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.
In December 2021, President Biden announced a new target for the country to achieve "a 50-52 percent reduction from 2005 levels in economy-wide net greenhouse gas pollution in 2030." To put that into context, in 2020, net greenhouse gas (GHG) emissions were approximately 17 percent below 2005 levels.
As a result, fossil fuel operators are now aggressively trying to reduce their emissions. Sustainable energy companies from renewable natural gas to renewable methane are being bought up by oil & gas super-majors, whose balance sheets have expanded thanks to the surging price of energy and fossil fuels in the past two years.
By acquiring these assets and incorporating them into their existing infrastructure, thereby creating larger diversified energy companies, these groups have the potential to establish profitable renewables businesses. The bottom line is that fossil fuel companies are adapting to this new environment, and one of the fastest ways to achieve this transformation is through buying rather than building, meaning that there is likely to be substantial M&A activity in this sector. Case in point: Chevron Corp made its biggest investment to date in alternative fuels when it acquired biodiesel maker Renewable Energy Group for US$3.15 billion in February 2022.
A game-changing law
A major catalyst for investment in energy transition is the landmark Inflation Reduction Act (IRA), which Congress passed in August 2022. It is the most sweeping legislative development in the history of renewable energy income tax incentives. The IRA has reset existing tax credits while introducing new incentives for a variety of renewable energy sources and projects in what will amount to an expenditure of more than US$400 billion.
Under the IRA, extant tax credits for traditional solar and wind projects (the value of which, under prior law, had begun to taper off significantly), have been restored to their original dollar value and extended until 2032—and potentially later if emission targets are not achieved in that time. The tax credits are available on the condition that claimants comply with new "wage and apprenticeship" requirements designed to ensure that construction workers are paid prevailing wages, and qualified apprentices registered with the US Department of Labor are used for projects. Moreover, in what will likely serve as a significant boon to the burgeoning carbon-capture, utilization and storage (CCUS) industry, under the IRA, tax credits associated with carbon oxide sequestration will enjoy both significant increases in credit value and significant decreases to applicable minimum capture thresholds.
Additional incentives under the IRA include tax credits for standalone battery storage, clean hydrogen, and manufacturers of components for qualifying clean energy projects and facilities. The legislation also provides for new and potentially game-changing ways to monetize tax credits. This includes transferability provisions—which, for the first time, allow tax credits to be bought and sold between taxpayers—as well as so-called "direct pay" provisions, which allow for taxpayers in loss positions to simply collect cash from the Treasury Department rather than being forced to wait until they have taxable income in order to make tax credit claims.
Focus on energy security
There is a notably different emphasis in how US energy incumbents are attempting to decarbonize. Unlike in Europe, where companies are far more focused on renewables, US businesses are directing more investment toward CCUS. This extends beyond the energy sector into adjacent applications.
For example, in December 2022, ExxonMobil, the largest oil & gas company in the US by market capitalization, partnered with Mitsubishi Heavy Industries to deploy the latter's carbon-capture technology as part of ExxonMobil's end-to-end carbon-capture and storage services for heavy-emitting industrial customers.
There are two key reasons for the growing investment in CCUS. Rapidly weaning the world off carbon-based fuels will be incredibly challenging because of their widespread accessibility and lower cost relative to renewables.
Then there is the question of energy security—renewables continue to face energy storage constraints. Prevailing battery technology, lithium-ion cells, are limited by raw material scarcity and have a relatively short effective operating life.
Private financing is working to solve this. For example, in December 2022 Houston-headquartered energy infrastructure company Schlumberger and Saudi Aramco's corporate venture arm backed a US$100 million Series A round for EnerVenue, a Californian startup developing long-life nickel-hydrogen batteries. In due course, advanced battery technologies have the potential to further unlock renewables' contribution to the overall energy mix.
In the shorter term, CCUS offers a timely solution for reducing carbon emissions to help offset the impact of the continued use of traditional energy sources. Like renewables, the space has received a substantial boost from the IRA, which has significantly increased the tax credit value and decreased the applicable minimum capture thresholds for carbon-capture projects. All of this will go a long way toward the government's goal of achieving net-zero by 2050.
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