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Global merger and acquistion (M&A) activity plunged to decade low in 2023 with $2.9 trillion in deal value announced, a 17% decline from 2022.1 Activity was subdued through most of the year as dealmakers grappled with higher inflation, rising interest rates, increased regulatory scrutiny and market uncertainty. But there are signs of hope for a revival in 2024.
Private equity buyers saw a notable decline in activity in 2023 after accounting for nearly a quarter of all buyouts in the previous two years as tighter financing conditions and higher interest rates weighed on the ability to complete leverage buyouts.
Commodity and industrial sector companies saw a big pickup in activity as inflation benefited many of these businesses and companies looked to scale their operations to drive improved efficiencies. The energy sector led M&A activity with several mega merger deals announced in the back half of the year with deal activity in the U.S. Permian shale region surpassing $100 billion.
While technology sector M&A declined in 2023 by both deal volume and deal value, two of the largest merger deals of the year, Activision Blizzard Inc’s $69 billion acquisitions by Microsoft Corp. (NSD: MSFT) and VMware Inc’s $61 billion acquisition by Broadcom Inc (NSD: AVGO) closed successfully, and the sector continues to see strategic and financial deals being struck.
The healthcare sector also saw a significant pickup in activity with dozens of biotech and pharmaceutical merger deals announced as the industry’s largest drugmakers face a steep patent cliff over the next decade and are actively seeking to refresh and extend their patent drug portfolios.
Overall 2023 was a challenging year for M&A and merger arbitrage with various headwinds impacting deal activity and deal closings, but with a notable pickup in activity in the fourth quarter there are many reasons to be optimistic on the M&A outlook for 2024.
Merger arbitrage in 2023 saw a decline in deal activity and a more hostile regulatory environment resulting in extended periods to closing, higher deal breaks and fewer bidding wars occurring. Regulators were more hostile and politically motivated, applying novel theories of harm to block deals and expressing unprecedented levels of activism.
Rising geopolitical tensions increased real and perceived deal-risk spanning from the Ukrainian/Russian war, ongoing tensions with China, rising Middle East conflicts, and increased supply chain and energy security in a post pandemic world. While equity valuations recovered by year-end, it was a challenging year for equity markets with U.S. IPO volumes down 15% and U.S. M&A activity down 11%.
Deal negotiations stalled as buyers and sellers were too far apart on valuation and valuations on strategic merger deals hit a 15-year low. The challenging regulatory environment weighed on boardroom confidence curbing demand for larger transformational deals. Even small-cap merger deals were subject to more regulatory scrutiny and geopolitical risk. While these factors impacted M&A and merger arbitrage in 2023, the short duration of the strategy provides investors with the ability to quickly adapt to market conditions and reprice risk to corresponding market factors.
We enter 2024 optimistic about the outlook for M&A and merger arbitrage. On the deal side, indications across the board from investment banks, advisors, and company insiders all suggest that the M&A pipeline is robust.
Rising equity markets have given management and boards the confidence needed to make deals with a growing number of companies in active dialogue. Shareholder activism is also on the rise as frustrated shareholders seek out ways to realize value in stocks trading at deep discounts to intrinsic value. As we head into proxy season, ineffective boards may become targets for replacement and increased shareholder dissent could bring an opportunistic acquirer to the table.
The investment opportunity with merger arbitrage is also attractive with merger arbitrage yields in excess of 10% for average North American merger deals, a material premium to historic levels and a significant spread over high-yield bonds. In a more hostile regulatory environment, arbitrage investors can now benefit from the precedent of actions taken last year, formulating a better understanding of what deals are likely to be targeted by regulators.
After a string of losses by the regulators, arbitrage investors’ resources are also stretched thin, limiting the number of deals they can actively target. With wide spreads, an improved playbook for assessing deal risk, and the potential for more M&A activity to materialize, 2024 could shape up to be a strong year for merger arbitrage performance.
Amar Pandya, CFA, is Portfolio Manager of the Pender Alternative Arbitrage Fund and the Pender Alternative Special Situations Fund at PenderFund Capital Management.
Notes
1. Source: Refinitiv – Deals Intelligence
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