M&A Is Expected to Pick Up in 2023 as Companies Adapt to Tougher Conditions

“The M&A market is not going to stop. It just doesn’t work that way. What it does is it evolves,” said

Christopher Auld,

head of leveraged finance at investment firm

Stifel Financial Corp.

The total value of deals announced globally fell 37% last year from 2021’s record high, to $3.61 trillion, according to financial data company Refinitiv. That is the biggest year-over-year percentage drop since 2001, a year when the U.S. economy slid into a recession and the value of global deal making plunged 50%, to $1.68 trillion, according to Refinitiv. Still, last year’s results were roughly in line with prepandemic levels.

Deal advisers expect M&A to pick up in 2023 following last year’s slump, though when that will happen remains an open question. Buyers and sellers want more certainty about the pace of further rate increases from the Federal Reserve, as well as data showing inflation continues to abate after notching 40-year highs, advisers said. 

“The most important ingredient, in a way…is confidence,” said

William Regner,

partner in the mergers-and-acquisitions group at the law firm Debevoise & Plimpton LLP, discussing factors that sapped M&A momentum in 2022.

Multiples on strategic deals—a metric that compares a target’s enterprise value to its earnings before interest, taxes, depreciation and amortization—fell to a 10-year low of 11.6 times at the median last year through Nov. 30, compared with 15.4 times a year earlier, according to advisory firm Bain & Co. Lower share prices across industries, driven by a selloff in stock markets throughout 2022, made it harder for acquirers to pay up for acquisitions, according to Bain. 

“As interest rates go up, valuations are coming down,” particularly for certain fast-growing companies that aren’t generating free cash flow, said

Suzanne Kumar,

a vice president in Bain’s M&A practice. That is especially true in the technology and healthcare sectors, where deals for high-growth companies are most common, she said. 

In addition to macroeconomic pressures, companies faced a tougher regulatory environment in 2022, with antitrust enforcers globally applying greater scrutiny to large transactions. 

Last year’s biggest deals included

Microsoft Corp.’s

$75 billion, all-cash deal announced in January to acquire videogame maker Activision Blizzard Inc., as well as chip maker

Broadcom Inc.’s

planned $61 billion takeover of enterprise software company

VMware Inc.,

announced in May.

The companies are responding to inquiries from regulators globally. Microsoft said Wednesday it is working toward a resolution with the U.S. Federal Trade Commission, which sued the company in December to block the Activision purchase. The FTC said it is always open to considering proposed settlements. 

Volatility in the bond markets, meanwhile, kept potential acquirers on the sidelines, advisers said. U.S. investment-grade bond issuance declined 20% last year compared with 2021, to $1.31 trillion, according to Dealogic, a financial data provider. High-yield issuance plunged 71% over the same period, to $390.37 billion, Dealogic said.

Still, companies continued to move forward with major transactions, putting together financing structures to meet the moment. 

A driving factor behind last year’s decline in M&A was a pullback by big investment banks from the leveraged-loan market, advisers said. Banks last year faced hundreds of millions of dollars in losses on loans they agreed to provide for the acquisitions of companies including cloud-computing giant Citrix Systems Inc. and Twitter Inc., before demand from institutional investors collapsed. Investment banks as a result lost their appetite for this type of financing, prompting acquirers to turn to alternative sources, including private lenders. 

Blackstone Inc.

relied on private lenders in a deal announced in October to buy a 55% stake in

Emerson Electric Co.

’s climate-technologies business, which makes compressors and other HVAC products. Under the transaction, which is valued at $14 billion, Emerson agreed to retain a 45% stake in the business. 

To fund the transaction, Blackstone raised $5.5 billion of financing from direct lenders and a group of commercial banks with a smaller presence in the market. Typically, big investment banks would participate in this type of deal and sell the debt to a syndicate of investors. 

Additionally, Emerson contributed $2.25 billion in financing through what’s known as a seller’s note. The 10-year note carries a 5% interest rate that is capitalized twice a year, meaning it is added to the underlying principal. “We feel very confident that we’re going to get paid out on that on the accreted value at the appropriate time,” Emerson Chief Financial Officer

Frank Dellaquila

said during an Oct. 31 investor call. Emerson and Blackstone declined to comment further. 

More acquirers also turned to short-term loans known as 364-day facilities to finance acquisitions, bankers said. Demand for such facilities in the U.S. jumped 17% in 2022 through Dec. 29 compared with the full-year 2021, to $317.3 billion, according to Dealogic.

Finance chiefs are increasingly using 364-day loans because of conditions in the leveraged-loan markets, bankers said. “You probably have a view that within the next year, you’re going to activate in the capital markets,” said

Siamak Saidi,

managing director in the commercial bank at

Wells Fargo

& Co., discussing the uptick in demand for 364-day loans. “And if not, you’re going to reassess what the options are at that point.” 

Grocery giant

Kroger Co.

in October said it took out a $17.4 billion, 364-day bridge loan from

Citigroup Inc.

and Wells Fargo to fund its planned acquisition of rival Albertsons Cos. Kroger plans to pay off the credit when the acquisition closes, which is expected in early 2024, using cash on hand and proceeds from a new debt financing. 

One way acquirers are minimizing financing costs is by negotiating deals for minority stakes in companies—for instance, buying less than 50% of a company that is majority-owned by another private-equity firm. Companies in 2022 struck $240.4 billion of such deals, down from $385.5 billion a year earlier, but up 4% compared with 2020, according to Dealogic.

Such deals can avoid a legal change in control, which typically requires a company to refinance its debt, bankers and advisers said. Doing so today would require the company to pay higher interest rates than before the Fed began to aggressively raise rates last year to fight inflation. 

Think of the financial benefit of this type of transaction as purchasing a new house but keeping the seller’s existing, low-rate mortgage in place, said

Ken Wallach,

co-head of the global capital markets practice at the law firm Simpson Thacher & Bartlett LLP.

“It’s all about trying to figure out how to move into that house, but keep the existing debt,” Mr. Wallach said, noting that it is a playbook more companies will likely turn to in 2023.

Write to Kristin Broughton at [email protected]