In their 2023 M&A Outlook Report, Morgan Stanley indicates that following a muted second half of 2022, M&A activity should gain momentum as the second half of this year unfolds. That prediction will bring much needed relief to a market that has been under pressure for the better part of the last year.
According to Tom Miles and Brian Healy, co-heads of Americas M&A at Morgan Stanley, deal-making is likely to accelerate. Factors driving 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; and cross-border M&A making a comeback.
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Up to now, macroeconomic uncertainty, volatile capital markets, rapidly rising interest rates, and the impact of inflation caused many corporations to focus internally versus making acquisitions. According to the investment bank, that could all start to change beginning as early as this summer.
Against this backdrop, the consensus view among economists and strategists calls for a mild recession in 2023. While there is still a strong possibility of recession, the nature of this downturn may not hinder M&A the way previous downturns have, according to the firm’s analysis.
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.
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. And that carried into the first five months of this year.
According to Morgan Stanley, strong balance sheets in a market primed for strategic acquisitions will help to anchor M&A from the corporate side in the second half, but financial sponsors will not be outdone. The bank reports that many financial sponsors are primed to deploy capital and to exit existing investments.
One notable difference today is that increased specialization among PE firms has enabled action even in uncertain times. Funds are better able to predict how their businesses will perform in different market cycles. As recently as 10 years ago PE firms would wait for uncertainty to clear before taking action. But the rapid increase in specialization among PE sponsors has helped to clear sight lines even in trying times. Firms are more empowered to take decisive action despite market swings, and that alone is expected to fuel deal flow into the third and fourth quarters.
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 Mr. Healy, adding that it could be especially fueled by pent up demand from financial sponsors. Mr. 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 themes to shape the M&A market for the remainder of the year:
Well-Capitalized Companies Making Acquisitions in Their Core Businesses
While the consensus view among economists and strategists calls for a mild recession in 2023, 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.
Financial Sponsors are Primed to Deploy Capital and Exit Existing Investments
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 Mr. 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, he said.
Cross-Border M&A Could Be On the Rise
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. As the overhang from these headwinds diminishes, cross-border activity should rise during the next two years, Mr. 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.
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.
Caleb A. Edmundson is Editor-in-Chief of ExitUp, the investment blog from Hunt Scanlon Ventures designed for professionals across the human capital M&A sector. Caleb serves as an Associate for Hunt Scanlon Ventures, providing robust industry research to support the firm’s investment group. Connect with Caleb.