M&A: How soon before we will be "drinking from the fire hose" again?

2023 began with an extremely cautious, if not outright negative, M&A outlook, with elevated recession fears, interest rates rising rapidly and without any clear top, and the possibility of a widespread financial crisis increasing due in large part to some US regional bank failures. The first half of the year has indeed been extremely difficult, with deal value down 38% and count down 21% against 2022.

Fortunately, a number of things have changed since the beginning of the year. We see inflation finally cooling, interest rates likely nearing their peak levels, and financial turbulence fears are now subsiding. Even the potential for a collapse in commercial real estate, in particular office buildings, is expected to be relatively self-contained.

More significantly, the “earnings collapse” that was anticipated by many has largely been avoided. Across our client base, and particularly in the US, we are seeing many if not most corporate players beginning to ramp up their deal-making activity. And even PE players appear to be starting their engines, albeit slowly and deliberately. Industry disruption, whether in Energy, Life Sciences or Technology has certainly not slowed down. Looking at the second quarter numbers one can see a clear desire to transact and returning confidence to pull the trigger.

The second quarter saw global transactions worth US$716b, up 26% against the sluggish first quarter, as CEOs accept the new realities of deal fundamentals, including having to bridge a wider valuation gap, more expensive funding, and a greater likelihood of regulatory scrutiny.

Even in terms of deal count, the numbers stood up 2% against 1Q23, providing some data points to support stabilization. Further, looking at June numbers gives us me even more confidence, as the month was up 3% compared to May and 84% against January 2023. The month recorded 274 deals over US$100m – the highest monthly count of 2023. Also, an appetite could be seen towards high valued deals as the month registered 59 billion-dollar-plus deals – the highest seen in the past 15 months.

Trends that underpinned the deal market in the post-pandemic M&A boom, such as the continued imperative for digital transformation, accelerating ESG considerations and maximizing portfolio optimization, will continue to create opportunities for a more active M&A market in the coming months.

And what remains the most important is undoubtedly what everyone is talking about – Generative AI – a game changer that everyone needs to be ready for. ChatGPT and other recent technologies has shaken up the world of artificial intelligence, spurring companies like Google and Microsoft into action. Investing in AI could be the next big thing in 2023 and according to Pitchbook data, M&A in AI has seen a 3X increase in deal value in 2022 compared to prior years. The year 2023 is actually on the path to be another record year for GenAI driven investments, beating 2022.

The first half saw deals such as Microsoft investing US$10b in OpenAI to support building artificial general intelligence (AGI) with widely distributed economic benefits, developing a hardware and software platform within Microsoft Azure which will scale to AGI. The deal was a big bet on ChatGPT, which could help Microsoft boost its efforts in web search, a market dominated by?Google.

Other than technology, the life sciences sector also saw strong deal flow in 1H23 with deal value up 37% YOY. This reflects an improving demand for differentiated biotech and pharma assets that should continue accelerating in the coming months. Performance of the NASDAQ Biotechnology Index shows that biotech/pharma valuations remained supressed throughout 2022 continuing into 2023, which will likely help attract more potential buyers. The?high cash reserves of leading pharma giants will also help them pursue transactions. We continue to see these cash-rich giant pharma companies acquiring smaller targets at earlier stages of innovative drug or device development to build on and diversify their existing portfolios, through 2023.

Energy has also been pushed to the top of dealmakers focus. Three themes dominate the energy market — energy security, the energy transition and some consolidation/re-alignment in the sector which appears to be bifurcating the space into those who are wanting to take advantage of the more attractive economics of “old energy” and those who want to be leaders in “new energy”. M&A activity in power and utilities is likely to be driven by firms investing in new energy platforms to strengthen their businesses towards energy security, decarbonisation, and energy transition–aligned themes. Metals and mining and security of supply will continue to be the primary driving factor for M&A activity. Miners are keen to maintain competitive positions and reorganize their portfolios through geographic and asset diversification. In the oil and gas space, it will be mainly around strategic consolidation of operations, aimed at improving capacities and optimizing operational costs.

Though the market sentiment has improved, uncertainty continues to prevail. With the recovery expected to be slow, companies are having to navigate multiple interconnected issues, for which they require a holistic & innovative strategic approach to position for future growth.

The situation reiterates the need for companies to review their portfolio and growth strategies. EY’s Sell and Separate 1Q23 survey reveals that 95% of business leaders plan to continue their portfolio transformation in the next 12 months. Companies should recognise that investment in future opportunities is critical, and they need to stay ahead of the disruption curve in their industries, with digital and technology being a primary driver.

M&A used to be a largely episodic activity. Today it is business as usual and a necessary part of the growth playbook. This trend will not reverse, not now, and not ever, as M&A continues to be the preferred route to stay ahead of disruption.

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