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.
Last year was a transition period following a record-shattering 2021. The deceleration in M&A activity was palpable in the second half of 2022 and raises concerns for some that the worst is yet to come. Although there are signs that we may be turning a corner, deal volume will likely lag until confidence is restored. Here are six key trends that will define the US M&A market and regulatory environment in 2023.
1. Lower inflation and market stability will stir the M&A pot
Although it is difficult to know for certain how the macro picture will play out, there are encouraging signs that inflation may be losing steam. After having peaked at 9.1 percent in June, the US 12-month inflation rate dipped to 6.5 percent by December.
Further signs of this trend continuing—if not accelerating—in the first half of 2023 should see equity markets bottom out and a shift in sentiment. In this scenario, there would be less impetus for the Federal Reserve to keep tightening even if labor markets remain firm, as they have.
Stock market volatility was also high in 2022, with the VIX Volatility Index averaging above 25 through the year, which has historically been followed by a more stable year. Stability across equities and a drop in inflation to more familiar levels should, in principle, cement confidence among dealmakers and bring M&A activity back to pre-pandemic levels—though that is the glass-half-full view.
2. Interest rates are set to stabilize
This time last year, interest rate hikes were seen as inevitable, but few could predict just how aggressively they would be applied. Whichever way you look at it, the Fed is now closer to the end of its interest rate cycle than the start, after a sharp rate of change in 2022. In December 2022, the Federal Open Market Committee projected a 5.1 percent federal funds rate for 2023 year-end, indicating that three further 25 bps hikes may be on the table. That is most likely the worst-case scenario—it is also possible that only some of these increases will be made. Inflation trends and, perhaps more importantly, the Fed's reaction to them, will likely dictate the direction of travel for interest rates, financing and M&A activity in 2023.
3. Debt accessibility should improve
A lack of financing was an impediment to deal activity in the second half of 2022, to say nothing of the rising cost of debt. Syndicated loan and high yield bond markets seized up, which impaired private equity's (PE) ability to get deals done. As a result, sponsors turned to private credit and focused on smaller deals.
Assuming macro conditions stabilize, access to financing should also improve, especially for higher-quality deals involving companies with stable credits that have demonstrated robust growth through the pandemic and subsequent inflation. However, there is uncertainty regarding how long it will take for improved conditions to return, and the cost of financing will remain high for the foreseeable future. PE funds responded to this last year by adjusting their bid levels and will remain similarly prudent until the base rate is meaningfully reduced.
4. Antitrust agencies are broadening their scope
This year, among other antitrust challenges being made against major mergers, the Federal Trade Commission (FTC) is attempting to block Meta's planned purchase of virtual reality company Within. But Big Tech will not be the only ones in the crosshairs.
As the past two years have shown, antitrust agencies are taking a far more interventionist approach. Revised merger guidelines are due to be published and will set the stage for what follows. Until then, uncertainty remains over how anticompetitive behavior is being identified and interpreted, and how exactly the agencies will view any given acquisition. Dealmakers should prepare to seek counsel early.
5. New legislation will drive deals
The Inflation Reduction Act is a big step toward boosting the growth of clean energy, and the sheer scale of the incentives involved will propel M&A deals in the space. Oil & gas companies and PE are already keen to capitalize on the opportunity.
The CHIPS and Science Act will prove to be another legislative incentive for years to come. In a bid to boost domestic semiconductor manufacturing, approximately US$280 billion will be made available in the next decade for investment in chip research and production.
This is already producing results—shortly after the law was signed on August 9, 2022, Intel and Canadian PE firm Brookfield Asset Management signed a US$30 billion joint investment agreement to support the semiconductor maker in the expansion of two plants in exchange for a 49 percent stake in the project. There are also second-order effects to these landmark pieces of legislation, with PE actively seeking to back companies in these industries' extended supply chains.
6. The SEC is coming for crypto
The Securities and Exchange Commission (SEC) started issuing its first charges against participants in the cryptocurrency industry in 2021. Predictably, these ramped up by the final weeks of 2022, as alleged bad practices came to light amid the implosion of asset prices. This initial period of enforcement could be a preview of what is to come. The SEC has beefed up its resources to pursue the industry and SEC chair Gary Gensler has said the watchdog does not need to wait for Congress to pass laws on how the space should be regulated.
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