and as inflation and rising interest rate concerns took center stage.
A flurry of activity early in 2022 sees real estate outperform
Real estate has historically shown resilience during challenging economic periods and is considered a reliable hedge against inflation—but not all assets are created equal, and dealmakers were highly selective in the transactions they pursued in 2022.
2022 was a big year for the Committee on Foreign Investment in the United States (CFIUS)—notification filings as well as mitigation agreements were both trending up, adding to the already challenging landscape for cross-border transactions
CFIUS activity was already on the rise before September 15, 2022, when President Biden signed the first-ever CFIUS executive order (EO 14083), the first of two milestones last year that increasingly sharpened the US foreign direct investment watchdog's teeth.
EO 14083 clearly articulates national security risks that the Committee must consider when reviewing covered transactions. The five areas of focus are: supply chain resilience; impact on US technological leadership; assessment of aggregate investment trends in industries; cybersecurity risks; and sensitive data.
The Committee chair (the US Department of the Treasury) takes the lead in each case, supported by a co-lead—the federal agency with the most appropriate expertise to review a particular case.
While the five areas identified by the recent EO have traditionally been championed by co-leads on a case-by-case basis, they are now indisputable codified areas of focus by CFIUS.
A good guide
A second milestone came on October 20, 2022, when the Department of the Treasury published the CFIUS Enforcement and Penalty Guidelines. These describe, for the first time, how CFIUS identifies, processes and assesses National Security Agreement (NSA) violations and imposes penalties.
The guidelines identify three acts or omissions that constitute a violation:
Failure to file a mandatory declaration or notice
Conduct that is prohibited or otherwise fails to comply with CFIUS mitigation agreements, conditions or orders
Material misstatements or omissions relating to information filed with CFIUS, including false or materially incomplete certifications filed in connection with assessments, reviews, investigations or CFIUS mitigation
Together with the CFIUS EO, the guidelines are a clear signal that the Executive Branch, from the White House to the CFIUS member agencies, is committed to protecting US national security interests across the entire deal screening process, from case assessments to monitoring NSAs.
As a result, deal parties are increasing their scrutiny of covered transactions for any national security concerns that may draw the attention of CFIUS, motivated by the more central role that penalties may play in the future. To date, CFIUS has publicly announced only two instances of civil penalties, one valued at US$1 million in 2018 and a US$750,000 fine in 2019.
This will change as CFIUS increases its emphasis on enforcement. Indeed, the explicit inclusion of what constitutes a violation and the setting out of the penalty process is a sign that non-compliance is likely to be met with a more forceful response.