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.
The crypto industry has endured arguably its toughest year to date. Nonetheless, it remains a fertile ground for innovation as developers use "crypto winters" to build the next cycle's most exciting products.
The first shoe to drop was Terra Luna in May 2022. Investors were lured in by the high yields in exchange for staking their TerraUSD (aka UST) stablecoin which, unlike Tether (USDT) and Circle (USDC), was not collateralized by real assets. Critics had argued for some time that the algorithmic dollar-pegged coin was doomed to fail—and that is exactly what happened. The resulting contagion surprised even the biggest crypto skeptics, with ripples felt for months to come. Some of the largest centralized finance (CeFi) companies would soon topple and declare bankruptcy.
The wave of insolvencies that emerged in the second half of the year has already produced some market activity. In December, Binance.US agreed to pay US$20 million to acquire Voyager Digital's customer accounts plus the market value of its crypto assets, which at the time of the announcement was approximately US$1 billion.
The deal, essentially, is intended to provide Voyager's customers with a crypto-based recovery and liquidity while expanding Binance.US's user base, although there are no certainties the sale will obtain regulatory approval or close. Post-close, it is uncertain whether customers will stick around.
This could be the first of similar deals, with existing crypto players seizing on a consolidation opportunity by acquiring certain assets from their fallen competitors. For example, Celsius Network, FTX and BlockFi, all of which filed for bankruptcy after Voyager, are all running processes to solicit proposals to fund their chapter 11 exits.1
There are three primary motivations for crypto natives to acquire assets out of bankruptcy. One is access to new customers, as illustrated by the Binance.US-Voyager deal. Another is to acquire technology infrastructure and human capital, though there is typically an exodus of talent in any insolvency situation. Finally, acquirers may be attracted to a failed target's regulatory infrastructure, licenses, and authorizations. It is not only large buyers acting alone that are reviewing current insolvency acquisitions; industry consortia have also been sizing up potential deals.
Moving through Congress
The biggest short-term challenge for the digital assets industry is uncertainty surrounding the impact of incoming legislation and regulation. The Digital Commodity Consumer Protection Act (DCCPA), introduced in August 2022, seeks to give the Commodity Futures Trading Commission (CFTC) more oversight of the industry, to the extent digital assets are considered commodities.
At a December 1, 2022 hearing, Democratic Senator Debbie Stabenow, chair of the Senate Committee on Agriculture, Nutrition and Forestry (which oversees commodities) and the DCCPA's sponsor, remarked that the purpose of the legislation is not to take authority away from other financial regulators. She added: "Because crypto assets can be used in many different ways, no single financial regulator has the expertise or the authority to regulate the entire industry."
This is what makes crypto such an innovative area of the digital economy—and a challenge for regulators. For example, Bitcoin (BTC) is accepted as a commodity, playing the role of a fungible, digital gold. But the next largest crypto by market capitalization, Ether (ETH), is a very different animal. Developers can readily build decentralized apps (dApps) on the Ethereum network, providing users with banking services, the ability to trade collectibles and artwork in the form of NFTs, play video games with financial incentives, and socialize and make transactions in the metaverse.
In 2018, the then-Director of the Division of Corporation Finance at the Securities and Exchange Commission (SEC) publicly stated that ETH is not a security due to its decentralized nature and its long-term development.
On September 15, Ethereum transitioned from a proof-of-work (PoW) to a proof-of-stake (PoS) network, slashing its carbon footprint.
It is not only the DCCPA that will be watched closely in 2023. In December, Democratic Senator Elizabeth Warren and Republican Senator Roger Marshall introduced the Digital Assets Anti-Money Laundering Act. The proposed legislation seeks to extend know-your-customer requirements to digital asset wallet providers, miners, validators and other blockchain network participants, and calls for these to be designated as money service businesses by the Financial Crimes Enforcement Network.
A path forward
While these developments have the potential to hamper decentralized innovation, consumer demand for digital assets remains strong, even amid ongoing market volatility. Proponents of decentralized finance (DeFi) argue that, thus far, it has worked as designed, unlike some centralized products—self-liquidating loans administered via smart contracts on the blockchain functioned just as expected—and this is likely to keep DeFi in the spotlight.
Use cases for blockchain technology also continue to emerge, including in the institutional world. For example, in September 2022, KKR, one of the largest private equity firms in the world, made its Health Care Strategic Growth Fund available on the Avalanche blockchain.
Meanwhile, some of the biggest consumer brands, including Walmart and Nike, continue to plant their flags in the metaverse, the latter launching its first line of digital sneakers last year following its acquisition of NFT company RTFKT.
Fashion brands have been particularly active in expanding their digital footprint in this new frontier. In June 2022, Salvatore Ferragamo opened a concept store in New York offering customizable sneakers via hologram, as well as 256 NFTs created in collaboration with digital artist Shxpir. That same month, Burberry launched its second NFT collection in Mythical Games' Blankos Block Party, the branded limited edition Burberry Blanko NFT (aka, a unicorn named Minny B) as well as a variety of digital accessories. Tag Heuer even launched a smartwatch that allows users to display their collection of NFTs.
The digital assets space moves at such a rapid pace that it is difficult to predict where the biggest innovations and M&A opportunities will be by the time the current crypto winter thaws. There is evidence of products that could solve the issues underpinning some of 2022's biggest collapses. Within DeFi, decentralized trading platforms became popular in Q4, allowing users to trade leveraged products while acting as custodians of their assets rather than entrusting them to centralized exchanges.
In the venture capital space, 2023 will bring renewed focus on due diligence, risk management and compliance with incoming laws and regulations. Hard lessons were learned in the past 12 months and these should make for a more resilient, battle-hardened industry over the medium to long term, even if asset prices remain deflated in the coming months. Whether it is called crypto, Web3 or is soon known by another name, this space is here to stay.
1 White & Case LLP represents parties in interest in the Celsius Network and FTX Trading restructuring processes. This publication is for informational purposes only, and no statements in this publication shall be attributable to any client of the Firm.