Mid-Year Deals Update: From a Boil to a Steady Simmer

By: PJ Patel

(Estimated reading time: 2 minutes)

After a record-shattering year for mergers & acquisitions—according to Refinitiv, 2021’s $5.8 trillion in deals was up 64% from the previous year—the blistering pace of M&A appeared to slow slightly in the first half of 2022. Even as the post-pandemic pent-up demand for dealmaking continues to work itself out and some U.S. market participants look to transact before anticipated changes to the tax code, buyers and sellers are considering the impact of a number of exogenous factors—the Russia/Ukraine conflict, a cooling off of SPAC activity, a sharp uptick in inflation, and tight labor markets.

Another metric to track because it can drive the outlook for M&A is the price of risk in equity markets. NYU Prof. Aswath Damodaran calculates that the implied equity risk premium had firmed to 5.14% in May 2022. The ERP continues to rise from its recent low point of 4.07% in May 2021.

Despite all of this, private equity continues to have much dry powder at its disposal, and good companies continue to attract strong multiples. That said, the market is responding to what many strategic and financial buyers perceive to be flashing yellow lights by proceeding with a bit more caution. Despite the cautionary signals, the high multiples that characterized 2021 carried through into 2022. Middle market multiples hit 14.6x EBITDA in the year’s first quarter, a new recent peak.

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In addition to the evolving deal environment, a host of regulatory, accounting, and tax initiatives can be expected to have a big impact on M&A and M&A-related valuation for the rest of the year and beyond.

On June 15, 2022, the FASB announced that it is moving its goodwill and intangibles project from the technical agenda to the research agenda, effectively terminating its plan to amortize goodwill. The FASB may revisit this issue later, possibly conforming its approach with its international standards-setting counterpart.

The FASB has embarked on a research project to explore accounting for internally-generated intangibles, including trademarks, brand names, and patents.

In addition to accounting changes, two regulatory issues continue raising questions among private fund clients. Funds have been scrambling to adopt best practices laid out by the SEC in its Rule 2a-5 under the ’40 Act, which establishes requirements for fund boards regarding determining fair value. In addition, the SEC recently proposed more new rules under the ’40 Act that call for a fairness opinion when assets are being transferred between funds. The biggest practical implication is for so-called continuation funds, where one or more assets are transferred from a fund that is winding down to a new fund that often includes some of the LPs from the original fund along with new investors in the continuation vehicle.

Changes to international tax regimes can also be expected to shape M&A for the year’s balance. The OECD’s efforts to harmonize global tax rates for large companies with international operations—the base erosion and profit shifting (BEPS) initiative—is moving ahead quickly, and multinational enterprises can be expected to react, reorganizing to optimize tax exposure and potentially shedding certain assets that don’t fit in. One upshot of the optimization movement: A number of U.S. companies have been repatriating some of their intellectual property to the U.S. while moving all of their non-U.S. IP into a single holding company.

For a more in-depth conversation on these or other topics related to the deal or regulatory environment, we welcome you to contact a member of your VRC Team or PJ Patel at ppatel@valuationresearch.com