Brian Fahrney, Co-Head of Sidley Austin’s Global M&A and Private Equity Practice, discusses the global dealmaking market, including financing challenges and regulatory hurdles on the horizon.
No matter what industry you’re in, you have to conduct due diligence – legal, regulatory and reputation – on ESG-related aspects of the target companyBrian Fahrney, Co-Head of Global M&A and Private Equity Practice, Sidley Austin
In your opinion, what is the general outlook for the global M&A market? Do you expect to see a drop in activity following a record year?
It’s choppy right now. While activity in the first two quarters of the year was pretty strong, the third quarter experienced slowness and we expect the fourth quarter to be similarly soft. There are certainly challenges on the horizon – the financing markets are difficult, and there are concerns about a general economic downturn.
The IPO market has effectively shut down and the debt markets are soft, which will create a difficult environment for dealmakers heading into the end of the year and 2023.
What effect is this softness in the capital markets having on M&A? Do you think it will push dealmakers to get deals over the line, or will they adopt a wait-and-see approach?
Some dealmakers are adopting a wait and see approach to see whether conditions improve. People are very nervous about making a mistake in difficult economic times. And there is a lot of uncertainty around access to financing and the regulatory front – and uncertainty is not a friend of M&A. When these uncertainties exist, people are very cautious. They tend to move more slowly and take a pass on certain opportunities. On the other hand, quality businesses are always going to sell, even in difficult times, so long as agreement on valuation can be reached between buyer and seller. Often, that requires creative pricing structures.
Do you think these conditions are leading to a more defensive style of M&A, where dealmakers are favoring steady returns over high growth?
Clearly, where there’s concern around interest rates and general economic conditions, some of the more speculative investments don’t get made. That’s why we’ve seen venture capital activity effectively cut in half in terms of fundraising and early-stage investments. Technology deals in particular are more difficult to get done, as future returns and cash flow can be more speculative.
Businesses that have very stable cash flows will be easier to sell. Those are the sorts of deals that people are more likely looking at under the current conditions. If there is uncertainty around a target businesses’ cash flows, it is now more difficult to get it over the line as accessing finance has become more of a challenge – there’s a greater deal nervousness among financing sources and obviously pricing has moved up dramatically with the overall increase in interest rates.
You mentioned that financing conditions are becoming more challenging under the current climate. Do you think that this will result in ongoing or future deals being structured differently?
It may be more difficult, for instance, to secure high yield financing. The high yield markets are challenged. This would impact larger deals in particular, as those are the ones that tend to require more high yield debt. Acquirers may need to look at less traditional sources of financing as a result.
On the private equity side, investors may need to provide more equity and consider putting in an equity backstop if there’s real concern around the ability to access financing. But that of course has its own risks and has a negative impact on returns for PE sponsors.
On the strategic side, using debt to finance an acquisition program will become more challenging, though probably not as challenging as for PE. Additionally, with the stock market having corrected downward and being as volatile as it’s been, companies may be less willing to use their own stock as an acquisition currency. So, there are some challenges on the strategic side as well.
Do you think that the challenging deal environment you describe will lead to a greater number of distressed deals and turnaround situations within the M&A market?
Likely – we’re starting to see indicators that this will be the case. It’s something that’s on the horizon – if not in the last quarter of 2022 certainly as we move into 2023.
You definitely can see two sides to the market: On the one hand, there are the high-quality assets, where it is easier to get deals done and less execution risk. At the other end of the spectrum, there are distressed assets where acquirers can secure good valuations if they are willing to take on more risk and deal complexity. This is a trend I see happening to a much greater extent in 2023 – we are definitely beginning to see indications of it.
You have mentioned an increase in regulation and its impact on M&A. Over recent years, we have seen a more interventionist approach from antitrust or merger control authorities across a number of jurisdictions. Is this something that in your opinion could discourage deals moving forward?
There is no doubt that the antitrust environment in the US and Europe is particularly challenging right now. Regulators have become quite active and aggressive, discouraging dealmakers from attempting certain deals.
And certainly, as more deals are being reviewed, we’re seeing a greater delay on deals than in previous years. Having said that, if a deal is compelling, there are ways to get it over the line.
Other than antitrust, protectionist regulation surrounding foreign direct investment – in the US, but also in many other countries – is one of the biggest challenges to deals. In many cases this is delaying if not killing deals, and I don’t see any sign of this abating. If anything, the trend is getting stronger.
One topic that we are seeing repeatedly mentioned in dealmaker conversations is ESG. How do you see this affecting M&A?
There’s been a ton of regulatory and activist activity which is influencing public companies’ ESG strategy. I don’t see that slowing down. How much it affects M&A depends on the industry you operate in. If you’re working in the fossil fuels industry, for example, this absolutely will affect M&A activity, in part positively as companies invest more in renewables. But no matter what industry you’re in, you have to conduct due diligence – legal, regulatory and reputation – on ESG-related aspects of the target company.