Ready, set, boom. Why the AI race will feed the M&A ecosystem

As published in Finance et Investissement on 28 August 2023

It’s been a dry season for capital markets as mergers activity remains in a state of suspended animation with deal value at US$873.4 billion in Q2, down over one-third this year, as purchase price multiples contract. In both Canada and the U.S. investment bankers and event-driven hedge funds are facing a drought in dealmaking, but the boom in AI is likely to change that. 

Much like the technological disruption that occurred during the pandemic when people started working and shopping from home and companies faced massive business disruptions in the way they transacted with customers, today, AI is the catalyst for companies to quickly find new capabilities to remain competitive. In 2021, companies needed to have the right technologies and the right talent for the new business environment. If they couldn’t build it organically, they had to acquire it. Now we’re starting to see a similar pattern with AI-driven technological and business disruption feeding a growing appetite for partnerships, mergers, and acquisitions. Some high-profile recent transactions include Databricks, backed by venture fund Andreessen Horowitz, buying generative AI startup MosaicML, Snowflake’s acquisition of Neeva, and a slew of pricey partnerships between Microsoft and OpenAI, Nvidia and Cohere, and Amazon with Hugging Face. There is a lot of capital being raised and a lot of dry powder in both private equity (approximately US$1.3 trillion) and domestic and foreign corporations (approximately US$5.8 trillion).  

Some AI-focused start-ups are being valued at very rich multiples. They may have high growth rates, but our view is there’s also some froth in the prices. Some of these companies will end up launching IPOs and, again, similar to 2021, we believe there will be a mix of some very good businesses, some mediocre ones, and, likely, a few stinkers. In any event, this will set up the next wave of consolidation and future deal activity in both private and public markets.  

Corporations need AI capabilities, and they need them fast. This is creating greater opportunities for M&A activity throughout the entire ecosystem, not just in the more visible and newsworthy places. At the moment, activity is primarily focused on the private side where small, start-up, and venture-packed companies in the AI space are getting funded. Admittedly, we’re in an AI hype cycle and these firms are getting a lot of capital thrown at them. However, looking further out there will be more M&As along the AI value chain —from miners which produce the materials that go into the production of wafers in semiconductors to the businesses implementing AI in their workflow to improve productivity and gain market-share. Most investors think of AI in terms of companies like Amazon, Nvidia, Microsoft and Google but there is an entire ecosystem related to this new technology and many of the companies which supply it are small and less risky from a regulatory standpoint. Some of them may be acquired in private transactions, which represent over 90% of deals, while others will go public. Private equity buyers remain well capitalized and are incentivized to make acquisitions despite higher financing costs and tighter lending conditions. However, it is worth noting that, since peaking in 2021, the share of private equity M&A deals has been trending downward.  

On the public side, incumbents like Google and Microsoft are dominating the early innings but because of their size, they need to tread carefully in a hostile regulatory environment. In a higher rate environment, businesses with deflationary benefits, such as technology, can be highly attractive targets for acquirers. Within the next several years we believe there is a large potential for M&A across the entire value chain. 

Today, the M&A players are in somewhat of a space hold, pinned among growing regulatory headwinds, tight credit markets and an uncertain interest rate environment. Acquiring companies are taking a wait-and-see approach to deploying capital. They are mostly focusing on smaller, tuck-in deals with lower regulatory risk and shorter closing periods. However, market watchers expect deal flow to rebound in the next several years as the AI story plays out.