Have M&A Trends Flipped for 2022?
Expectations for Blowout Deal Flow Shift Due to New Macro Economic RealitiesMay 16, 2022
Nothing could stop 2022 from setting new global merger and acquisition activity for both value and volume of deals. Then, the second quarter happened: The most aggressive interest rate increases from the central bank since the 1980s. Double-digit inflation with key categories such as energy and used cars up 25%+. War in Europe, and ongoing supply chain issues.
BankerAdvisor has already detailed how the IPO market was already slowing. We also wrote that countering high inflation is a greater priority for the Fed than the possibility of slowing the economy into a recession.
But fewer IPOs, a down market and the specter of recession don’t necessarily equal fewer mergers. According to M&A prognostications and research reports from KPMG, Morgan Stanley, PitchBook and others, easy access to low interest capital and a recovering post-pandemic global economy would help deal makers easily eclipse the $5 trillion worth of transactions from 2021.
Key M&A Trends Upended
Earlier in the year, executives surveyed by KPMG said that the biggest inhibitor to new deals were high valuations. But with an S&P 500 down 18% in 2022 at the time of this writing, an aggregate bond index down 9.4%, more than $1 trillion in crypto losses and a NASDAQ down 25%-plus, both private and public companies appear less expensive.
A closer look at traditional P/E ratios may reveal there is more room downward, however. The S&P 500 is trading at roughly 17 times its projected earnings over the next 12 months, according to FactSet. That is still above the average multiple of 15.7 over the past 20 years, but down from a recent peak of 24.1 in September 2020.
Some analysts believe companies are still too expensive. As the Wall Street Journal pointed out, analysts at Citigroup Inc. said that the U.S. stock market entered bubble territory in October 2020 and is now exiting that bubble, though they said equities aren’t as stretched as during the dot-com era. Forward multiples climbed as high as 26.2 times earnings in March 2000. In the selloff that followed, they plummeted. By 2002, the S&P 500 traded at a low of 14.2 times its next year’s earnings. In 2008, when the country was in a severe recession, that figure hit 8.8.
The Fed has signaled more interest rate increases are coming but how many and how high are questions roiling Wall Street. Higher interest rates reduce the worth of companies’ future cash flows in commonly used pricing models.
Increasing Number of Targets in Second Half?
Along with high valuations, deal makers noted there was fierce competition for a limited number of high quality targets. However, with a contracting economy and a tighter capital, more companies may be looking for an exit.
In addition, with more deals originating from private equity (PE) firms , the appetite to buy may start to grow as other companies see a sales as a better option. Lower valuations for targets during down cycles improve the chances for acquirers to realize higher returns. With a greater supply of high quality targets more open to acquisition, M&A activity may accelerate.
An analysis by PWC points out,
Companies that acquire in a downturn can see benefits. In the recession from March to November 2001, marked by the dot-com bust, the median shareholder returns for companies that made acquisitions outpaced their respective industries in the following months, rising as high as 7% one year after the transaction was announced. More than 900 companies made 1,600-plus deals during that recession. In several sectors – including consumer durables, insurance, media and entertainment, and healthcare equipment – the median returns for those acquirers after a year were higher than the overall sector by double digits, our analysis found.