By Russ Banham
Corporate Board Member magazine
From a mergers and acquisitions standpoint, it’s easy to look at last year and think this one has been a bust. But last year was like no other year: Deal volumes and values skyrocketed to record levels. Fueled by near-zero interest rates and federal stimulus money, public companies amassed a war chest of cheap capital to chase risky assets, strategies and yield.
The global M&A market closed 2021 at an all-time record of $5.9 trillion over 63,000 transactions, an annual increase of 64 percent and 24 percent, respectively, according to data provider Refinitiv. The final tally smashed the previous high watermark set in 2015 by almost $1.5 trillion. By contrast, the decline in the number and value of M&A deals in the first six months of 2022 feels like a downer—except it isn’t.
“One cannot look at 2021 as a bellwether of normal deal volume,” says John Potter, partner and U.S. deals sector lead at audit and advisory firm PwC. “Although deal volume is down in the first half of 2022, it’s coming down from the highest watermark in history. We’re actually experiencing M&A deal volume on par with the past 20 years, with about 25,000 deals concluding in first-half 2022.”
Those numbers should rise the rest of the year, Potter says. “Lower valuations are creating opportunities for corporates and private equity dealmakers to generate healthy returns over the remainder of the year and into 2023.”
He’s not alone in this view. “There’s still a lot of money available to companies to invest in M&A opportunities,” says B. Ben Baldanza, independent board director at JetBlue Airways and Six Flags Entertainment Corp. “The cost of capital is higher, but that’s a relative term, with many companies finding the current availability of capital attractive and others finding it not so attractive. Those that see it as attractive are likely to be buyers.”
He adds, “Depending on the industry, opportunities abound.”
Welcome to what is shaping up to be an M&A buyer’s market. For companies flush with cash, now may be a good time to find bargain deals in sectors like technology, healthcare, life sciences and consumer goods, industries whose sky-high valuations in 2020 and 2021 have since come down to earth. Also hitting the runway hard are IPOs (initial public offerings) and SPACs (special purpose acquisition companies). “With no IPO market to speak of right now and a lack of SPACs, the one exit strategy still available to companies is M&A,” says Charles Ruck, global chair of the corporate department at multinational law firm Latham & Watkins.
As with any market shift, the economic factors subduing a seller’s market lift prospects for a buyer’s market. Despite stiff economic headwinds, robust M&A opportunities are there for the taking, with many companies enjoying steady cash flows and strong balance sheets.
“In today’s high-inflation environment, strategic acquirers with lots of cash on the balance sheet need to do something with it,” says Christopher R. Moore, M&A partner at white-shoe law firm Cleary Gottlieb. “Most big acquirers already have their [stock] buybacks in place at tolerable [investor] levels, so that’s out of the picture. It’s also not necessarily a good time to do capex, with prices going up. That leaves one definitive place to invest capital.”
That spells M&A. “Buyers can acquire a business at a price they could only dream about last year,” Moore says.
Ruck shares this opinion. “In the first few months of the year, as the war in Ukraine was developing, the stock market was in free fall, inflation was kicking in and interest rates were set to rise, all the boards I work with had a ‘wait and see’ approach to M&A,” he says. “It was too early to make a move, too risky. Nobody wants to be the person who buys high when the bottom is about to fall out.”
These misgivings are quickly fading. “The boards I would consider ‘inquisitive’— interested in acquiring other companies to wrap into the business—are shifting their mindset,” says Ruck. “For the first time in 20 years, there is parity between the U.S. dollar and the euro, making a company’s dollars go further. Things are suddenly cheaper by 20 to 40 percent. There are lots of bargains out there. Now is a good time to buy.”
Reading The Economic Tea Leaves
The economic headwinds whipping up the reset from a seller’s market to a buyer’s market are clear to all board members—persistent supply shocks, unnerving geopolitical tensions, fast-rising inflation, higher interest rates and deep talent shortages. Now that two consecutive quarters of negative GDP growth have occurred, a recession appears ever more likely.
These factors typically put a squeeze on M&A activity. But Moore, Potter and others say the opposite may be in store. “Like Yogi Berra said, ‘It’s hard to make predictions, especially about the future,’ but what I’m seeing is a once-in-a-lifetime combination of factors creating opportunities to buy companies at good prices, particularly in sectors like healthcare, technology, life sciences and possibly consumer goods,” says Moore.
“We’ve gone from an environment where companies could do no wrong and venture investors would continue to fund the business to where they now have to show a path to profitability,” he says. “Absent that, companies have to reduce their valuations and go to the same investors asking for money, which they’re not likely to provide because the business isn’t worth as much as it was. That leaves the door open to an acquisition at the lower valuation.”
