Companies in the deal market are grappling with high funding costs and low valuations as inflation and an uncertain economic outlook threaten to weigh on mergers and acquisitions for the remainder of the year.
Last year was a record year for deals thanks to low interest rates and huge cash accumulations. But businesses are now facing difficulties when it comes to buying and selling businesses. Among them: rising interest rates, Russia’s war in Ukraine and a sell-off in the capital markets.
In the first six months of the year, companies announced deals worth $2.17 trillion worldwide, down 21% year over year, according to data provider Refinitiv.
“The year has begun with unprecedented turbulence,” said David Harding, consulting partner at consulting firm Bain & Co. Bain estimates the value of businesses worldwide will reach $4.7 trillion in 2022, down from a 20% decline corresponds to the previous year. The first, but still the second best year for M&A in the last two decades.
Despite an uncertain economic backdrop, companies continue to forge big, strategic deals in a tight regulatory environment. Among the top deals announced this year was Microsoft Corp’s $75 billion purchase of video game maker Activision Blizzard Inc. and microchip company Broadcom Inc. for rival Duke Realty Corp. for $26 billion.
Prologis increased its bid in June after Duke rejected an earlier offer of about $24 billion. “We view this as fair value,” Chief Financial Officer Tim Arndt said last month after Prologis announced the revised transaction. The transaction will add 160 million square feet of storage space to Prologis’ portfolio in 19 US logistics markets. It currently manages approximately 1 billion square feet of industrial space worldwide.
Companies have amassed huge cash piles during the pandemic, further strengthening their balance sheets. Cash on hand, including short-term investments in S&P 500 companies, grew 1% year over year to $8.3 trillion in the first quarter, according to data provider S&P Global Market Intelligence.
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But the decline in stocks and bonds in recent months has made the capital market less attractive for companies looking for financing. US companies – especially those with non-investment grade credit ratings – raised less money through debt and equity issuance in the first half of 2022 than in the same period last year.
Many acquirers are relying more on bank loans than the capital markets to fund deals, said Stephen Phillipson, head of commercial products at Minneapolis-based lender US Bancorp, as bond investors seek higher yields and bank loan prices are cheaper. “This year has been a big turning point, especially in the last few months,” Mr Philipson said.
But bank lending also comes with limitations, including the fact that it often provides companies with less capital than bond issuance, he said.
Meanwhile, private equity firms are turning to private lenders to fund deals after junk bond and leveraged loan issuance plummeted. Leveraged loans are typically syndicated by a group of banks and other financial institutions that set the terms and may change them in volatile markets or terminate loans late in the process. However, concerns such as geopolitical uncertainties and aggressive US Federal Reserve rate hikes have made banks more cautious.
“We have found that our private equity clients are more likely to turn to us [private lenders] In an environment where money center banks just don’t write off commitments,” said Paul Bird, senior M&A partner at law firm Debivois & Plimpton LLP, referring to large commercial banks.
A slowdown in financing markets has helped drugstore chain Walgreens Boots Alliance Inc. K decide to postpone its plan to sell its Boots and No7 Beauty Company businesses. The company, which began talks with potential company acquaintances in January, has attracted eight to 10 interested buyers for Boots, Britain’s largest pharmacy chain, chief executive Rosalind Brewer said on a June 30 conference call. But Walgreens said it was unhappy with the offers it received.
“We had very productive discussions and conducted detailed due diligence as the market began to turn to us,” Ms. Brewer said on the conference call, adding that the change was “unexpected and dramatic.” The company declined to comment further.
Transaction valuations — calculated as the average enterprise value of the target company divided by earnings before interest, taxes, depreciation and amortization — have fallen from last year’s record highs for strategic deals across industries. They have fallen to 12.6 times since June 1 of this year, compared to 15.4 times. 2021, according to Bain.
Buyers also include their inflation expectations for the coming months in their offers. “What you model for inflation can make a big difference in your company’s value,” said Colin Witmer, US deal leader at accounting and consulting firm PricewaterhouseCoopers LLP.
Advisors said lower valuations would create buying opportunities for some companies this year. US Bancorp’s Mr Philipson said he advised investment-grade companies to keep in mind the goal of freezing funding before further rate hikes. “Take the money today,” he said.
write to Kristin Broughton at [email protected]
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