Eat or be eaten: gauging M&A appetite in 2022

Last week, I moderated a panel on the outlook for M&A at the Greenwich Economic Forum in Miami. The event brought together leading alternatives, family offices, thought leaders and entrepreneurs, including my esteemed panelists Laurence Goldberg, managing partner at Onex Partners, Arlen Shenkman, EVP & CFO at Citrix, and Laura Turano, partner at Paul Weiss. Coming off a record 2021 for M&A activity, where volumes reached an all-time high of $5.9 trillion globally, an increase of 64% over 2020, we explored the prospects for M&A deal making in 2022 given the evolving and uncertain geopolitical and economic landscape, interest rate increases and regulatory environment under the Biden administration.

What drove record activity in 2021?

Last year, as the world emerged from the pandemic, several factors aligned to create the conditions for eye-popping M&A activity.??Corporates quickly pivoted away from prioritizing liquidity and risk mitigation toward growth. Buoyant stock markets, healthy balance sheets and low cost of funding, supported by accommodating monetary policy, increased their confidence to transact.??In addition, private equity firms were ready and willing to deploy funds, accounting for nearly 40% of overall M&A transactions.? Finally, last year saw record activity from SPACs, as they raised peak proceeds and hunted for targets.??The technology sector was the most active in M&A, capturing 20% of total activity, as a driving force for growth and digital transformation. The COVID-19 pandemic also had an unexpected positive effect in deal making activity.??Removing the barriers of time-consuming travel, virtual meetings and new technological capabilities enabled unprecedented operational efficiency.??This propelled the speed of the M&A processes, supporting the volume of transactions across sectors, deal sizes and geographies.??

How does valuation come into play?

With markets up ~20% (DJIA) in 2021, and high growth companies garnering 35% premium compared to 25% industry average, valuation were stretched, raising concerns of a potential asset bubble.??In addition, many de-SPACs transactions derived their target price based on aspirational projections a few years out, putting further upward pressure on valuations.??

In thinking about a valuation framework when making an investment or acquisition, the panelists reverted to M&A fundamentals: ensuring the industrial logic, opportunities for value creation and risk adjusted returns. But in a competitive environment, buyers are forced to pay market clearing prices for quality assets. To get comfortable with that requires deep research and diligence on a sector to establish conviction, knowledge of the asset in advance of an auction and building relationships with the target to surface value even at high multiples.??

Who has the leg up on M&A?

Historically, corporates had the advantage through potential synergies and operational efficiencies. But in recent years, the landscape has shifted. The growth of the alternatives sector with its broad portfolios enables private equity to do the same. As investment strategies of alternatives have expanded beyond the traditional focus on cost cutting and cash flow optimization into growth, they now compete for assets by offering capital to fuel this growth and a broad network of experts to advance the investment thesis. And they do so with the benefit of doing it away from the scrutiny of public investors. Flexible investment strategies have also presented private equity with opportunities in PIPE investments, continuation funds and partnerships with other players in the ecosystem, including hedge funds.

How will the regulatory backdrop affect activity?

Under the Biden administration, regulators have taken a much more prescriptive view around monitoring anti-competitive behavior. The M&A market is seeing significantly more scrutiny, particularly in the technology and healthcare sectors.??As a result, boards are investigating deals more closely, and have a lower appetite for risk when making decisions.??Data security and privacy have become a concern, with Europe taking the lead in enforcement.??To be successful in this environment, it is essential to do your work early, identify potential areas targeted for anti-trust concerns, define the market, and pinpoint the risks and remedies associated with the transaction.

Where does shareholder activism fit in?

After a hiatus during the height of COVID-19, shareholder activism in the US has returned with?M&A-related activism the dominant thesis. The past year also saw several high-profile campaigns come to a close. These included big battles like that at ExxonMobil, which attracted the attention of little-known Engine No. 1 and its push for an ESG agenda at the energy giant. Engine No. 1 emerged successful, and was able to place three directors on the board of Exxon.??Shareholders also have become more vocal as seen in the case of Zendesk, who had their acquisition of Momentive (SurveyMonkey) voted down by its own shareholders.??The return of activism serves to highlight how communication with stakeholders is key to the success of an M&A transaction.

Thumbs up or down for M&A activity in 2022?

Looking ahead, my panelists gave M&A a tentative thumbs-up for 2022, albeit at a slower pace of activity than the records of 2021. Corporate balance sheets remain healthy, with over $3.0 trillion of cash holdings among S&P 500 companies.??Private equity fundraising has continued at a fast clip, with estimated $2.3 trillion dry powder available to be deployed. SPACs continue to seek targets, and the cost of debt remains low.??While risk level has increased, shaking overall confidence, the adage that one must “eat or be eaten” will continue to fuel M&A activity.