There is a saying that ‘when it rains, it pours’. This perfectly summarises the story of M&A markets in 2020, a story which is continuing as 2021 progresses.
Last year began with a robust first quarter until the pandemic enforced lockdowns which shut down M&A activity alongside much of the economy. Then in the fourth quarter of the year, the floodgates opened with pent up demand due, in large part, to global quantitative easing and economic stimulus packages complemented by the corporate hoarding of cash. This produced a record volume of M&A deals amounting to six times the volume of M&A activity compared to the second quarter.
Not only were the stalled deals of the spring and early summer reactivated but dealmakers added new deals as they sought bargains or the means to strategically reposition themselves for the post-COVID period. Yet, despite the low volumes in the middle of the year, 2020 still represented one of the top 10 years in history for M&A, with over $3.6 trillion of deals announced.
Activity drivers for M&A
As we progress through 2021, research at the M&A Research Centre at The Business School (formerly Cass) shows that we can expect to see trends continuing for the rest of the year. One of the most important driving factors for deal activity is the vast amount of cash available for companies to spend on acquisitions. This is not only due to the expectation that economies will start torecover, lockdowns will end and consumers will return to their traditional spending patterns. It is also because equity markets have been rising steadily since the troughs of early 2020.
It is this cash-rich environment that has led to the issuance of significant amounts of new equity in terms of secondary offerings, but more importantly Initial Public Offerings (IPOs). Why are these new IPOs so critical to the M&A markets? Our research shows that the peak in M&A markets typically occurs between six and nine months after an equity issuance peak, due, largely to the fact that firms tend to raise new capital in order, amongst other things, to be able to invest in acquiring new businesses.
This new equity issuance has been further expanded by the phenomenal growth of Special Purpose Acquisition Companies (SPACs), principally in the United States but increasingly elsewhere, as other regions seek to cash in on the SPAC bonanza. These companies raise money with the sole purpose of acquiring businesses. In the first quarter of 2021, SPAC activity exceeded the record levels of the entire year 2020. These relevant SPACs will need to invest the funds raised within the next eighteen months to two years. This volume of activity provides a strong base to the M&A markets over this timeframe. Should new SPAC formation activity continue unabated, this period will extend.
The second half of 2020 also saw private equity firms, with their record amounts of dry powder driving their investment levels to the highest in a decade. This private equity activity can also be expected to continue throughout 2021.
China, the US and cross-border opportunities
Chinese companies have been very active acquirers of overseas assets in the past decade, but Chinese M&A activity has returned home in the past two years. This is not only due to Chinese domestic policy but also because of the rise of protectionism in the West. Recently, according to Mergermarket, over 90% of M&A deals from Chinese companies have been domestic and this is expected to continue into the future.
Meanwhile, US domestic activity is likely to remain strong as the massive US stimulus package works its way into the economy and interest rates, despite some upward pressure, remain at historic lows. Deutsche Bank predicted that up to 40% of the $1.9 trillion fed stimulus is being invested into the stock market and companies with rising share prices are more likely to carry out M&A activity.
That said, despite the strong domestic markets in both China and the US, there will continue to be an appetite for cross-border activity, with Europe remaining a strong target area.
Sector focused prospects
In terms of sectors, global technology trends, such as digitalisation and artificial intelligence, are driving M&A activity even in traditionally non-tech-related industries like banking. The pandemic has also created opportunities in the pharmaceutical and healthcare sectors and there has been a heightened awareness of changes in the energy sector, especially with the shift towards renewables and sustainability.
For companies looking for bargains, the retail, hospitality and transportation sectors will continue to provide targets as they restructure. With the massive government support schemes likely to end in 2021, more bankruptcies will follow but companies under pressure will likely try to stay ahead of creditors by proactively restructuring and selling assets.
While there are many struggling businesses, equity markets remain robust. That said, there is a potential downside. One concern comes from the rise of increased protectionism, alongside the threat of competition. Authorities are looking more closely at the dominant positions of large companies, particularly in ‘Big Tech’. Even the mere threat of being broken up may slow down the acquisition activity of such firms. The good news, however, is the fact that any divestments by technology giants could actually be acquisitions by non-tech companies, or the merging of smaller tech players seeking scalability. Another concern is the distribution of vaccinations and new variants of COVID-19.
What next for M&A?
Overall, the number and volume of deals should continue at pace for the foreseeable future. The deluge of M&A deals that started in the fourth quarter of 2020 should continue for some time to come.
Scott Moeller is Professor in the Practice of Finance at The Business School (formerly known as Cass), City, University of London where he also is the director and founder of the M&A Research Centre. He has written and co-written a number of books, including one for The Economist business book series, entitled Why Deals Fail & How to Rescue Them: M&A Lessons for Deal Success. Prior to his teaching and research, Scott spent six years at Deutsche Bank in London. Prior to Deutsche Bank, Scott worked first at Booz Allen & Hamilton management consultants for over 5 years and then at Morgan Stanley for over 12 years in New York, Japan, and then as co-manager and member of the board of Morgan Stanley in Germany. Scott is a graduate of Yale University.