World over there have been rising concerns about monetary tightening, corporate earnings disappointments and the risk of recession have been weighing more heavily on investors lately. Indeed, certain misses in corporate earnings recently shone a light on rising costs denting company profits and dampening consumer demand and sentiments. Mounting concerns dragged stocks down in another volatile week, with the S&P 500 Index logging its seventh-consecutive weekly loss. The slow down we’re observing now is more a likely return to pre-pandemic trends, rather than a real contraction in which demand falls below the long-term trend.
The good news is that experts opine that although 2022 may be in the clear from a recession for the US economy, the next few years may tell a different story. An economic downturn could arrive as early as 2023. Policy changes are expected world over, which will result in more business cycles that many companies will not be ready to face. Even if the world is lucky enough to dodge a recession in 2023, economic decline is likely in 2024 or 2025 and could be more detrimental. The governments world over will eventually start easing up on stimulus initiatives and raising interest rates at the same time that inflation is on the rise. It usually takes the economy about a year to react to such actions, so we will start feeling the impacts a couple of years later.
After a record-breaking year 2021 in M&A activity, global deal making has begun showing signs of abating. Alongside the rise in interest rates and inflation, geopolitical uncertainty is making it difficult for businesses to predict their affairs, as well as the profitability of their potential targets. Sellers within the market have not completely adjusted either to the economic reality that they are facing. This is causing a disconnect, thus leading to a cautious approach. Corporate performance is a big focus and importance is placed on solving already existing issues such as supply-chain shortages and creating contingency plans for future inflation and general uncertainty. Looking at the broader macro economic environment, volatility is a major headwind that is consistently depressing M&A activity. Due to leveraged finance markets, it is becoming harder for private equity sponsors to access capital. Banks that till now relied on syndicated finance are struggling to adhere to commitments made before the rise of interest rates and the Russia Ukraine conflict. They are now struggling to deploy new capital and facilitate private equity sponsor activity that meets these commitments. Corporates are facing the issue of whether to continue putting out financing that is expensive relative to historic rates, which will ultimately affect the private equity industry’s ability to pay. Private equity is either less present or having trouble to put forward more equity to be able to complete transactions. From a valuation and return perspective, private equity is being compelled to rethink, reformat and figure out how to make deals work during this volatile period.
Moreover There is a problem with valuations also. Higher price expectations is causing low public market valuations. This is leading companies to wait for an improved environment for their financing, and funding that will deliver for them better returns on their expectations. Data suggests that firms are selling for lower percentages of their 52-week high and yet are fetching higher premiums on average. It is a norm that volatility decreases M&A spending and activity, but in the current scenario companies that are willing to go out and conduct business in this volatile environment are being rewarded by the market. So essentially, companies that are willing to take that higher risk in a volatile market which is rewarding growth and scale, M&A is a potentially profitable strategy.
ESG considerations have changed institutional investors’ decision-making processes too. Alongside ESG, areas that are also of concern are compliance, regulatory quality, data privacy and cybersecurity. These factors are only becoming increasingly more important compared to three to five years ago. All three components of ESG are equally considered value drivers. Among the top trends that continue to be seen in the second half of 2022 are ESG (environmental, social, and corporate governance) deals, cross-border transactions, and complex recession-proof industry deals—top among them being Fintech, technology, energy, health care and telecommunications. While some may be concerned about inflation and rising interest rates, historically these have not been halting factors for M&A. Although the cost of capital has increased and there is an overhang on the syndicated bank market, many companies are sitting on record numbers of cash reserve and private equity and family office investors still have significant amounts of cash ready for deployment. It’s safe to say savvy businesses will continue to make deals in the remainder of 2022-23.
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