Global mergers and acquisitions plunged to a decade low last year, with $2.9 trillion in deal value announced, down 17% from 2022. Dealmakers mostly stayed on the sidelines as they grappled with higher inflation, rising interest rates, increased regulatory scrutiny, and market uncertainty, while potential sellers remained anchored to previous, richer valuations.
Activity among private equity (PE) buyers declined last year after accounting for nearly 25% of all buyouts in the previous two years as tighter financing conditions and higher interest rates made completing leveraged buyouts more difficult. In Canada, of the 441 completed transactions last year, most were bolt-ons to an existing company within a PE portfolio.
PE firms found ways to keep doing deals in a higher rate environment by purchasing minority interests in companies. They preserved capital by writing smaller checks but allowed the target company shareholders to maintain interest in the company should the valuation recover.
There were some bright spots. Activity picked up among commodity and industrial sector firms as inflation benefited many of them and companies looked to scale their operations to drive improved efficiencies. The energy sector led M&A activity with several mega merger deals announced in the back half of the year with deal activity in the US Permian shale region surpassing $100 billion. While technology sector M&A fell overall, two big deals — Activision Blizzard’s $69 billion acquisition by Microsoft and VMware’s $61 billion acquisition by Broadcom Inc — closed successfully. In the health care sector, activity increased as well with dozens of biotech and pharmaceutical merger announcements, while many large drugmakers face steep patent cliffs over the next decade and are seeking to refresh and extend their patent drug portfolios.
Despite the challenges of 2023, the pick-up in the last quarter gave investors a glimpse of better days ahead. In 2024, dealmakers are battle-hardened and have adapted to the new regime by employing more structured deals to balance risk. These include the use of earn-outs, contingent value rights, carve-outs, and spin-offs. Dealmakers are also structuring transactions with all or part stock consideration as opposed to all cash. Acquirers often structure deals with all cash consideration when they have ample cash or access to financing and are confident enough to assume all the risk. With tighter financing conditions in general and especially for deals in capital-intensive industries, sharing the risk and reward with shareholders is becoming more common.
Last year’s headwinds may become this year’s tailwinds, and we are optimistic about the outlook for M&A and merger arbitrage in 2024. As inflation cools, interest rate expectations trend lower, and companies adapt to the post pandemic environment, investor confidence is returning. Despite the geopolitical and economic backdrop of uncertainty, savvy companies are seeking opportunities to drive future growth and acquire the technologies and capabilities needed to compete and otherwise avoid being disrupted.
On the deal side, indications from investment banks, advisors, and company insiders all suggest that the M&A pipeline is robust. Rising equity markets have given management and boards confidence to make deals with a growing number of companies in active dialogue. Shareholder activism is also rising as frustrated investors seek to unlock value in stocks trading at what they perceive as deep discounts to intrinsic value. Heading into proxy season, ineffective boards may become targets, and increased shareholder dissent could bring opportunistic acquirers to the table.
Merger arbitrage may also offer an attractive investment opportunity, with merger arbitrage yields exceeding 10% for the average North American merger deal. This is a material premium relative to historical levels and a significant spread over high-yield bonds. Amid a more hostile regulatory environment, arbitrage investors now understand what sorts of deals may come under greater regulatory scrutiny.
After a string of losses, regulators are stretched thin. With wide spreads, an improved playbook for assessing deal risk, and the potential for more M&A activity to materialize, 2024 could be a strong year for merger arbitrage performance.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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