Improving sentiment in the equity markets could provide a positive indicator for M&A activity in the year ahead. There is already evidence deal volumes are recovering from a first quarter which represented one of the worst periods for dealmaking in decades. How far that recovery continues is likely to depend on financing and private equity fundraising conditions improving later in the year.
Equities market sentiment is one of the stronger indicators that M&A could be set for a recovery in Q2 and beyond.
Boosted by a resolution to the US debt ceiling dispute, equities markets are currently at their most benign since 2021, when stock markets and dealmaking were in full swing.
Europe’s benchmark Stoxx 600 Index is up 8% year-to-date. Performance on that index is usually a signal for dealmaking, potentially pointing to improvements in risk appetite in the year ahead.
Low volatility offers fertile ground
Volatility, as measured by the annualised implied standard deviation on the Stoxx 50 index over the next 30 days, provides further support. The VStoxx 50 gauge is trading at around 16, levels last seen in 2021 and below the 20 threshold at which capital markets transactions like IPOs become easier to execute.
That indicates equity market investors are sanguine on the near-term outlook after a series of shocks that began with Russia’s invasion of Ukraine in February 2022.
Debt yields remain a drag
Debt market pricing looks set to remain a drag on activity, however. Bond yields remain at exceptionally high levels in 2Q23, with weighted average yields approaching 7%. Single B loan yields are nearer to 8%, according to Debtwire data.
Issuers have tapped the bond market at respectable levels in 2023, but have focused on the refinancing of existing debt with higher coupons via amend and extend type deals. These refinancings merely push out the maturity on existing debt in the hope of more favourable financing conditions in the months and years ahead.
Meanwhile, M&A-related issuance has slowed to a crawl with EUR 13bn raised via leveraged loans in the first five months of the year and just EUR 3.3bn via high yield bonds. This equates to a year-on-year decrease of 65%.
Conflicting markets
The combination of easing equity markets and tight credit conditions is an unusual one but there are signs M&A is bouncing back from a low base in Europe. Second-quarter deal volume of EUR 85.8bn through the end of May is not far behind Q1’s total of EUR 93bn.
The quarter’s headline deal was Carrier Global’s [NYSE:CARR] EUR 12bn acquisition of Viessmann Climate Solutions in April, Europe’s first EUR 10bn-plus deal this year.
European M&A, however, remains down more than 60% in the year-to-date. Most of this decline has been driven by smaller average deal sizes rather than a reduction in the number of deals.
More mega-deals like Carrier/Viessmann will be needed to sustain the dealmaking recovery across the remainder of the year.
Private equity’s challenge
Private equity dealmaking is also starting to bounce back after falling in 1Q23 to its lowest aggregate value since the global financial crisis of 2008-9. So far in 2Q23 sponsor-backed dealmaking has reached EUR 16.4bn, more than double the prior quarter.
While financial sponsors see opportunities to deploy capital in the current market, fundraising challenges continue to plague the industry.
Private equity funds have raised EUR 76.4bn to date in 2023, a 9% decrease versus the same period in 2022, according to Unquote Data. Smaller funds are still struggling to reach their targets: half of this total went to three EUR 10bn-plus vehicles, and the number of funds closed in the same period has dropped 42% year-on-year.
General partners (GPs) who raised funds last year and in 2021 will be in a position to deploy capital, albeit selectively, in the current market. Those fundraising now face one of the toughest markets in recent memory, with LPs’ liquidity constraints making it hard to secure commitments.
GPs’ ability to close exits and make realisations for their investors in the coming months will be critical in easing some of the constraints on LPs’ ability to make new commitments brought about by a fall in distributions in 2022.
That means M&A conditions are likely to remain challenging for a while – particularly with credit conditions tight. But equity market conditions provide some encouragement to dealmakers looking to bounce back from a disappointing first quarter.
