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Dealmakers Look Forward to an Active but Slightly Cooler Market in 2022
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Dealmakers Look Forward to an
Active but Slightly Cooler Market in 2022
WRITTEN BY ANASTASIA DONDE | ILLUSTRATED BY EVA VÁZQUEZ
Some of the factors driving heightened activity and rising valuations in 2021 will continue into 2022, but M&A practitioners expect less of a dealmaking frenzy in the new year.
Winding down from a frantically
busy year of M&A transactions, investment professionals are looking ahead to another active market, even if it’s not expected to be quite as busy. According to a recent survey of ACG members sponsored by S&P Global, 80% of respondents said their outlook on M&A activity for 2022 remains positive.1
“I’m positive on dealmaking, but I don’t think it’ll be gangbusters like it was in 2021,” says Art Penn, founder of direct lending firm PennantPark. The backlog of deals that didn’t launch in 2020, coupled with expected changes to tax rates and attractive valuations, were some of the factors for unprecedented activity in 2021.
The volume of U.S. middle-market buyouts from January through November 2021 came to $714.8 billion, eclipsing 2020’s year-end total of $613 billion, according to Pitchbook. Prepandemic total deal volume amounted to $699 billion in 2019.
“It will be busy in 2022, but not as busy as it was this year, which is good, because everyone is exhausted,” Penn adds, explaining that private equity firms and lenders, as well as their lawyers, accountants and other service providers, have been stretched thin.
“2021 was fueled by the fact that the world shut down for a long time. The market didn’t start picking back up until August or September of 2020, so there was a lot of pent-up demand,” says Lauren Boglivi, partner and co-chair of Proskauer’s M&A and Private Equity Group. “2022 will still be busy but probably less so. I don’t think you can keep up that level of demand.”
Some of the elements that drove a particularly busy year in 2021 will still be around in 2022, but will be less pronounced. For example, a record amount of dry powder will still be present, but the fear of changes to the capital gains tax rate is dissipating, which will likely lead to a less frenzied dealmaking pace.
Thirty-six percent of survey respondents said that deal flow quality and quantity was the primary variable that influenced their positive outlook on M&A. Dry powder and credit market conditions came in second at 22%, while valuations and seller
Lauren Boglivi
Which industries do you expect to focus on in 2022?
50
47%
40
30
20
27% 33%
10
38% 37%
0
Businessservices Consumer productsand services Healthcare & pharmaceuticals Manufacturing Technology
*Industries shown are the top five that scored the highest. The question had 29 other options, where respondents could choose multiple answers. Source: Survey of ACG members
expectations were in third place at nearly 17%.
Dealmakers and advisors say that the number of auctions and new deals hitting the market peaked in late summer 2021 and industry practitioners spent the rest of the year working on closing them. David Clark, head of financial sponsors at Raymond James, was telling most of his clients to prepare for exits in 2022 rather than try to fit them in during the fall or winter. There was too much of a backlog of work that needed to be done to close existing deals.
“Our recommendation to sellers was: Don’t try to bring something to market now, people are busy trying to get deals closed by the end of the year,” Clark says. He’s recommending that his sponsor clients prep marketing materials and quality of earnings and plan to launch processes in the first or second quarter of 2022.
Sash Rentala, head of the financial sponsors group at Solomon Partners, agrees: “Deal volume peaked in August. Post-Labor Day, we’ve focused on closings.”
Some market participants expect a busy dealmaking environment to be the new norm, even if it slows a bit from 2021. “We’re in an environment where activity will remain busy on a near-perpetual level,” says Andrew Olinick, co-head of North America Private Equity at Londonheadquartered 3i.
Excess dry powder, more companies in line to be sold and sellers looking at high valuations garnered by competitors all continue to be motivating factors for a strong pipeline.
“There was a lot of pent-up demand in 2021, both for buyers and for sellers. The expectation of the capital gains tax changes might have artificially inflated volume in 2021,” says Michael Ewald, global head of private credit at Bain Capital Credit.
Despite the fear of changes to the capital gains tax, which drove some dealmakers to hurry toward exits, the
What is your outlook for M&A in 2022?
What is the key catalyst or variable that most influences your outlook?
Positive 80%
Neutral 18%
Negative 2%
Consumer trust and economic recovery
Potential tax policy changes
Dry powder and credit market conditions
Deal flow quality and quantity
Valuations and seller expectations
COVID-19
2% 10%
14%
22%
16% 36%
rate now looks less likely to change at all. If it does, the hike is expected to be minimal.
Market players are now watching another potential change: the likely rise of interest rates that will impact the cost of debt for leveraged buyouts. Federal Reserve officials said in November that interest rates will likely rise before the end of 2022. A rate hike will mean that lenders won’t be able to offer as much leverage on deals, which could directionally impact valuations. Private equity sponsors will then have to lower their purchase prices or put up more equity.
“Our expectation is that next year, demand for M&A will remain high, growth will slow down a bit, rates will go up a little and that will solve the inflation problem to an extent,” says Olinick.
VALUATION TRAJECTORY
Despite the busy dealmaking pace, high valuations have continued to make it difficult to compete. However, 56% of survey respondents think high valuations are a short-term phenomenon, while 44% said that high valuations will remain for an extended period. Beyond the potential for rising interest rates, market players say that valuations are expected to at least level off in 2022. Many of the top tier businesses coming out of the pandemic have already been sold.
“Some of the better companies have transacted already. I think the market will cool off a little bit and valuations will come down,” says Clark.
Sectors also impact valuations. Sectors such as technology will continue to garner high multiples, while others like manufacturing, industrials and consumer tend to fetch lower valuations. More of the latter type of businesses are expected to come to market next year.
“There are a lot of high-quality companies that had minimal impact from COVID that came out in late 2020 and early 2021 and were able to attract very high multiples,” Clark says. “Midway through 2021, more COVID-impacted companies came out, and there were more EBITDA adjustments. It’s harder for buyers to get comfortable around those.”
Still, sellers will remain aggressive. “The way businesses are being sold is changing,” Olinick says. “There are a lot of preemptive approaches and narrow processes. The market has gotten much more focused but hasn’t compromised valuations.” He also expects valuations to level out a bit when interest rates rise.
The good news is lenders have been disciplined through the frenzy and are prepared for a busy but more subdued 2022. “Some lenders have gotten fast and loose with pricing and terms but not necessarily on leverage multiples. While purchase prices have gone up, the leverage hasn’t followed as much, which is encouraging to see,” says Ewald.
