Picture this. It's midway through 2022 and after a record year in 2021, the merger and acquisition (M&A) market is firing on all cylinders. Interest rates are low, cash is flowing freely around the economy and valuations are booming as consumers get back out after long lockdowns.
A perfect environment for M&A but not one set to last. June 2022 will be remembered as a turning point for M&As. The US Federal Reserve (Fed) made its first move to raise interest rates, starting what would turn into the fastest rate hiking cycle for a generation.
What followed sent waves through capital markets as businesses faced higher inflation, increased cost of capital and slowing economic growth. Thoughts turned inwards, to streamlining operations and cost cutting instead of expensive deal making.
The result? A 12% drop in deal volumes over 2022, with a higher 36% drop in total value. It wasn't just the M&A market that suffered, things were looking just as grim for IPOs (initial public offerings).
Higher rates meant valuations of growth companies took a major hit. The idea of listing on a stock market and raising capital at a depressed valuation wasn't very appealing. The value of IPOs in 2022 was down around 70% on the year before.
This year hasn't gotten off to a much better start, but we're starting to see signs that conditions over the second half and into 2024 might be brighter.
What's next and where are the opportunities for investors?
While it looks like we might be nearing the end of rate hiking cycles, higher for longer seems to be the message from most major central banks.
It's unlikely we'll see interest rates and therefore costs of capital come down in the near future. Still, a more stable environment should be enough to coax some of the green shoots we're seeing into action.
"Be greedy when others are fearful"
It's often the case that the best opportunities come up when things look bleak, for those willing to take a leap. Warren Buffett famously said "be greedy when others are fearful".
There's data to back this up too. If we look at the 2008/09 crisis, those who acquired during the downturn actually outperformed over the following decade compared to those that didn't. But it takes a strong belief in a strategy, and the financial strength to back it up.
We've already seen some megadeals announced this year. Cisco has just made its largest ever acquisition, of Splunk for $28bn; Pfizer's proposed $43bn acquisition of Seagen; and Newmont's announced spend of $19.2bn on Newcrest Mining. Let's also not forget Microsoft's ongoing pursuit of Activision (though that technically began last year).
But it's not just mega deals, the mid-market is arguably even more important. It's where most of the transactions take place and there's much less risk of the regulator coming in to put blockers in the way.
With companies looking to adapt to the new world of higher borrowing costs, that could present opportunities. Be on the lookout for those with good cash generation, low debt levels and strong market leadership to make some attractive deals.
Are IPOs back?
Despite shares performing relatively well this year and volatility calming from last year's mayhem, IPO activity is still muted in Europe and the US.
Investors are still demanding a hefty discount to some of the valuations seen during the 2021 IPO boom. For founders and boards, that presents a tricky conundrum.
Push on, knowing you're going to have to take a discount to where you were a year or two ago, or hold fire and hope things recover?
The irony is if everyone does the latter, then the market gets stuck.
Thankfully, we've seen some headline grabbing movement in recent weeks. Most notably Softbank decided to finally take the plunge and list Arm Holdings in the US at around a $55bn valuation. We'd argue that was more out of necessity than a belief the market was back, given Softbank's need for liquidity. Nevertheless, it might just be the catalyst markets needed.
The general feel is for a slow stream of activity this year, with things picking up in 2024. For retail investors, IPOs present an opportunity to buy into some exciting new names. And a healthy market helps create general confidence that the equity environment is on a solid footing, so it's certainly important for anyone with skin in the investing game.
One thing we'd caution on is jumping too early. Recent history shows IPOs tend to underperform the market in the early years. So don't feel like you need to rush in because things are pasted over the news.
Investing is for the long term, that's at least five years – you need to have confidence in the long-term prospects of any company you're investing in.
Of course, past performance isn't a guide to the future and there are no guarantees either way. Investments can fall as well as rise in value, so you could get back less than you put in.
Investing in an individual company isn't right for everyone because if that company fails, you could lose your whole investment. If you cannot afford this, investing in a single company might not be right for you. You should make sure you understand the companies you're investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.
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Investments rise and fall in value so investors could make a loss. This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.
Article image credit: Spencer Platt/Getty images.
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