As seen in CFA Institute: Enterprising Investor, July 14, 2023
Hook ups just aren’t what they used to be. The worldwide value of merger and acquisitions dropped to around US$1.22 trillion at the end of June, down from US$2 trillion at the end of the second quarter last year. One reason is higher interest rates. They may be cooling inflation, but they are also raising financing costs thus pinching the potential for strong returns via an acquisition. Formerly avid acquirers, especially in private equity, are sitting it out for now. In private equity, the value of deals has decreased over 50% to US$251 billion while nearly US$2 trillion sits in cash.
Another reason is a less friendly regulatory environment, particularly for larger deals. In May, one of the UK’s key regulators, the Competition and Markets Authority (CMA) had blocked Microsoft Corporation’s (MSFT) proposed acquisition of Activision Blizzard Inc. (ATVI), although they are now willing to negotiate Then the FTC sued to block Amgen Inc.’s (AMGN) proposed acquisition of Horizon Therapeutics Public Ltd. Co. (HZNP). If successful, this would be the first FTC lawsuit to block a pharmaceutical deal since 2009.
Despite the global drought in M&A, bright spots remain—if you know where to look. Healthcare deal value is up 40% year-over-year, boosted by Pfizer’s (PFE) agreement to acquire Seagen (SGEN), and Eli Lilly’s (LLY) agreement to purchase Dice Therapeutics (DIC). Deal values are also up over 200% in metals and mining with the biggest transaction being Newmont’s (NEM) proposed acquisition of Newcrest (NCM).
Another M&A hot spot is Canada. While there was a solid uptick in North American deal activity overall in May and June, Canada is experiencing a veritable M&A boom. Compared to the second quarter of 2022, transactions have increased 30 per cent rise with a value exceeding US$90-billion.
The usual reasons for M&A apply such as trying to capture synergies, improving growth in a high-inflation/high-interest-rate environment, buying power from the US dollar, diversifying, acquiring talent and expertise, or eliminating a competitor.
While regulators have been focused on large and mega merger deals, small- and mid-cap merger deals in Canada are not exposed to the same regulatory risk. And, despite tighter financing conditions, in our core target universe of small- and mid-cap companies, the strength in equity markets this year is providing confidence for acquirers to do deals.
Bloomberg’s Matt Levine once suggested that “a large percentage of M&A activity might be driven by executives who want to avoid spending time with their children”. Family dynamics aside, M&A activity is likely to increase for several reasons. For the management of small-to-mid-cap companies, especially those that went public during the period of low interest rates, current lower valuations have been hard to stomach. Servicing debt and attracting financing is also more challenging at the same time as revenues are strained because customers are cutting back or postponing purchases. In certain cases, this has led to a distressed situation. While some company founders are holding on tight in anticipation of a re-rating, others accept that one way to grow their business is to move it into stronger hands via an acquisition. Within Canada, there are several well-known serial acquirers. These include Constellation Hardware, CCL Industries, Open Text, Enghouse, and Premium Brands, among others. For example, since 2005, Premium Brands has invested over $3 billion in 79 transactions. It had a CAGR of 22.4% from 2010- 2022.
Despite pockets of softness, M&A appetite is expected to return in due course. Good capital allocation, buying the right company, at the right price, creates incremental value over the long term.