Buyers in many past recessions were crimped typically financially to buy companies, even with their lower valuations. Not this go-round, says Potter. “Historically, M&A and economic cycles had a more correlated path leading into a recession, but what’s different today is the continuing availability of capital, although higher interest rates have increased the cost of this capital,” he explains.
Dealmakers are still seeking growth, but many buyers are targeting a candidate’s supply-chain resilience, software and automation technologies, ESG (environmental, social and governance) factors and workforce skill sets. “Growth is nice, but these days talent is far more of a concern in M&A transactions,” says Stephen Kasnet, who chairs the boards at publicly traded real estate investment firms Granite Point Mortgage Trust and Two Harbors Investment. (See “Talent is Front and Center,” below.)
The interest in buying companies with these resources is on a decided upswing, says David Harding, M&A advisory partner at management consultancy Bain & Company. “Across our client base, we’re seeing strong interest in capability-oriented deals, where companies buy a business with historically expensive technologies like digital analytics or ways of doing business whose valuations have since been marked down, as well as other deals predicated on reimagining the supply chain to become shorter and more traditional industry consolidation plays.”
Good deals are to be had in sectors like healthcare, life sciences, technology and consumer goods enduring declining valuations. “Publicly traded companies in these sectors experienced the biggest expansion in their multiples when people were working from home and spending the government’s stimulus money,” Moore says.
This year was a different story, with demand deteriorating in the most price-sensitive sectors of consumer products and retail, according to S&P Global Ratings’ midyear corporate credit outlook. “We expect this to spread to the consumer-facing subsectors of technology and, if advertising budgets are trimmed, to ad-driven media and entertainment providers,” the outlook stated.
That’s not to say that companies in these sectors are open to a deal—yet. “Sell-side boards still have lingering memories of their 52-week highs and don’t yet want to admit that this is a good time to sell; they’re still hoping for a rebound,” says Ruck. “The balancing discussion in these boardrooms is the prospect of a recession, intimating that worse times await. We’re at an inflection point now, with more boards thinking this just may be the optimal time to sell.”
Small- and medium-size enterprises (SMEs) are a case in point. “Fears over a recession drive more interest from investors who want to own a SME,” says Thomas Smale, CEO and chair of FE International, a U.S. investment fund and global M&A advisor primarily focused on SMEs in the e-commerce, SaaS and content sectors. “Our deal flow going into the second half of the year is up and remains pretty strong.”
As for buyers, the dead-in-the-water state of the IPO market and especially SPAC IPOs have put a shine on traditional mergers and acquisitions. According to data compiled by Bloomberg, a paltry $4.9 billion was raised through the end of June for IPOs in the U.S., a meager 6 percent of the record sum raised in the first half of 2021 and trailing the $47 billion five-year average for the first-half period. “Companies that otherwise would be public by now are not able to go public because the IPO window is shut,” says Moore.
For SPACs, the window is more like a guillotine. Whereas SPAC formations accounted for $250 billion in investments in 2020 and 2021, a reported 600 of the SPACs have been unable to find a private company to acquire. The number of new SPAC deals this year is half what it was last year at this time. Even worse are SPAC values, which are double the decline of the S&P 500 through the first six months of 2022, The New York Times reported, citing data from the CNBC SPAC Post Deal Index.
Not surprisingly, 73 SPACs that planned to go public this year have since changed their minds. “It’s too early to call SPACs dead for all time, but for now, there is no IPO market to speak of,” Ruck says.
Caution And Care
As always, what looks too good to be true is less than the case on closer inspection. Regulators in the U.S. and Europe have stepped up reviews of M&A transactions on antitrust, national security and competitive grounds. “Given that there are 140 antitrust enforcement agencies around the world and no agreement on the procedures or substance, adherence is an incredibly complex and time-consuming matter,” says Ruck’s colleague Makan Delrahim, a partner in Latham & Watkins’ antitrust and competition practice and a former U.S. assistant attorney general.
In July 2021, President Biden signed an executive order requiring greater scrutiny of proposed M&A deals by the Federal Trade Commission and the Department of Justice, due to what the president called the “failed experiment” of the previous administration’s economic approach to antitrust enforcement. “Deals are now taking longer to close as companies factor in the procedures for more vigorous antitrust review,” Delrahim says. (As a result, more buyers are insuring transaction risks via RWI policies.)
Cross-border M&A transactions are impeded by the growing number of countries adopting foreign direct investment screening regulations to prevent transactions posing possible risk to critical technology, defense, economic and national security interests.
“It’s getting to the point where deals have to go through multiple foreign direct investment regimes, forcing boards to be more proactive about these issues,” says Moore. “They need to be discussed when the deal is presented to members, as opposed to just before the deal signing.”
