There was a notable decline in private equity (PE) buyer activity last year, after accounting for almost a quarter of all acquisitions over the previous two years. This activity was slowed by tightening financing conditions and rising interest rates which weighed on their ability to make debt purchases. In Canada, there were 441 transactions completed in 2023, most of which were companies that were a good fit with another company within an IC portfolio.
CI companies found a way to continue to make deals in a high rate environment by acquiring a minority stake in the companies, which allowed them to preserve capital (since the amount was smaller) and also allowed the shareholders of target companies to maintain their participation in the event of a price recovery.
However, some areas shone brighter than others.
Companies in the industrial and commodity sectors have benefited from an upswing in activities as inflation has actually benefited many of these companies who have incidentally sought to expand their operations to improve efficiency.
The energy sector was taking the lead on the M&A front with several mega merger deals announced in the second half of the year, with deals in the Permian shale region of the United States exceeding $100 billion (G $).
Although technology sector M&A fell overall, two big deals – Microsoft Corp’s (NASDAQ: MSFT) acquisition of Activision Blizzard for $69 billion and Broadcom Inc’s (NASDAQ: MSFT) purchase of VMware AVGO) in return for $61 billion – were successful.
There has also been an uptick in M&A activity in the healthcare sector where dozens of merger deals between biotech and pharmaceutical companies have been announced; large drug manufacturers will, over the next ten years, come close to a patent abyss, so they are strongly motivated to replenish and expand their portfolios of patented medicines.
Despite the challenges of 2023, the rebound of the last quarter has given investors hope for the months to come.
In 2024, negotiators are more experienced and have adapted to the new context by using more structured agreements to counterbalance risks. Among them, note the use of indexation clauses on future profits, rights with conditional value, exclusions and splits.
A growing number of deals are also structured to incorporate a portion or the entire amount in shares rather than just cash. Typically, the acquirer structures a cash transaction when it has sufficient liquidity or access to financing and is willing to assume all risks because it has high confidence in its ability to realize synergies or strategic objectives through this acquisition.
With tighter financial terms, particularly for deals in capital-intensive industries, it is becoming more common to share risks and rewards with shareholders.
Last year’s headwinds may become this year’s tailwinds, so we enter 2024 with optimism regarding the prospects for M&A and merger arbitrage.
As inflation slows, interest rates are expected to decline, businesses adapt to the post-pandemic environment and investor confidence returns strongly.
In light of uncertain geopolitical and economic conditions, smarter companies are seeking opportunities for future growth and acquiring the technologies and capabilities required to compete and avoid disruption.
On the deal side, indications coming from all directions from investment banks, advisors and insiders seem to highlight the robustness of future M&A deals.
The stock market rise has given management teams and boards of directors the confidence needed to reach agreements, as evidenced by the growing number of companies that have initiated talks.
Shareholder activism is also increasing, as they, frustrated, want to update the value of their shares traded at prices significantly discounted from intrinsic value.
As proxy season approaches, the timing is ripe for the replacement of ineffective boards and, with increased shareholder discontent, the arrival of opportunistic buyers.
In terms of arbitrage-focused investments, the opportunities are also attractive given that the rate of return on merger arbitrage transactions averages over 10% for North American deals. This is a significant premium to historical levels and a significant departure from high yield bonds.
In a more hostile regulatory environment, arbitrage investors now have a better idea of which deals will be targeted by the authorities. After a series of defeats, authorities no longer have as many resources, which limits the number of transactions they can actively target.
So, given the pronounced spreads, greater visibility to assess risks and a potentially higher number of completed deals, the year 2024 could prove very favorable for merger arbitrage products.