As published in Finance et Investissement on 27 September 2023
Materials, healthcare, and consumer staples remain the bright spots in global M&A activity which is down from $2.56 trillion to $1.84 trillion through the first eight months of 2023. Across all sectors and industries, rising prices are influencing how businesses operate and make strategic decisions. While rising inflation and interest rates have crimped some deals due to higher funding costs, they have also been a catalyst for M&A. The surge in inflation has driven many companies to consider mergers to achieve greater scale and unlock potential cost synergies through efficiencies and increased bargaining power. Three sectors have generated significant M&A activity this year:
- The materials sector is seeing increased consolidation. This is being driven two factors: demand for raw materials for the energy transition, and the development of new mines due to environmental and regulatory concerns.
- The healthcare sector is experiencing M&A driven by a lack of capital in the biotech space and demographic and technological trends influencing management teams and boards to acquire new distributions and capabilities.
- Consolidation in the consumer staples space is being driven by higher input costs and the need to make supply chains more robust.
The hostile regulatory environment has targeted large cap merger deals. For example, in February, Quebec-based Velan, Inc. (TSX:VLN) a global leader in the design and production of valves and traps, the company announced that it had accepted an offer to be acquired by Dallas-based Flowserve Corporation (NYSE: FLS), a leading global provider of flow control products for C$13/share. With a total purchase price of $245 million including net debt, this was a small tuck-in acquisition with Velan expected to be folded into Flowserve’s Flow Control Division with modest cost and revenue synergies expected to be realized. With support from controlling shareholders, no antitrust issues or security issues of concern for Canadian regulators and the deal not subject to any financing conditions, this merger appeared to be a straightforward and high-quality merger.
Reflecting the current uncertain regulatory and geopolitical environment, Velan’s France-based business, Velan SAS, which represents nearly 25% of revenue, was revealed to have attracted the attention of French politicians who are looking at ways to prevent assets they deem strategic from falling into US hands. The most security-sensitive part of Velan’s French business, a nuclear-submarine supplier, was already carved out of the deal and expected to be sold to a domestic buyer. The spread widened in August as France’s efforts to block the deal were revealed and both companies have agreed to extend the merger closing date as they work to find a solution with the French government.
While 2023 has been a more challenging year for merger arbitrage, we are seeing encouraging signs across the board, specifically the accelerating pace of deal activity, as well as the spread environment widening and more appropriately reflecting deal risk and the predictability of the regulatory environment improving. Several wins against regulators over the summer have set a new precedent and may deter regulators from overstepping. The new guidelines proposed by the Federal Trade Commission (FTC) and DOJ currently seeking public comments, in addition to modifications being made to the Canadian Competition Act by the Liberal government, may eventually lead to broad changes in M&A markets and the assessment of merger risk. Still, the letter of the law and historical precedent will still determine whether a merger is approved or not. A return to a regulatory environment with increased predictability and transparency should be a driver for more deal activity and improved merger deal risk assessment, a potential tailwind for risk-adjusted returns.