The remarkable boom in M&A transactions that occurred in 2021 — a 2.5x increase in one year — begs the question: will we see in our lifetimes anything like it again? At least far enough in advance to exploit the next wave of enthusiasm? The answer depends on what caused that historic bubble. Analysts are pretty confident they understand those causes.
A Perfect Storm of Six Compelling Causes
Stimulus
Driven by unprecedented government spending and the beginning of the end of lockdowns, the economy began to recover from the COVID-19 pandemic in the latter months of 2020. This, in turn, led to increased market liquidity. And that opened the gates for “animal spirits” to roam the land seeking quick growth opportunities via M&A. (A situation probably not to be repeated any time soon.)
Low Interest Rates
As part of the Fed’s energetic efforts to refloat the economy, it drove interest rates into the basement. (The Prime Rate dropped to 3.25% in March 2020. It’s now 7%.) Cheap debt is catnip to PE acquirers who seek to expose as little of their own cash as safely possible when acquiring targets. (Interest rates rise and fall — we’ll see low rates again.)
Low Valuations
Pandemic fears also initially drove valuations way down, especially for companies trapped in stringent lockdowns like those in California. Then acquirors gradually began to re-emerge after taking Baron Rothchild’s advice, “Buy when there's blood in the streets.”
Even after valuations recovered, strong M&A activity continued, buoyed by rising economic optimism. (Wait for the next recession or depression to reduce valuations, though in the relevant future, they are unlikely to drop to the levels seen in the lockdown’s darkest days.)
Deal Backlog
In a related point, acquirers initially put hundreds of deals on hold till economic optimism returned. When they put them back on active duty, those deals added to the M&A surge. (The scale of the lockdown-driven deal backlog is probably unique in our lifetimes.)
Piles of Dry Powder
By pandemic time, PE firms had accumulated record-high surpluses of "dry powder" (cash committed by investors) that they must deploy profitably before returning the capital. Said another way, cash was burning a hole in their pocket. (A chronic condition of the modern PE industry. Expect growing pressure on PE firms to spend their limited partners’ cash.)
Changed Strategic Buyer M&A Criteria and Rising Deal Efficiency
Many larger strategics used the periods of inactivity imposed by lockdowns to navel gaze and reassess their growth goals. That led to divestitures of non-core assets and acquisitions of businesses that better aligned with their new direction. (We think strategics will become increasingly competitive acquirers of mid-market targets through a combination of: 1) more efficient deal sourcing and processing, and 2) AI forcing wholesale reassessment of corporate strategy.)
Accelerated Tech Adoption
The enforced isolation of lockdowns accelerated the adoption of online communications (teletech), payment processing (fintech), remote diagnosis and prescriptions (medtech), etc. All this demand made tech companies newly attractive targets. (The acceleration of tech industry deal closings continues. See my M&A Factoid #6: Hot Deal-Making Industries.)
Bottom Line
In the next 10 years or so, we think it’s unlikely we’ll see a repeat of 2021’s astonishing M&A boom. However, we do believe we’ll see falling interest rates, rising “animal spirits,” more pressure on PE firms to spend their dry powder, and rising acquisition activity from strategics. For mid-market sellers, the future may not be blinding, but it’s certainly bright.