2022 is coming to a close, a time of reflection on the highs and lows in M&A activity throughout the year. 2021 was a record-breaking year for M&A activity, which led to an optimistic start for 2022. However, at the mid-year point, we saw growing and newly-emerging headwinds from geopolitical turmoil, increasing interest rates and inflation, as well as lower equity markets.
Typically, M&A volumes and values tend to decline during periods of uncertainty and market volatility. We've observed this during prior economic recessions, such as the dot-com bust in 2001 and the global financial crisis in 2008-2009. The most recent example can be seen through deal trends in the second half of 2021 and the first half of 2022. PwC’s Global M&A Industry Trends: 2022 Mid-Year Update showed that deal volume and value in Asia Pacific declined by more than 30%, with an average deal size of USD 60 mil during the first half of the year.
Understandably, deal momentum has slowed down in recent months as decision-makers are cautious of making big investments in a downturn. Declining stock markets also pose another challenge in assembling deal funding, making financing acquisitions a costly strategy. Global inflation is expected to moderate next year but it will likely remain above inflation targets in many economies, according to the World Bank’s June 2022 Global Economic Prospects report. Growth for East Asia and the Pacific region is projected to decelerate to 4.4% in 2022 before increasing to 5.2% in 2023. High interest rates and reduced valuations may delay the path to profitability for highly valued startups, pushing positive cash flow to the future.
Despite these challenges, it may not be the time to put deals on hold, contrary to traditional thinking. PwC's publication Succeeding Through M&A In Uncertain Economic Times found that companies that acquire during an economic downturn can see positive returns. For instance, organisations that made acquisitions during the 2001 recession ultimately saw better shareholder gains than industry peers in the months that followed. Similarly after the Great Recession in 2007-2009, new regulations spurred a shift in M&A funding, leading to many cash acquisitions including high profile ones among technology companies.
Dealmakers who are bold and strategically pursue a deals strategy rooted in capabilities and aligned with strategic goals will be best positioned to create long term value. The same forces creating market uncertainty, such as pandemic restrictions, supply chain disruptions and the energy crisis are also driving dealmaking. Whether a company needs to transform its capabilities or go-to-market approach, one of the fastest ways to accelerate transformation is through M&A. For 47% of US business leaders polled in our January 2022 Pulse Survey, pursuing corporate M&A, joint ventures and alliances are very important growth drivers for their organisation.
Compared to past recessions, we can anticipate a more resilient market, with available investment capital not as closely linked to economic trends. For businesses with an appetite for M&A, there are diverse sources of capital available. Private debt funds, venture capital and private equity have grown and can be counted on to fuel deal volumes. In fact, private equity firms have had a record cache of dry powder at $2.3 trillion based on our mid-year analysis. They will continue to be a key participant in mid-market and large deals. It will be critical to focus on sophisticated value creation strategies and identify the right targets.
There is also a growing interest in cross-border activity, with Southeast Asia being especially attractive to investors from outside the region. Sectors seeing the highest M&A activity are ESG-driven, for example energy, utilities and resources, and will continue to be a big driver going forward. We may also see a recovery in the airline and hospitality sectors.
For dealmakers to put themselves in a better position to create value and drive successful deals during these times, there are several point to consider:
Wearing an ESG lens - The board plays an important role in ensuring that the strategic plan of the company supports long term value creation and includes strategies across the environmental, social and governance dimensions of ESG as well as economic considerations.
Some investors may put pressure by only considering companies that meet certain ESG criteria and practise robust reporting on ESG strategies and risk assessment. In a PwC Malaysia investor survey in collaboration with the Malaysian Institute of Certified Public Accountants (MICPA), 91% of Malaysian respondents agreed that how a company manages ESG risks and opportunities is an important factor in investment decision-making. This data reflects the sentiments of respondents in PwC's Global Private Equity Responsible Investment Survey 2021, in which 72% always screen target companies for ESG risks and opportunities at the pre-acquisition phase.
Capital availability - Divestiture of non-core assets can be a good solution to generate capital that can be re-deployed into other core businesses. Successful companies actively manage their portfolio of businesses, identifying those with the greatest growth prospects and divesting others that no longer fit their overall strategy.
Deals strategy - Be proactive and agile in pursuing a deals strategy. Update valuations on existing and targeted businesses to consider strategic deals, based on market developments. Focus on capabilities-driven deals as these significantly outperform limited-fit deals in total annual shareholder returns.
The capabilities fit between a buyer and a target is a better indicator of deal success than the stated strategic intent. Our Doing the Right Deals report in October 2021 shows that the stated strategic intent had little or no impact on value creation, with the logical exception of capability access deals. Delivering Deals in Disruption: Value Creation in Asia Pacific in September 2022 shows that capabilities-driven deals outperform deals that are made for other reasons such as consolidation, diversification or entering new markets by approximately 14% in total annual shareholder returns (TSR). With deals growing in complexity due to increasingly challenging environments, having a capabilities-driven approach helps dealmakers focus valuable management time and investment on the most differentiating elements of the deal.
In conclusion, while the prospect of making a deal in uncertain times can be daunting, it is a common misconception to perceive M&A as being off-limits in a downturn. Dealmakers can learn from historical lessons and best practices, informed by the recent changes to the business environment over the past few decades, in order to achieve significant success in creating value.
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Deals Partner, Corporate Finance Leader, PwC Malaysia
Tel: +60 (3) 2173 0269
