With interest rates remaining historically low, equity markets continuing to be enthusiastic, private equity maintaining record high stockpiles of dry powder and more than 400 SPACs looking for targets, 2021 was on course through the end of the third quarter to be a record year for dealmaking. And while the transactions that may have been postponed during the COVID-19 pandemic have likely worked their way through the system, we expect M&A to continue to be robust in 2022 as well.
In the year ahead, activity will be buoyed by PE sponsors and SPACs hunting for deals, and strategics continuing to both optimize their asset mixes by selling or spinning off businesses that are not in line with their corporate visions and making acquisitions where organic growth is not possible.
There may also be headwinds that drag on M&A, including the potential for higher interest rates, increased regulation, challenging macroeconomic factors (such as inflation and continued supply chain issues) and the uncertainty associated with all these factors. To this end, in particular, corporate boards and dealmakers should be prepared for a continued surge in tech M&A, increased regulatory scrutiny of deals – and greater focus on ESG-driven and affected transactions.
Tech remains a significant driver of deal activity
The technology, media and telecommunications sector was the largest for deals through the first three quarters of 2021 (according to Refinitiv data) with nearly $1.3tn worth of transactions globally. Industrials and materials was the next-most robust sector, accounting for $723bn of global deal value. During COVID-19, digital life became all life, sending tech companies on a buying spree. Prime examples in 2021 include Intuit’s proposed purchase of Mailchimp for $12bn and Microsoft’s proposed acquisition of Nuance Communications for $19.6bn.
However, tech companies are not only buying but are also targets for acquirors in other industries, many of which are fervently working to move into the digital space. UnitedHealth Group’s proposed acquisition of Change Healthcare, and shipbuilding company Huntington Ingalls Industries’ acquisition of Alion Science and Technology, are key examples. Finally, tech businesses are also likely to continue to benefit from the more than 400 SPACs that are looking for acquisition targets. The practice in de-SPAC transactions of using financial projections can be particularly useful for pre-earnings – sometimes pre-commercialized product – companies like late-stage private tech businesses.
Antitrust and foreign investment landscape continues to evolve
The last 12 months have seen significant movement in the competition and foreign investment regulatory landscape. The incoming Biden administration has led to new leadership at the US Federal Trade Commission and the Antitrust Division of the US Department of Justice, both of whom have been vocal in their more aggressive stance on consolidation. With Brexit, the UK Competition and Markets Authority is no longer part of the European Commission’s collective review process.
The Committee on Foreign Investment in the United States (CFIUS) continues to closely monitor acquisitions of US assets and, in late 2020, the EU foreign direct investment regime came into effect. The result is ever-increasing scrutiny of M&A transactions by regulators across the globe, with deals taking longer to close, more litigation risk and more focus than ever by dealmakers on allocating regulatory risk (see Antitrust Outlook for the Year Ahead).
Notable casualties have included Aon’s proposed $30bn acquisition of Willis Towers Watson and Visa’s proposed $5.3bn acquisition of Plaid. Regulators are also increasingly requiring (or parties are offering upfront) divestitures, such as Alimentation Couche-Tard’s obligation to divest stores in connection with its acquisition of Holiday Stationstores and Bristol-Myers Squibb’s obligation to divest Celgene’s Otezla, meaning that deals are in some cases leading to more deals. Boards, ever focused on deal certainty, will need to ensure they have a well-thought-through strategy to engage with worldwide competition regulators in their transactions, including having to consider when litigation might be a necessary tool and to ensure consistent, and effective, communication across jurisdictions.
In addition, regulatory covenants included in transaction agreements need to be even more carefully tailored to ensure that risks are allocated in the way the parties intended. The longer periods between signing and closing may lead to a return of ticking fees or other measures to ensure that buyers have time to get their deals cleared while sellers are compensated for delays. We also note that long executory periods can put pressure on parties’ obligations, particularly sellers’, to maintain ordinary course operations and refrain from taking certain actions, which have been subject to important recent litigation amid the backdrop of the COVID-19 pandemic requiring great change in certain industries (see Trends in Delaware Litigation that will have an impact in 2022 and Beyond).
ESG set to play a major role in 2022 and beyond
Finally, while ESG is an ever-increasing focus for boards generally, it is also likely to drive dealmaking behaviors. There have been acquisitions of ESG-positive assets, such as Mitsubishi’s acquisition of Eneco, a sustainable energy company. Acquirors are seeking assets that are targeted at ESG-focused investors, such as Goldman Sachs’s proposed acquisition of ESG specialist-asset manager NN Investment Partners or the acquisition of Sustainalytics by Morningstar. Boards should also be considering ESG due diligence on the assets they are buying, including to identify any cultural or governance problems that would be problematic if integrated into existing operations or that may have negative reputational effects.
Finally, a focus on ESG may bring derivative effects as well. For instance, activist investor Third Point’s desire to break up Royal Dutch Shell into its legacy business and renewables business represents a tried-and-true activist campaign where a company comprises businesses with differing multiples, now with an ESG twist. Indeed, the increased focus on ESG likely exacerbates the difference in multiples between these varied businesses and is likely to result in ESG-focused funds chasing divested assets in that class, while also allowing activist investors to tout their ESG bona fides.
Key takeaways for boards
The technology sector will continue to spur significant deal activity, with technological innovators making for attractive targets both for consolidation within the sector and for non-tech acquirors looking to add capabilities.
Increasingly active competition and foreign investment regulators will pose greater challenges to deal certainty, requiring parties to carefully craft provisions for regulatory efforts and related risk sharing.
ESG will continue to be front of mind for the investor community and boards of directors. This will both drive the types of deals that are done and require additional attention to ESG-related risks in transactions.