Q3 M&A Recap: Global Activity Sluggish, US Leads

• At $730 billion, global M&A value changed little from Q3 of last year, but transaction volume was down 31% to roughly 7,000 deals.
• Despite the global drop, America deal value and volume were up 37% and 49%, respectively. indicating continued resilience in the American economy over the past year. North American deals, valued at $377 billion, comprised over half of the global total.
• Most sectors have seen activity fall, but earnouts and distressed buyouts are proving more common in less certain times.
• Geopolitical instability, economic uncertainty and high interest rates don’t suggest a banger end to the year, but it seems like the market has found its footing after a tough drop in 2022.

In 2023, the economy continues to spur surprise, concern, and relief for investors and stakeholders. Economic experts, who broadly thought a recession was imminent a year ago, have kept revising the probability downward over the course of the year. Unemployment remains low, and inflation has fallen from a peak of 9% in June 2022 to a much more manageable 3.7% last September.

However, equity markets remain nervous. High interest rates make risk less attractive, especially when they raise the perceived risk of recession. Beyond high rates, there are a number of risks on the horizon, including a likely government shutdown. Experts also point to an increasingly frightening geopolitical landscape as a weight on world markets.

Despite these headwinds, it seems there is no better place to be (or buy) than the United States. The US continues to outperform the global economy, and comprised about half of global M&A value in Q3 of this year. If things do go south, less conventional forms of M&A, from hostile takeovers to deals featuring earnouts could help buoy activity in a downturn.

Here are some of the quarter’s biggest deals:

• Roark Capital agreed to a $9.55 billion acquisition of sandwich chain Subway.
• Cleveland Cliffs is aggressively pursuing a buyout of rival Steelmaker, U.S. Steel. The deal would propel Cleveland Cliffs into the global top ten steel producers.
• Cisco System Inc's $28-billion takeover of Splunk Inc will help to grow the company’s cybersecurity footprint.
• BioGen will acquire Reata Pharmaceuticals for $7.3 billion. Acquiring the company, whose flagship product helps reduce the inflammation caused by neurological disorders, will be a boost the pharma giant’s aging patent pipeline.

American (and Indian) Exceptionalism

The US economy continues to surprise the experts. Though a majority of economists predicted a recession in 2022 or 2023, the US has outperformed virtually every other country in terms of employment, taming inflation, and general economic resilience.

Though the M&A market is much less active than in 2021 and 2022, American activity now comprises about half of the global total. Private equity dry powder is near record highs, as companies wait to see how the economy changes. Many acquirers face looming deadlines to use these funds or return them to investors, which should help buoy acquisitions in over the coming quarters.

Meanwhile, another large country half a world away is showing its strength in tough times. In 2023, India’s market is proving one of the world’s most robust. It’s an increasingly attractive destination for investment; major companies love India’s high growth runway, large English-speaking population, and business-friendly environment. It also serves as a geopolitically safer alternative to China’s labor force as tensions rise between China and the United States.

For India, the proof is in the pudding when it comes to M&A. While most countries saw shrinking figures, India’s M&A volume and deal value jumped to nearly $40 billion, a more than 100% increase from the previous quarter. India’s deal volume has fallen over the same period, signaling that investors are willing to pay more for Indian firms, even in a softer M&A environment.

Earnouts Still in Fashion

In 2023, we discussed how earn-outs are becoming more common as dealmakers seek greater security in their deals, and we gave some advice on how to incorporate them into a potential acquisition or sale.

An earn-out is a provision that part of a target’s acquisition price will be provided as the acquired company hits certain targets, typically revenue or income. We can think of an earnout in two ways: a discount for the buyer if the target company underperforms, or a bonus for the company’s seller if it hits certain goals.

One of the quarter’s biggest deals, Roark Capital's $9.55 billion buyout of sandwich chain Subway, employed an earnout structure. The earn-out provision will reduce Subway’s valuation by $600 million if it doesn’t hit certain performance targets over the next two years.

We correctly predicted at the beginning of the year that earnouts would be a big part of 2023’s M&A landscape. Out prediction was based on the high-rate environment, which dampens valuations and makes risk less attractive, as well as the general sense of economic concern that settled in during 2022. As long as rates are high and people are nervous about a recession, we don’t expect frequent earnouts to go anywhere.

Looking Ahead

After 2022’s fall, M&A has “found its footing” in 2023.
Source: White&Case

The market seems to have found a normal range that, barring a big shock like a recession, should persist through the near term. M&A value over the past five quarters has kept within a relatively tight range of $650 to $750 billion, and there’s a reasonable chance that Q4 of the year will finish in a similar range.

As Naveen Nataraj, head of US Investing at Evercore Inc recently told Reuters, “It’s very consistent with historical trends where after a boom year like 2021, it takes about two years for the market to bottom out, settle and find its footing - and we are seeing that."

We expect the market to remain resilient, and for M&A to transform rather than plummet if we hit choppier seas in the market, with a greater focus on distress buyouts, earn-outs and horizontal mergers.

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