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 2022 US SPAC IPO market was a shadow of its former self. There were 86 SPAC listings on US exchanges, totaling US$13.4 billion in proceeds—a far cry from the 613 listings in 2021, which raised US$162.6 billion in proceeds. The largest SPAC IPO of the year, Screaming Eagle Acquisition Corp, sponsored by Eagle Equity Partners (EEP), raised a relatively modest US$750 million on Nasdaq, compared to the previous SPAC sponsored by EEP, which raised US$1.725 billion in 2021.
While record sums of capital were collected in 2021, leaving plenty of dry powder for deals, de-SPAC transactions also slowed. These transactions nearly halved to 101 in 2022 from 199 a year prior. In terms of total value, US de-SPACs came to US$167.5 billion—a major step down from the US$502.8 billion announced in 2021. The largest of these was the announced US$3.1 billion merger between Horizon Acquisition Corp II and Flexjet, a provider of fractional ownership aircraft, leasing and jet card services.
Perspective is important here: After growing in popularity in the second half of 2020, it is no exaggeration to say the US SPAC market exploded in 2021, as capital markets and M&A markets were each flooded with liquidity. It was to be expected that 2022 would be slower. A proposal in March 2022 by the Securities and Exchange Commission (SEC) to impose stricter rules on the asset class further dampened activity.
Statements made by the SEC in connection with its announcement of the proposed rules about various stakeholders including SPACs, targets, underwriters and other transaction participants being potentially liable for information included in SEC filings during de-SPAC transactions—including projected financial information—were enough to seriously temper the market. The SEC said that it considered it important that there be liability on so-called "gatekeepers" in de-SPAC transactions akin to the liability that underwriters would have in a traditional IPO. A number of law firms, industry associations and other SPAC market participants submitted comments to the SEC, questioning various aspects of the proposed rules. The SEC has yet to respond to the comments or adopt any of the proposed rules.
As a result, the SPAC marketplace finds itself somewhat in limbo. Mergermarket reports that, in Q4 2022, the average time between a SPAC IPO and the announcement of a merger was 15.2 months, up from 8.7 months in Q1. By comparison, it took just 5.9 months for SPACs to find a merger target in Q4 2021.
Similarly, on average, the gap between a SPAC IPO and completion of a merger was 22.5 months in Q4 2022, versus 15 months in Q1 2022 and 11.2 months in Q4 2021.
In addition, the number of SPACs that liquidated more than doubled in each quarter of last year. Per Dealogic data, more than 60 US-listed SPACs announced they would return nearly US$24 billion to investors in 2022. The Inflation Reduction Act—which includes a 1 percent excise tax on corporate stock buybacks that takes effect in 2023—has been cited by some as part of their motivation to liquidate earlier than required. For example, the Gores Group returned cash in the trusts of three of its SPACs in 2022, rather than wait until 2023. However, based on guidance issued by the Departments of the Treasury and the Internal Revenue Service on December 27, 2022, that redemptions in connection with liquidations are not subject to the excise tax, many of those accelerations may have been unnecessary.
Many SPACs waiting to go public, faced with potential SEC scrutiny among other restrictions, simply decided to pull the plug—115 SPACs valued at US$31.5 billion withdrew IPO paperwork in 2022, according to Dealogic. In addition, more than 50 SPAC mergers were terminated in 2022.
In addition to regulatory and economic pressures, 2022 presented SPACs with a number of civil litigation challenges. These included both breach of fiduciary duty claims and securities litigation.
On January 3, 2022, the Delaware Court of Chancery issued a long-awaited decision in the In re MultiPlan Stockholder Litigation case relating to the de-SPAC transaction between Churchill Capital Corp III, a SPAC founded by Michael Klein, and MultiPlan, Inc.
The complaint in the MultiPlan case generally alleged that the structure of the SPAC created divergent interests between the Class A stockholders (public investors) and Class B stockholders (the sponsor, directors and other founders), and alleged that the defendants (including the directors of the SPAC, the sponsor and the alleged controlling stockholder, Klein) prioritized their personal interests above the Class A stockholder interests in completing the merger and issued a false and misleading proxy statement that deprived Class A holders of the right to make an informed decision as to whether to redeem their shares. In this respect, the complaint asserted breach of fiduciary duty claims against the directors of the SPAC, Klein and the sponsor, among others.
The court "applying well-worn fiduciary principles" concluded that the plaintiff's allegations were sufficient to survive defendants' motion to dismiss, principally because of the potential conflicts of interest between the public stockholders (who would only profit if the stock were to trade above the redemption price of US$10.04 per share) and the defendants (who would profit from their Class B shares even if the stock were to trade substantially below that price). In November 2022, MultiPlan announced that the case had been resolved with plaintiffs for US$33.75 million.
Many SPACs do not have the same level of alleged conflicts as witnessed in the MultiPlan case. In the latter, among other things, the sponsor had the ability to elect all directors prior to the de-SPAC closing, the directors held substantial amounts of Class B shares and there were longstanding relationships between Klein and the other directors. Nonetheless, plaintiffs have looked to the MultiPlan case to craft breach of fiduciary duty allegations in subsequent lawsuits.
In addition, cases have been filed in Delaware and in the US District Court for the Southern District of New York against SPACs that received termination fees stemming from failed mergers and subsequently liquidated. These cases generally focus on whether the Class A holders are entitled to receive additional distributions above and beyond their pro rata share of the trust account in the event the SPAC liquidates. The Delaware courts have yet to issue a dispositive decision on any of these cases and this will be an area to watch in 2023.
Finally, plaintiffs' lawyers continued to aggressively target SPACs with securities litigation in 2022. According to the Stanford Class Action Securities Clearinghouse, there were 25 class action securities litigations filed involving SPACs in 2022. We expect this trend to continue into 2023.
Despite the slowdown in activity, SPACs remain a viable method of reaching public markets. They give private companies access to growth capital and investors a means of getting in on the ground floor to back high-potential companies. Nevertheless, the volatile markets and regulatory environment have imposed challenges that SPACs will need to address in order to stage a comeback.
For the time being, with the broader IPO and M&A markets remaining challenged and investors leaning away from more speculative assets—which have often been the target of SPACs—SPAC activity is likely to remain subdued. Once the broader markets recover, and the regulatory picture is clarified, SPACs likely will adapt and retake their place among capital markets alternatives, although nobody expects—or even wants—a return to the overheated market of 2021.