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Reality check: US M&A H1 2022

What's inside

US deal activity saw an annual decrease in H1 of this year, but remains buoyant compared to pre-pandemic standards

M&A proves its resilience after a year of excess

US M&A deal levels remain robust, despite dropping from historic highs set in 2021

US M&A activity eased off in the first half of 2022 following an annus mirabilis for US M&A in 2021. Total value slipped to US$995.3 billion, a 29 percent year-on-year fall, though this is consistent with dollar volumes seen before the pandemic and so remains healthy by historic standards. Deal volume also fell, by 21 percent to 3,818 transactions. While this also remains above average, there was a material softening in the frequency of deals moving through Q2, which saw a quarter-on-quarter drop of 22 percent to levels last seen in Q1 2020, when the market was just beginning to recover from the initial shock of the pandemic. 

A lot has happened this year to test acquirers’ nerves. Inflation concerns had already begun to set in before the war in Ukraine started. The conflict catalyzed further unease in capital markets as well as exacerbated supply chain troubles which have, in part, contributed to inflationary pressures. The S&P 500 officially entered a bear market in mid-June, and the Federal Reserve has embarked on a monetary tightening program to bring prices under control, leading to an increase in financing costs. 

Regulations are another consideration. The SEC has taken the SPAC market to task, proposing accountability for deal parties and intermediaries for inflated projections. This type of transaction ground to a standstill in Q2 this year, as participants digested their risk exposure and the implications of the regulator’s proposals weighing on overall M&A volume. More recently we have seen some truly innovative SPAC structures that have the potential to re-stimulate interest in these deals. 

For the most part, the US M&A market has stood up impressively to everything that has been thrown at it, which alone is solid grounds for optimism. Despite technology stocks being sold off heavily in equity markets, the sector has once again outperformed on the M&A front as companies and PE sponsors, who remain heavily armed with dry powder in spite of the more challenging deal financing conditions, continue to be attracted to innovation. 

The fall in price-to-earnings ratios in the public markets and EBITDA multiples in private markets mean that, all else being equal, acquisitions are more attractive today than they were a year ago. Naturally, investors remain cautious as they closely watch how inflation plays out, the Fed response and the impact of those actions on underlying economic growth. However, the second half of 2022 has the potential to reclaim some of the confidence lost in recent months.

 

US M&A settles back down

Deal value in the first half of 2022 could not match the record-breaking level of activity in 2021

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Private equity firms battle headwinds in H1

Despite facing economic and regulatory hurdles in H1, PE dealmaking remains resilient, and looks set to reach its second-highest value on record

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SPACs are overcoming expectations

After a series of rollercoaster years for the SPAC market, investors and sponsors are finding ways to improve deal integrity

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Sectors

In Focus

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Walking the tightrope of Russia sanctions

Buying an asset with operations in Russia remains permissible under sanctions laws, but any such process must be carefully considered

Insight
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3 min read

The conflict in Ukraine and subsequent sanctions have had a chilling effect on M&A involving Russian entities, as these assets are now squarely off-limits for US buyers.

The Office of Foreign Assets Control (OFAC), the financial intelligence and enforcement agency of the US Treasury Department, in June issued guidance that provided clarity on what types of deals may be permissible, although many remain highly complex from a compliance standpoint.

Broadly speaking, acquiring an equity interest in a company outside of Russia that may have some Russian operations can proceed under US sanctions law, under certain circumstances. But the devil is always in the details.

Investors are strongly advised to pre-clear even sanctions-compliant deals through the transaction chain, not just with the originator or beneficiary banks but with the intermediaries too.

A fact-specific analysis is necessary to understand the purpose of the investment, the extent of the target company's investments in Russia, and what the revenues from those Russian investments might be for the target company, before a US investor can get comfortable with an acquisition.

There are many nuances around the edges. OFAC has not determined specific thresholds, rather the language in the regulator's guidance centers on "predominance." Any non-Russian target that derives a predominant portion of its revenues from its Russian investments could therefore elicit some form of sanctions risk. A company that receives upwards of 51 percent of revenues from Russia would now clearly be off-limits. However, the predominance test could be interpreted more conservatively to apply to companies that receive the largest share of their revenue from Russia, which may still be a minority share.

Even for permissible transactions, it should be kept in mind that banks and other financial institutions commonly engage in over-compliance. With that in mind, investors are strongly advised to pre-clear even sanctions-compliant deals through the transaction chain, not just with the originator or beneficiary banks but with the intermediaries too. Otherwise, at any point in the deal, process banks may delay or block a deal based on their own internal policies, leading to unnecessary and avoidable challenges to the transaction's completion.

Divestments create their own headaches

A number of major multinational companies have begun pulling out of Russia, and this race to divest raises challenges too. In any divestment transaction, there's an investing party on the other side. That typically means exiting to a Russian company or the existing management, or in some cases to a business in a different country that has its own set of restrictions. US, UK or European companies, for example, must navigate not only the sanctions relating to blocked persons but also adhere to any export controls when transferring assets, particularly technology that authorities may consider strategically sensitive. Such items can include everyday office equipment, items used in manufacturing, and so-called "luxury goods."

There are also the financial institutions involved in the deal to consider. Extensive sanctions have been placed on Russian banks and acquirers, and sellers need to be extremely careful about which parties are mandated to administer a given deal.

There is a lot to think about and, as ever with sanctions, the situation is evolving. Sanctioned individuals are constantly being added to the blacklist by one authority or another, in some cases inconsistently. Investors must proceed with caution and the utmost diligence by carrying out a complex analysis of sanctions risks before attempting to execute any deal that may have some exposure to Russia.

This publication is provided for your convenience and does not constitute legal advice. This publication is protected by copyright.
© 2022 White & Case LLP

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