Volatility and uncertainty can bring out the true colors of a business. Some will take the safe route and wait for the volatility to subside, while others will double down and take on even more risk. Some will look to sell, while others will look to buy.
M&A deals reached $5.9 trillion in 2021, and many are predicting that the momentum will continue into the foreseeable future. Nearly 70% of the 156 companies surveyed by Grant Thornton that were involved in M&As said they expected deal volume to continue to rise over the next 6 months. As expected, more than half (53%) believed that the technology sector is a category expected for continued consolidation.
But why specifically now, during times of high market volatility, are companies looking to pay huge sums of money for M&A deals? Is it best to test the market now or wait for more stable times?
While in normal times, mergers and acquisitions tend to occur in a more straightforward and logical manner, the reasons for the increase in deals over the past year and a half may come from more unconventional causes and influences:
Supply and Demand- In times of volatility there will always be two sides- risk takers and conservative players. In acquisitions it is a case of supply and demand. Those willing to take risks are happy to buy out competition, and the more conservative businesses want to sell in order to reduce risk.
Acqui-hires- The labor market is one of the most affected categories of the current volatility period, and sometimes acquisitions occur to solve this problem. In a once rare phenomenon known as “acqui-hires”, a company buys out another company mostly for its employees. Overnight, this solves the expensive and lengthy problem of employee shortages and is a win-win for both parties involved.
Supply chain disruptions- Recent M&As also occur in part to solve the problem of supply chain shortages. Products that in the past were cheaper to outsource or buy from 3rd parties, may be more expensive or have inconsistent production today. Whether it's a physical good or a service, some M&As occur simply to solve this issue by providing more self-sufficiency and reducing the reliance on outside suppliers.
Interest rates- Part of the market volatility in the past few years has been due to the low interest rates. While the reason rates were lowered was specifically to encourage borrowing and spending, it has created a scenario where companies are going out of their way to search for M&As in order to take advantage of the low rates before they are raised again.
2021 was one of the biggest years for M&As, and all of the factors mentioned above give full reason to suspect that this strong showing will continue. Digital acceleration will also encourage tie-ups as companies scramble to acquire new products. In addition, the effect of M&As on specific market categories is something that CFOs and finance teams need to pay attention to.
Continuing M&A trends
Being that many of the reasons for the rise in M&As seems to be due to the current market volatility, there is reason to suspect that when inflation, interest rates, and supply chains all even out, the number of M&As will also slow down. But that is not necessarily true. Here are a few of the M&A trends to look out for as to why or why not M&As will slow down as 2022 progresses:
One reason for a potential slowdown in the number of M&As is the skyrocketing valuations in young companies. The higher the valuation, the harder it is for the buyer to produce results that keep up with the numbers. The new and improved company then has a lot of pressure to produce results right off the bat. Cost cutting, finding new and creative ways to grow revenue, and transforming business operations to fit the valuation are some of the ways companies try to keep up post- acquisition, but some may shy away from acquiring these high valued, young companies to begin with.
The recent downdraft of high valued IPOs, specifically in the technology sector, have raised caution and concern in all aspects of high valuations, including M&As. Those looking to buy may look for “bargain” mergers and acquisitions such as smaller companies or those who have not yet raised capital in order to make up for the challenge of producing immediate results from high valuation M&As. This may be one of the biggest causes for slowdowns in acquisitions as 2022 progresses.
Another noticeable trend in M&As that might linger during volatility is earnouts. In order to reduce the phenomenon of young companies producing high results in a short period of time and selling quickly, many buyers want the sellers to retain a stake in the company. This is particularly true during supply chain shortages, as predicting numbers is even more challenging, which is why buyers are increasing earnouts during the acquisition process.
Lastly, is the increased scrutiny and updates from the Federal Trade Commission declaring their intention to strengthen antitrust laws. Mergers and acquisitions are very important for the economy but can also kill competition overnight. There are still plenty of industries with low competition, and the FTC plans on reviewing their outdated antitrust guidelines for both vertical and horizontal deals in order to keep up with the challenges of M&As.
Conclusion
Mergers and acquisitions have seemed to take off recently due to all of the unconventional reasons for wanting to combine companies- mostly in order to deal with the recent market challenges. Because these issues do not seem like they will abate anytime soon, 2022 is expected to be another hot year for M&As. While the sheer number of deals may slow down after that, there are still plenty of reasons for companies to pursue acquisitions- even if the reasons for doing so may change.
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