After a muted second half of 2022 for M&A, activity should pick up in 2023 as financial sponsors deploy capital, activist investors press for corporate change and buyers and sellers agree on valuations and pricing.
Mergers and acquisitions activity (M&A) at the beginning of 2023 is expected to remain somewhat muted, consistent with the environment in the second half of 2022. But looking further ahead to the second half of 2023 and beyond, deal-making is likely to accelerate, according to Tom Miles and Brian Healy, Co-Heads of Americas M&A at Morgan Stanley. Factors most likely to drive activity include:
- Well-capitalized companies making acquisitions in their core businesses
- Financial sponsors, which are holding record amounts of capital, deploying it in acquisitions
- Uneven performance among companies stoking shareholder activism
- Cross-border M&A making a comeback
The 2022 mergers and acquisitions market experienced stark contrasts between the two halves of the year. In the first five months, deal activity was strong—a continuation of the record environment that existed in 2021. The volume and number of mergers and acquisitions in the first half of 2022 were better than historical norms, including several “mega deals” valued at over $10 billion. But in the second half of the year, deal activity slowed meaningfully. Macroeconomic uncertainty, volatile capital markets, rapidly rising interest rates and the impact of inflation caused many corporations to focus internally versus making acquisitions. Potential sellers faced declining valuations and were reluctant to transact at prices that were down significantly from earlier in 2022. In addition, large, transformational transactions faced increased regulatory scrutiny. The rapidly rising interest rate environment essentially shut down leveraged finance markets as banks and other lenders dealt with a large backlog of transactions needing to get financed, reducing financial sponsor activity.
Global Announced Volume ($Bn)
While the number of announcements slowed in 2022, dialogues about potential strategic transactions have continued. As some of the headwinds the M&A markets faced in the back half of 2022 abate, M&A activity should return quickly. “There may be an explosive return of activity,” said Healy, adding that it could be especially fueled by pent up demand from financial sponsors. Miles added that it may take some time for buyers and sellers to gain clarity on how inflation, foreign exchange rates, interest rates and consumer demand will affect revenues and valuations. “There has to be agreement between the buyer and seller on the outlook and the multiple to pay for today’s cash flows,” he said. “While that may take time to work itself out, I believe it will happen within the next couple of quarters.” Morgan Stanley’s bankers anticipate the following four themes to shape the 2023 M&A market.
While the consensus view among economists and strategists calls for a mild recession in 2023,1 company balance sheets are relatively strong compared to previous recessionary periods, and that could help drive corporate acquisition activity despite an economic downturn. Morgan Stanley’s investment bankers anticipate large corporates to make additive acquisitions in their core businesses. In a market environment with valuations remaining in flux, that activity could also take the form of unsolicited or “hostile” acquisition proposals. In particular, three industries are well suited to lead the way to greater activity:
- Healthcare: Coming out of the COVID-19 pandemic, some healthcare companies are seeking to grow through M&A. For example, pharmaceutical companies with expiring patents need to replace those products and are on the hunt to acquire biotechnology companies.
- Technology: After a difficult year for technology stock performance in 2022, some tech companies are continuing to consider leaving public markets via go private transactions. Private equity sponsors with expertise in technology are showing a strong interest in take-private transactions, where publicly-traded companies return to private status after a sale to one or more financial buyers. Corporates seeking technology capabilities are also potential buyers in this more buyer-friendly valuation environment.
- Energy: With substantial capital on hand from soaring energy prices in 2022, energy companies are seeking to deploy it via acquisition or to return it to shareholders. Mid-sized energy companies need scale to compete and may seek consolidation opportunities. In addition, some energy companies are attempting to improve their environmental, social and governance (ESG) practices through capabilities such as carbon capture or energy transition preparedness; M&A is one tool to achieve that goal.
Separately, lower valuations make corporate separations more likely—especially for high value assets trapped inside larger corporates. Companies that have a valuation overhang from mis-priced assets within their portfolio will seek to spin off or sell parts of the business to unlock overall value for their shareholders.
In the last decade, private equity firms have become more specialized in industries and sub-sectors, which has helped funds make investing decisions with a higher degree of confidence in how their businesses might perform in different market cycles, according to Miles. “Ten years ago, private equity firms wanted to wait for a certain time in the cycle before investing,” he said. “Now, they invest more consistently through the ups and downs of the business cycle.” This trend, in combination with private equity funds’ record amount of uninvested capital, could help drive more M&A activity later this year despite choppy debt financing markets, Miles said.
Global Financial Sponsor Available Equity Capital ($Bn)
Private equity firms own approximately 11,000 companies,2 and with average holding periods of three to five years, many could seek to monetize their portfolio holdings in the near term. “There are a lot of portfolio companies that private equity owners would like to sell but the market has been challenging to get deals done,” Miles said. “Once the financing markets stabilize, we will see a number of private equity firms bring more companies to market."
Companies handled last year’s inflationary environment differently, which caused a significant amount of performance variance between stocks in the same sectors, Miles said. For the underperforming companies, activists have already launched campaigns to push for changes they believe will create value, and that is expected to continue in 2023.
The number of activism campaigns at U.S. companies in 2022 exceeded 2021 levels by approximately 14%, with M&A and improvement in operations as the most common activist demands last year, each occurring in 49% of campaigns.3
“At these overall lower valuation levels and with varying operating performances between companies, an activist can develop a stake in a public company and launch a campaign with less downside valuation risk,” said David Rosewater, head of Morgan Stanley’s shareholder activist defense practice.
New Activist Campaign Activity Exceeds Historical Averages
The pandemic, trade tensions between the U.S. and China, and varying economic conditions by geography significantly dampened deal-making across international borders in 2022.
Cross-Regional M&A by Corporates
As the overhang from these headwinds diminishes, cross-border activity should rise during the next two years, Healy said. Companies around the world are seeking to fortify global supply chains, and many are likely to invest more internationally to achieve that goal. While in the near term, China and Japan are likely more focused domestically, we could expect higher cross-border volumes between geographic regions longer term.
Unlike past M&A down cycles, such as after the dot-com bubble of the early 2000s and the financial crisis of 2008-2009, Morgan Stanley’s bankers say it is likely the recent reduction in activity will be shorter lived. The growth in the private equity industry, sophistication of corporate clients and overall strength of corporate balance sheets and earnings should result in increased M&A activity in 2023 and beyond.