Kasnet agrees that regulation has become more heavy-handed, driven in part by what he called “non-market considerations.” He provided the example of M&A transactions in the energy sector. “At a time when M&A combinations would make good sense for the industry to deliver energy at greater quantity, better rates and geographically farther, too much regulation can slow otherwise beneficial goals,” he says.
Another obstacle is a target’s ESG profile. The anticipated reporting of risks like climate change and human capital management policies and practices to investors in public company 10Ks and 10Qs requires deeper board examination of a target’s ESG factors. “The due diligence has become more complicated and time-consuming,” says Marc Huffman, CEO and board member at BlackLine, a provider of financial and accounting software and services.
Huffman cited the Securities and Exchange Commission’s climate risk disclosure proposal, which require public companies to provide accurate data on the greenhouse gas emissions produced across the value chain. “Obviously, this is a complicated task, requiring the gathering, scrubbing, vetting and disclosure of data that will end up in the financial statements, if the current proposal becomes the final rulemaking,” says Huffman.
Boards need to intervene early to ensure adequate due diligence into a prospective acquisition’s competencies to achieve these aims. In some cases, the target’s data-related capabilities may exceed the buyer’s technological strengths, adding to the value of the deal. Technology is crucial in other M&A contexts, Huffman says. “It can help ensure that the balance sheet of the target company is properly represented, which can lead to better pricing and goodwill, and it can assist an accelerated post-transaction integration.”
Aside from enhanced regulatory scrutiny, ESG considerations and technology proficiencies/deficiencies, boards need to beware the possibility that in a frenzied buyer’s market, management may overlook traditional M&A risks. “There may be a tendency to snap up a target company without the usual due diligence accorded the integration of the organizations’ cultures; some businesses have strong cultures, some not so much,” Baldanza says.
The longtime airline industry board member cited the 1997 merger of Boeing and McDonnell Douglas as instructive. “With the benefit of hindsight, the merger changed the culture of Boeing from an engineering- and safety-focused enterprise to one that was cash flow- and bottom line-focused, which is considered a factor in the  crashes involving Boeing’s 737 Max jets,” Baldanza says.
He makes an excellent point. As good buys emerge, M&A fundamentals must be in view. “Uncertainty equals caution for boards,” says Huffman. “More debate and dialogue are needed to work through the assumptions and implications of the deal, considering anticipated revenues, margins, capex, profits, the hiring environment and the ability to retain people.”
“In times of uncertainty,” he adds, “it’s best to be a bit more conservative in the due diligence.”
Talent is Front and Center
Like many companies in the Great Resignation, accounting automation software provider BlackLine looked to buy a business that would enhance its existing capabilities and related skill sets, specifically the depth of subject matter expertise in intercompany accounting. “A key driver in our due diligence was talent, securitizing it as an asset to build out our intercompany software capabilities,” says Marc Huffman, the public company’s CEO and board member.
BlackLine found what it sought in FourQ Systems, a provider of intercompany financial management software complementing its existing functionality. The acquisition, which closed in January, adds advanced tax and regulatory capabilities in automating a manual process that has been traditionally time consuming and labor intensive. “In today’s challenging recruitment and retention environment, talent is critically important to our downstream value creation,” Huffman says.
He is not alone in this view, with several other board members emphasizing the importance of buying a company to acquire the people within it. “The demand for talent is the biggest issue we face today,” says Eric Pillmore, outside board director at publicly traded V2X, a provider of critical mission solutions to defense clients globally. “One of the key reasons to go into a deal is to obtain access to relationships.”
This reason was the compelling factor in forming V2X following the July 2022 merger of Vectrus and the Vertex Company, two companies with different government agency contracts and defense sector offerings. “You can’t just hire people and expect them to do business with the CIA, NASA or the State Department, but you can acquire a company with people who already have these critical relationships and the security clearances,” Pillmore says.
Not that buying talent is easy. “With the world of business becoming more digital and data-driven, companies need talent to manage these risks; the challenge is that every company is looking for the same people,” says Stephen Kasnet, who chairs the boards at Granite Point Mortgage Trust and Two Harbors Investment Corp.
“Lots of companies are choosing an M&A path to get access to pools of trained people who otherwise are hard and expensive to recruit, but there’s a downside,” says B. Ben Baldanza, independent board director at JetBlue Airways and Six Flags Entertainment Corp.
He cited post-transaction wage and benefits pressures as a case in point. “Boards need to stop and think—will the deal give management more leverage with the big labor organization or put management in peril with them?” Baldanza says.
Every company is prowling for talent, but no transaction is perfect, as the scores of failed mergers and acquisitions over the decades confirm.
Russ Banham is a Pulitzer-nominated journalist and best-selling author.