M+A Outlook for 2022
The Anatomy of a Deal Newsletter January 28, 2022
- Market fundamentals (excess dry powder, high valuations, comfortability with COVID, consolidation, and more) point to continued strong deal activity in 2022.
- Looming challenges and uncertainty in the form of rising interest rates, historically high inflation, and politics surrounding tax reform will keep some of that momentum in check.
- The unpredictability of COVID and its evolving variants (and the corresponding government response to those variants) could significantly sway deal activity one way the other.
2021 was a huge year for M+A activity, particularly in the U.S. The late-2020 recovery of the M+A markets turned into a full-fledged surge in M+A deal activity in 2021. As the calendar turns to a new year, it’s natural to wonder whether the M+A locomotive will keep chugging along full-steam-ahead in 2022, or whether we’re looking at a possible derailment.
If we’ve learned anything during the past two years of living a COVID world, it’s that things can change quickly. That’s perhaps more true than ever now as we find ourselves in the middle of the Omicron surge, the highest levels of inflation in a generation, and persistent supply-chain and labor challenges. With those (and other) headwinds at top-of-mind, what can we expect for M+A activity in 2022?
As of now, the M+A outlook for 2022 still looks pretty strong—probably not 2021 strong, but still plenty strong. Expect competition for deals to remain high, and consequently, valuations for good companies to remain strong. However, expect a lot more scrutiny as buyers work hard to ensure that they’re able to generate the value they seek while paying top dollar for deals.
So, let’s look at some of the factors that may drive continued strength in M+A markets for 2022, as well as some of the challenges we’re watching.
1. Most of the market fundamentals suggest strong deal activity will continue in 2022.
a. Lots of cash available for investment – Stop me if you’ve heard this one before, but both strategic acquirers and private equity funds have huge amounts of “dry powder” ready to put to work. Lenders are ready, willing, and able to lend in support of acquisitions, and interest rates remain favorable—at least for now. All of this available money, combined with the lack of better investment vehicles in which to park those dollars, means that a large number of potential acquirers will remain very active chasing deals this year. And that leads to…
b. High valuations – I’m no economist. But when you have lots of potential buyers with lots of cash, it’s generally going to produce higher values for strong sellers. The current “seller’s market” is likely to continue, but note the use of the word “strong” in the prior sentence. Buyers who are paying top dollar are going to be very choosy to make sure that they’re getting good value for that substantial investment. Sellers who spend the time and effort to prepare their companies for sale through sell-side diligence (including a deep quality of earnings analysis) will be rewarded for those efforts.
c. Better handle on COVID and its effects – I’m also not an epidemiologist (though it seems we’ve all become internet-certified epidemiologists over the course of the last couple of years). But there’s increasing hope that COVID will start to transition to an endemic state, at least in the U.S. and other similar countries. Furthermore, as countries transition out of the acute phase of the pandemic at different times, some of the M+A rebound we already experienced in 2021 here in the U.S. may start to show up in other countries, leading to further cross-border opportunities. Finally, industries that have been particularly hard hit, including those in the hospitality, travel, and leisure industries, might finally be poised for a big recovery. In any event, whether or not we successfully settle into something of a less-COVID-influenced world in 2022, we at least have a lot better handle on evaluating how companies operate through COVID, which should give buyers some more confidence in evaluating deals.
d. Continued movement toward consolidation – Consolidation is a long-running trend, but it affects industries at different times. That general movement toward increased consolidation will likely accelerate in light of several factors, such as the fierce competition for talent, the need for many businesses to evolve technologically, and the costs of complying with ever-increasing regulatory requirements.
e. Using M+A to acquire talent and capabilities – We’ve talked about the “acqui-hire” previously, but “acqui-hire” takes on an increased emphasis given all of the challenges companies face in attracting and retaining talent in the wake of the “Great Resignation.” In addition to acquiring talent, acquirers with businesses that have yet to adapt the capabilities needed to compete in the post-COVID world and to survive supply-chain issues may find M+A as the best and most efficient way to quickly bring those capabilities into the fold.
f. ESG focus – In our 2021 outlook, we talked previously about the increasing role of environmental, social and governance (ESG) trends on deals. ESG considerations have gone from corporate buzzwords to critical components of company strategy. Buyers will continue to put a strong focus on ESG issues in evaluating potential targets and in due diligence, and sellers who have a smart and tangible commitment to ESG considerations will be rewarded.
2. But challenges and uncertainty remain.
a. Increases in interest rates – There’s no question at this point that interest rates are going up in 2022. And as inflation continues to run red-hot, it becomes only even more likely that interest rates go up higher and sooner than we may have anticipated just a few months ago. While deal fundamentals still generally look good as described above, there’s no question that higher interest rates will affect the deal markets and put some downward pressure on valuations.
b. Supply chain + labor pains – As stated above, these factors are helping to drive M+A activity at a macro level. But on the micro level, sellers experiencing supply-chain or labor disruptions will have a difficult time successfully exiting their business. Even sellers who aren’t currently experiencing these issues, but haven’t focused on implementing robust business continuity and resiliency plans, will be caught flat-footed when buyers start asking the tough questions.
c. Potential tax reform – By now, we all know much more about Joe Manchin’s and Kyrsten Sinema’s politics and preferences than we ever thought possible. While many thought that significant tax changes were a certainty in 2021—and there was no shortage of major tax changes proposed in Congress last year—nothing actually happened. However, while the Build Back Better Act appeared dead late last year, it just might still have a faint pulse. If that bill—or something like it—ultimately becomes law, new tax revenues will almost certainly be necessary to pay for it. A lot remains to be seen, particularly in a Congressional mid-term election year, but any significant increases in taxes could hurt 2022 deal activity—although threatened tax changes might actually cause deal activity to accelerate in anticipation of those changes taking effect in the future.
d. Antitrust enforcement – Most “middle market” deals don’t get a whole lot of antitrust scrutiny, at least in the U.S. That said, the Biden administration has recently indicated an intention to step up its antitrust focus on M+A deals, particularly those between suppliers and customers. How much effect that increased enforcement might have on M+A activity remains unknown.
e. End of government stimulus programs – The U.S. economy has performed extraordinarily well through the COVID pandemic. However, we can’t ignore the fact that the government pumped massive amounts of money into the economy to keep things chugging along. As those programs come to an end and their effects on economic activity wane, it’s clear that economic and deal activity will slow, at least to some degree.
f. COVID uncertainty – Above, I took a look at the COVID situation from the glass-half-full perspective. But we know that COVID always has new surprises up its sleeve. If we see new and concerning variants, and negative governmental or social reactions to those variants, it’s possible that economic and deal activity takes a big step backward.
Read last month’s piece: Your Definitive Glossary to M+A Jargon