A weakening economy, rising interest rates and increased regulatory scrutiny have brought the pace of M&A to a screeching halt following a record-breaking year in 2021.
Merger and acquisition activity in North America is expected to remain weak for the rest of 2022 after the volume and value of dealmaking fell sharply in the first half of the year.
Some 10,602 deals were concluded in the first half of 2022 at a total value of $925.35 billion, according to data from S&P Global Market Intelligence. This was down from the record 12,421 deals at a value of $1.319 trillion announced in the first six months of 2021.
Executive reluctance
After a strong January, M&A activity in the U.S. and Canada fell, on a year-over-year basis, in each of the next five months. In June the aggregate transaction value of announced deals was down 60.4% from a year earlier, as the number of deals declined 30.1%.
With rampant inflation weakening the economic outlook, M&A is not a priority for many companies.
"We expect that the pace of mergers & acquisitions will slow in the second half of 2022," said Dave Sekera, chief U.S. market strategist at Morningstar. "There is plenty of dry powder available and financing remains available, but slowing rate of economic growth, tightening monetary policy, rising interest rates and high inflation are conspiring to drag down the pace of M&A."
For some this is a buying opportunity. Valuations of companies have fallen sharply this year, with the S&P 500 down 17.4%, making acquisitions potentially attractive. And corporate balance sheets remain in a healthy state as a result of extensive refinancing, as companies took advantage of low borrowing costs in 2021 to lower the cost of their debts and build up cash buffers. But on the whole companies are less likely to seek to expand at this time.
"If a recession is looking like a possibility, corporate leaders will be reluctant to take transformative actions without having a better understanding of what the economic landscape will be a year forward," said Gregory Staples, head of fixed income at DWS North America.
Dealmaking declines as inflation bites
M&A activity rebounded strongly in the second half of 2020 and into 2021 as liquidity measures taken by the Federal Reserve greased the wheels of financial markets and governments acted decisively to counter the health and economic crises caused by COVID-19.
The more than $1.3 trillion worth of deals announced in the first half of 2021 compared to just $304.2 billion a year earlier as companies put their cash to work.
"There was a lot of activity last year as interest rates, particularly 'real' [inflation-adjusted] rates dipped into negative territory," said Nick Kraemer, head of ratings performance analytics at S&P Global Ratings. "Some correction would eventually be appropriate, and with rates rising so quickly this year, combined with what many argue were overvalued equities, and rising expectations for a recession ahead, this has combined for a real one-two-three punch."
Some big acquisitions have still taken place in 2022. Broadcom Inc.'s $69.09 billion deal to buy VMware Inc., making it the fifth-largest software provider in the world, was the largest announced so far this year, ahead of Microsoft Corp.'s $68.99 billion takeover of Activision Blizzard Inc.
The third-largest announced deal was Elon Musk's $40.69 billion agreement to take over Twitter Inc., a process now heading for the courts after Tesla Inc. CEO Musk accused the social media group of failing to reveal the percentage of its users that are bots rather than people or organizations.
Cheap valuations offer tempting deals
The decline in valuations will make some companies attractive, but there is less cash sloshing around to be spent on M&A compared to 2021. Corporate cash buffers have fallen for each of the last seven financial quarters, while the higher cost of borrowing and less certain availability of debt financing will also limit those wishing to make acquisitions.
"High-yield and even investment-grade debt have seen recent periods where the issuance window has been very restrictive," Staples said, referring to the possibility of financing acquisitions with new debt. "Completing the financing for deals has become more uncertain."
The yield on the S&P U.S. Investment Grade Corporate Bond Index was 4.42% on July 25, meaning debt issued today would cost far more than it did at the start of the year when the index was yielding 2.2%, and thus making borrowing to invest in M&A more expensive.
"Rising interest rates and widening corporate credit spreads will make some acquisitions appear less attractive," Sekera said. Still, "this will not be enough to dissuade buyers if the valuation is attractive enough."