Q2 2023 Yields Cautious Optimism for M&A

M&A Falls, but Sentiment Rises

• Economic uncertainty and higher interest rates put a damper on Q2, continuing a recent trend of lower performance. Activity was well above the previous quarter, but deal value was down 25% from Q2 2022, while volume was down 20%.
• North America, particularly the United States, proved more resilient than Asia and Europe, while Latin America and India are standout performers.
• Dry powder and high interest rates continue to create a curious combo: high deal volume at lower average valuations.
• While world treads carefully, economic signs are looking better than they were a year ago. Resilient indicators and improving outlook could help avoid recession.

2023 continues to puzzle pundits, investors and dealmakers alike. While analysts debate whether recession is imminent, the economy has shown its resolve. That resilience is leading many analysts to switch their prediction, scooting recession expectations further into the future. While the stock market has performed well in the first half, however, M&A activity has slumped so far this year.

While not felt everywhere equally, we’re seeing a pullback in both deal size and volume for virtually all sectors, in all places. Some standout exceptions are the Life Sciences, Latin American and Indian markets. We expect similar caution, and resilience, throughout 2023.

Some of the quarter’s top deals include:

• ONEOK Inc's acquisition of Magellan Midstream Partners, valued at nearly $19 billion. This deal significantly bolsters ONEOK's market reach in the midstream energy sector, strengthening their position in energy logistics.
• Bunge Ltd's acquisition of rival Viterra Ltd, valued at $17.3 billion. This acquisition solidifies Bunge's status in the global agribusiness sector, enhancing its grain trading capacity and regional influence.
• Carrier Global Corp's purchase of the climate solutions unit of Germany's Viessmann Group for $13.2 billion. This deal furthers Carrier's expansion into climate solution technologies, reinforcing their role as a key player in this growing market.
• Glencore’s $17bn acquisition of Teck Resources. The company mines and develops a variety of resources, expanding Glencore’s market share in the space.

High Volume, Low Multiples

M&A during the pandemic, particularly the stellar period from late 2020 to early 2022, makes this year look bleaker than it would otherwise. Despite what seems like a depression in activity, M&A volumes looks robust compared to the average from 2017-2019. While total deal value is 15% lower than that three-year average, the market has seen 25% more deals.

What gives? True to form in 2023, we’re seeing mixed signals in the economy. The smoking gun is the combination of tailwins, economic resilience and large cash reserves, and headwinds like interest rates and uncertainty.

As a report by Pitchbook explains,
“The amount of unspent dry powder that has yet to be called and invested by [investing] sponsors stands at $1.35 trillion, just 9.7% shy of its all-time high. An even larger cash pile is on the books of corporations… [This] places pressure on potential acquirers to spend at the same time credit conditions are holding them back.”

Whether the bearish or bullish forces win the day will likely be decided in the next two or three quarters. For now, Q2 looks much more optimistic than the first quarter.

Activists Take a Breather Before Second Half

Despite setting records in the first quarter of 2023, activist investors took a breather in the second quarter, launching 53 campaigns worldwide, about a third fewer than Q1 2023. Despite the slowdown, analysts expect robust proxy activity ahead, as new rules and robust activity drive more successful proxy fights.

"Volatile markets and depressed M&A markets are not deterring activists from launching campaigns in 2023," commented Jim Rossman, global head of shareholder advisory at Barclays. He emphasized the rising geographical diversification of campaigns, with nearly half occurring outside the traditional U.S. sphere, focusing on Europe and Asia.

In fact, turbulent times could drive activist investors to seek more value for themselves and other shareholders, particularly if an economic downturn reveals strategic errors by the current leadership. These fights are easier than ever, with recent SEC regulations giving shareholders more control over selecting alternative directors.

Interestingly, despite sluggish financing flow and fewer deals, 46% of all campaigns in the first half had an M&A component, surpassing the 42% four-year average. Rossman anticipates this M&A trend to gain momentum, spurred by an estimated $1.4 trillion in private equity firms' war chests.

Rising Stars, Regional Rebounds

Source: White and Case

Here’s the day’s understatement: 2022 was a tough year for Europe. Russia’s invasion of Ukraine sparked complex economic impacts, kinking the supply of energy, food, and other key inputs. In such an environment, there’s naturally less appetite for making a deal.

That’s starting to change. While dealmaking activity in Western Europe is still just over half of Q2 last year, when companies were scrambling to complete mergers in the wake of the invasion, value jumped 80% from last quarter, the first quarterly increase in a year.

In a tougher M&A landscape, North America managed to hold the line a bit better than most of the world. Value was down roughly 20% from last year, while total deals (2,500) fell by about 15%. That compares to 25% and 20% drops worldwide for value and volume, respectively.

Following the pandemic, The Asia-Pacific region has struggled more than most to find its footing again. China’s rebound has disappointed expectations; US-led efforts to ice it out of emerging industries hasn’t helped. More broadly, there’s been a concerted effort in the Western World to bring supply chains closer to home, which could reverberate throughout Asia, but China looks to suffer disproportionately from those efforts.

Rising Stars

Two of the most exciting prospects for future activity lie in India and Latin America.

Latin American M&A jumped 43% from the same quarter last year, bucking an almost universal trend of year-over-year decline. The region is becoming an economic hotbed as American investment (and people) flow into it, spurred by abundant talent, relatively stable and open economies, and a low cost of doing business. To illustrate, Latin America’s share of global M&A value doubled to nearly 4% last quarter.

India is similarly positioned to thrive in a changing global environment. The country benefits from great powers competing for its friendship and influence, as evidenced by its unique ability to mostly “sit out” the sanctions battle between Russia and the western world. Its share of global dealmaking was a whopping 5% in 2022, more than doubling its average over the previous four years.

Same Sectors, Different Day

The same sectors that have dominated the M&A market since early 2022 broadly continue to do so. Life sciences (especially pharma), logistics, energy and technology are dominating the market.

Acquisitions reflect companies’ priorities: shoring up market share and protecting against cost uncertainty. For this reason, they’re acquiring logistics and energy firms to vertically integrate, reducing costs and protecting against more shocks to global souring, such as conflict or climate change.

At the same time, they’re sticking to what they know when it comes to growth, with more companies acquiring similar, competing firms rather than staking a new claim in unfamiliar territory.

Early Signs of Relief

In both the American and global economy, the theme of the second quarter seemed to be one of relief. The US has averted several potential financial crises in the first half of the year, from the string of bank failures in Q1 to a particularly close game of fiscal chicken in Q2. With the debt ceiling higher and deposits assured, economic sentiment is rising.

Recession expectations are falling and the stock market has continued its rebound, recently marking one of the longest winning streaks in recent history with eleven straight days of gains. We expect activity to continue to rebound as long as economic sentiment stays strong. While high interest rates may continue to dampen the market, the huge cash reserves held by investors and corporations should help mitigate their impact.

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