The European mergers and acquisitions (M&A) market has normalised thus far in 2022 after an unusually buoyant 2021. Although activity levels are trending down, they remain above pre-pandemic levels. The easing of the Covid-19 pandemic, which facilitated a rebound of consumer demand and the return of business activity, translated into a boom in economic growth last year.
The prospect of a hawkish turn in monetary policy to rein in prices was already looming large in early 2022. Inflation proved to be more deeply entrenched than the European Central Bank (ECB), the Bank of England (BoE) and other policy-makers had initially anticipated.
The Russian invasion of Ukraine further exacerbated already-elevated energy price pressures. As a result of inflation and the subsequent drag on demand, growth is expected to halve this year.
Great expectations
Against this backdrop, however, M&A expectations are still running high, according to the findings of our “CMS European M&A Outlook 2023” study released towards the end of last month. Increased market volatility makes predictions difficult, but the deal-makers surveyed for the study, who are the ones pulling the levers (and purse strings) of acquisitions, take a highly optimistic view.
Only 12% of respondents said that they are not currently considering M&A activity, which stands in contrast to the findings in the last two surveys – in 2021, 33% of those polled were not considering M&A and in 2020 this figure was much higher at 65%, though notably this was in peak Covid times.
73% expect the level of European activity to rise over the next 12 months
This optimism for the present extends to the future as well: one of the main headlines of the report is that 73% of these experts expect the level of European activity to rise over the next 12 months – 20 percentage points higher than the expectation last year.
It is expected that the technology, media, and telecommunications sectors will drive this uptick in M&A activity in the coming months as businesses continue to grow their technological offering in order to remain competitive in an increasingly digitised world. Deal-makers also expect the availability of undervalued deal targets to be a major driver of activity on the buy-side, whilst over a quarter say that distressed situations will drive the sell-side.
Reservations remain
This positive outlook for expected deal-making is not without its caveats: investors are realistic about borrowing conditions as the ECB and BoE hike rates, with further rises forecast, and reduce their balance sheets. Indeed, financing difficulties, as well as valuation gaps, are seen as two of the biggest obstacles to M&A activity over the next 12 months.
As much as 87% of all respondents expect financing to be tighter compared to last year – this includes 45% who expect it to be much harder.
Nevertheless, while the tightening of credit conditions is driving up the cost of financing, buyers remain well positioned to capitalise on deals where their conviction is high. Similarly, while valuation gaps pose a challenge to deal negotiations, the easing off of valuations in the first half will have increased appetite among buyers who were already actively seeking specific targets.
The impact of ESG
Another key finding of the report is the exponential growth of environmental, social and governance (ESG) factors in recent years, as investors face pressure to uphold higher standards. The forecast growth in ESG activity is not limited to those industries more explicitly associated with ESG, but has increased across all sectors as businesses realise that credibly being ahead of the sustainability curve generates significant market interest.
Europe continues to lead the world in setting out a path to a net-zero carbon future, and this is having a clear impact on the ins and outs of M&A. The high standards set by Europe are impacting jurisdictions that currently lack explicit ESG legislation, as important market players are bringing these baseline requirements with them to deals globally.
Some 90% of respondents expect ESG scrutiny in their deal-making to increase over the next three years, compared to 72% in 2021’s survey. Compared to last year’s survey, the proportion of respondents expecting ESG scrutiny to significantly increase nearly doubled to 48% from 26%.
ESG-driven deal activity will continue to enter new geographic regions, affecting new and old industries alike, further cementing it as an element not to be ignored by both commercial and legal decision-makers in the M&A industry.
To conclude
The fact remains that corporates and private equity are well equipped with capital for deals and optimism is running high, even in the face of dark clouds gathering on the horizon. Over the next 12 months, financing costs are likely to increase even further, and debt markets will be more selective with the deals that they are willing to back, seeking quality of earnings and business models that are fit for the future.
Until inflation crests, investors should be mindful of the macro context and hone in on assets that benefit from powerful secular tailwinds that fuel their performance amid high input costs and weaker macro growth.
Louise Wallace and Dr Malte Bruhns are co-heads of the Corporate/M&A Group at global law firm CMS. The practice’s “European M&A Outlook 2023” report can be found here.
