Global mergers and acquisitions plunged to their lowest level in a decade last yr, with $2.9 trillion in deal value announced, down 17% from 2022. Dealmakers largely remained on the sidelines as they struggled with higher inflation, rising rates of interest, increased regulatory scrutiny and market uncertainty, while potential sellers continued to carry on to earlier, higher valuations.
Activity amongst private equity (PE) buyers fell last yr after accounting for nearly 25% of all buyouts within the previous two years, as tighter financing conditions and better rates of interest made leveraged buyouts tougher to finish. In Canada, many of the 441 accomplished transactions last yr were additions to an existing business inside a PE portfolio.
PE firms have found ways to proceed doing deals in a better rate of interest environment by acquiring minority stakes in firms. They preserved capital by writing smaller checks, but allowed the goal company’s shareholders to take care of their interest in the corporate if the valuation recovered.
There were some vivid spots. The activities of firms within the raw materials and industrial sectors increased as lots of them benefited from inflation and firms sought to scale their operations to extend efficiency. The energy sector led M&A activity, with several large merger deals announced within the second half of the yr, with deal activity within the US Permian shale region exceeding $100 billion. While mergers and acquisitions declined overall within the technology sector, two major deals – Microsoft’s $69 billion acquisition of Activision Blizzard and Broadcom Inc.’s $61 billion acquisition of VMware – closed successfully. Activity also increased within the healthcare sector, with dozens of biotech and pharmaceutical merger announcements, as many major drugmakers face steep patent cliffs over the following decade and seek to refresh and expand their patented drug portfolios.
Despite the challenges of 2023, the rebound within the last quarter gave investors a glimpse of higher days ahead. In 2024, dealmakers are battle-hardened and have adapted to the brand new regime through the use of more structured deals to balance risk. This includes using earn-outs, conditional rights, carve-outs and spin-offs. Dealmakers also structure transactions with full or partial consideration in the shape of shares slightly than solely in money. Buyers often structure all-cash deals in the event that they have sufficient money or access to financing and are confident enough to assume all of the danger. Given the tightening of financing conditions typically, and particularly for businesses in capital-intensive industries, it’s becoming increasingly common to share risk and reward with shareholders.
Last yr’s headwinds could turn out to be this yr’s tailwinds, and we’re optimistic in regards to the prospects for M&A and merger arbitrage in 2024. As inflation cools, rate of interest expectations trend lower and firms adapt to the post-pandemic environment, investor confidence is returning. Despite the geopolitical and economic backdrop of uncertainty, smart firms are in search of ways to drive future growth and acquire the technologies and capabilities they should compete and otherwise avoid disruption.
As for deals, evidence from investment banks, consultants and company insiders suggests the M&A pipeline is strong. Rising stock markets have given management and boards of directors the boldness to enter into lively dialogue with a growing variety of firms to do business. Shareholder activism can be on the rise as frustrated investors seek to extract value from stock trading, which they are saying represents significant discounts to intrinsic value. As proxy season begins, ineffective boards could turn out to be targets, and increasing shareholder discontent could bring opportunistic buyers into the image.
Merger arbitrage may provide a beautiful investment opportunity because the return on merger arbitrage on a mean North American merger deal is over 10%. This is a big premium in comparison with historical levels and a big premium to high yield bonds. In a more hostile regulatory environment, arbitrage investors now understand what forms of trades may very well be subject to greater regulatory scrutiny.
After a series of losses, regulators are overwhelmed. With wide spreads, an improved deal risk assessment guide and the potential for further M&A activity, 2024 may very well be a powerful yr for merger arbitrage performance.
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