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In February 2023, an article published by Morgan Stanley, a financial services firm, mentioned that the global M&A market is expected to remain muted at the beginning of 2023, and will likely accelerate by the second half of 2023 and beyond. In our article today, we will be presenting a complete guide to M&A, while discussing the trends and factors driving this growth.
Let us begin with understanding what M&A stands for. The term Mergers and Acquisitions refers to transactions between two companies combining in some form. These terms are often used interchangeably and come with different legal meanings. However, in a merger, two companies of similar size combine to form a new single entity. On the other hand, an acquisition is when a larger company acquires a smaller company, thereby absorbing the business of the smaller company. Depending on the approval of the target company’s board, these deals may be friendly or even turn out hostile.
Moving on to the types of M&A transactions, these are generally of three types.
Horizontal transactions, occurs between two companies that operate in similar industries that may or may not be direct competitors.
Vertical mergers, occurs between a company and its supplier or a customer along its supply chain. Such transactions mainly occur when the company is aiming to move up or down along the supply chain, thus consolidating its position in the industry.
Conglomerate transactions, usually performed for diversification reasons and is usually done between companies in unrelated industries.
Our next segment is integration under M&A. M&A integration or post-merger integration (PMI) is the process of brining two or more companies together with the aim of maximizing synergies to ensure that the deal lives up to its predicted value. This process is also known as post-acquisition integration. It can be categorized into three forms,
Subsidiary mergers, occurs when the acquirer is much larger than the target and acquires the target’s assets and liabilities. After the completion of the process, the target company ceases to exist as a separate entity.
Subsidiary merger, occurs when the target becomes a subsidiary of the acquirer but continues to maintain its business.
Consolidation merger, occurs when both companies in the transaction cease to exist after the deal, here a completely new entity is formed.
Among the various reasons for Mergers and acquisitions to occur, a few have been mentioned below.
The prime reason why companies undergo M&A transaction is to unlock synergy. Synergy is the concept that the combined value and performance of two companies will be greater than the sum of the separate individual parts. The potential financial benefit achieved through the combining of companies is often the driving force behind a merger.
M&A allows for a faster way for a company to achieve higher revenues. Companies usually gain by acquiring or merging with a company with the latest capabilities without having to take the risk of developing the same internally.
M&A allows for stronger market power. For instance, in horizontal merger, the resulting entity will attain a higher market share and will gain the power to influence prices.
The benefit of diversification is also what drives these transactions. Companies that operate in cyclical industries feel the need to diversify their cash flows to avoid significant losses during a slowdown in their industry. Acquiring a target in a non-cyclical industry enables a company to diversify and reduce its market risk.
Moving on, let us now consider a few M&A trends to watch for in 2023, while making any deal.
Analysts have found that the beginning of 2023, activities in relation to M&A will remain muted, which will change in the second half of 2023 where the number of deals happening will accelerate. In the second half of 2022, the global market faced macroeconomic uncertainty, volatility in capital markets, rapid rise in interest rates and increase in inflation, causing many corporations to focus internally rather than making acquisitions. Potential sellers faced declining valuations and were reluctant to transact at prices that were down significantly from earlier in 2022. In addition, large, transformational transactions also faced increased regulatory scrutiny. Although the picture has been same since the start of 2023, we can expect M&A activity to return quickly. Buyers and sellers, on their part, will have to gain clarity on how inflation, foreign exchange rates, interest rates and consumer demand will affect revenues and valuations.
According to the investment bankers at Morgan Stanley, a study has held that among the trends in this sector, we can witness large corporates to make additive acquisitions in their core businesses. Three industries are well suited to lead the way to greater M&A activity.
1. Healthcare- the healthcare sector had been highly affected due to the COVID-19 pandemic. Since we have now entered an era where businesses are going back to normal, many healthcare companies will be seen going through M&A, as a result to grow their business. For example, pharmaceutical companies with expiring patents need to replace those products and are on the hunt to acquire biotechnology companies.
2. Technology- in 2022, technology stocks fell more than 30% and the overall market experienced a drop of 20%. In relation to this, some technology companies will continue to consider leaving public markets via go private transactions. In addition to this, private equity sponsors with expertise in technology have also been showing a strong interest in take-private transactions, where publicly-traded companies return to private status after a sale to one or more financial buyers.
3. Energy- the energy sector has created quite a buzz since past few years. With companies attempting to improve their ESG practices through adoption of capabilities such as carbon capture or energy transition preparedness, we can expect such companies to undergo M&A transactions to achieve this goal. For mid-sized companies in this sector, we can even expect consolidation mergers to take place.
If we consider the working pattern of private equity firms, a few years back they waited for a certain time before investing in any business, however now they invest more consistently through ups and downs of the business cycle. Along with this, private equity firms have also become more knowledgeable about industries and their sub-sectors, which has allowed them in making investing decisions with a high degree of confidence in how the business might perform in different market cycles. This trend, along with private equity funds’ record amount of uninvested capital, will help in driving more M&A activity in later 2023.
According to a new report from Dentons Canada and Mergermarket, the “Shifting Tides of Cross-border M&A”, 2% of U.S./Canada respondents and 93% of their peers outside North America predict they’ll be involved in transactions in the TMT sector. Financial services, cited by just over half the respondents, was the next most popular industry, followed by pharma, medical and biotech (PMB). 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. Still more than a third of U.S./Canadian respondents and 40% outside North America are predicting increasing M&A activity for 2023. Among U.S./Canada respondents, 39% expect it to decrease compared with the past 12 months—a view 36% of non-North American executives share. The majority expect to be involved in one to four deals in the new year.
Reference- https://www.morganstanley.com/ideas/mergers-and-acquisitions-outlook-2023-trends#:~:text=Well%2Dcapitalized%20companies%20making%20acquisitions,border%20M%26A%20making%20a%20comeback
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