2021 M&A Market Outlook

January 2nd, 2021

The year 2020 will always be remembered for its challenges and dynamic nature. As of December 31st, 2020, there were 83.2 million global cases and 1.81 million global deaths from the coronavirus.¹ The virus has had unfortunate health and economic impacts on society at large. However, vaccines from Pfizer/BioNTech and Moderna have provided optimism for 2021. 

The hopefulness regarding the reopening of the economy is giving confidence to individuals, governments, businesses, and investors. With many elements at play, 2021 has the potential to be a substantial year for M&A activity. Some factors supporting the potential growth include new economic policies from the Biden administration, the timing for entrepreneurs, a favourable valuation environment, record levels of dry powder, a low for long rate environment, and growing funding options with the increased usage of special purpose acquisition companies (SPACs).

Firstly, many investors are weighing geopolitical factors and the impacts of the new Biden administration in their investment decisions. Recently, the UK and the EU signed a fair-trade deal that allows for tariff and quota-free trade. We may see increased deal flow now that Britain has more economic certainty. The UK is governed by common law, and private company M&A activity has historically been covered by English contract law. Thus, the regular M&A process will not change due to Brexit.³ Further, The EU and China have also recently announced a deal for an investment treaty. This deal helps European businesses, as it removes barriers such as joint-venture (JV) requirements and caps on foreign equity for EU companies that invest in China. For China, they get enhanced access to manufacturing and renewable energy.⁴ On top of the changes in Europe and Asia, the United States will see developments in its policies with the new Biden administration. It is expected that the administration will increase capital gains tax, however, this change is not expected to occur immediately. Biden's tax plan shows that capital gains tax rates will rise from 20% to 39.6% on investment profits over $1 million.⁵ A critical element that can affect deal policies is the control of the US senate. The race in Georgia will be watched closely as there will be two runoffs on January 5th to see if the Democrats can gain two additional seats, would which give them a 50-50 split and control of the senate. As of December 31st, 2020, the Republicans held a 50 to 48 lead over the Democrats.⁶ The outcome of the Georgia runoff will determine control over the senate and ultimately foreshadow the Democrats power during Bidens term.

For entrepreneurs creativity was essential for survival in 2020. Many had to adjust their business models, accommodate COVID-19 restrictions, and pivot their operations. Some business owners have become fatigued and might be tired of adjusting their operations. Additionally, technology continues to disrupt business operations. Operators have had to consider technology transformations to accommodate remote work, enhance efficiency, keep up with competitors, cut costs, and update cybersecurity. A pre-crisis survey from EY found that 60% of Canadian respondents and 72% of global respondents said that they "were undergoing a significant business and technology transformation program".⁷ Entrepreneurs and operators recognize that there is pressure on them to consistently reinvent themselves, adapt and update their operations. These pressures are causing many businesses to consider selling to investors with greater resources.

The M&A market saw volatility in deals and deal values in 2020. The second quarter saw a slowdown in deal volume. In Q3 the market saw a QoQ increase of 33% in deal volume and a 140% increase in deal value.⁵ In North America there were 2,714 deals worth $361.1 billion in Q3, this represents QoQ gains of 23.5% and 7.0% respectively.

One comparison using cyclically adjusted price/earnings (CAPE) shows that the adjusted P/E today is 31.1 based on the S&P 500 price of 3,327 on August 5^th. The CAPE only reached this level three other times in history. The first time was in August 1929 during the great depression, followed by June 1997 before the tech bubble, and the third time was in November 2017. Overall, a CAPE of 31.1 is remarkably high and shows that investors are willing to pay a lot for each dollar of earnings.¹⁰

In 2020, it was an excellent year to go public as more than $167.2B dollars were raised in 454 offerings through December 24^th.¹⁷ Companies make the decision to go public based on several factors. An important variable to the IPO decision is timing. Companies want to go public when they can get the best valuation. Based on a sample of five significant IPOs in 2020, I found that the median LTM EV/Sales multiple was 26.7x and the median NTM EV/Sales multiple was 21.7x. Right now, investors are willing to pay a high amount for companies’ sales and earnings.

Valuations are especially high for businesses that are considered "essential", as those that could remain open and withstand the pandemic saw prices jump 20%, this comes as there is a high demand for pandemic-proof businesses.⁸

Globally, Q3 saw strong increases in deal activity as there was over $1 trillion worth of transactions announced. However, there are still 21% less M&A deals in the first nine months of 2020 compared to 2019.¹⁴ In Canada, there were $40.9 billion worth of M&A deals announced in Q3, this is up 200% from Q2 but down 19.3% from the $50.7 billion of M&A activity from Q3 2019. There was major consolidation in one of Canada’s biggest industries as the oil & gas (O&G) sector felt the impacts of COVID-19. The headline deal was Cenovus Energy’s $3.8 billion acquisition of Husky Energy.¹³ This deal could be a sign of things to come, as the O&G sector has been greatly impacted by the coronavirus and demands to reduce carbon emissions. It was found that Energy M&A fell to historic lows in H1 2020, which was then followed by US$900 million in new upstream deals in Q3.¹³ Looking into 2021, it was found that business leaders are looking to increase M&A activity. As PwC found that 53% of US executives said their companies plan to increase M&A investment in 2021.¹¹ Lastly, in an EY survey of Canadian companies it was found that 46% of respondents were planning bolt-on acquisitions in 2021. However, to stay competitive companies must be creative and seek acquisitions that help them diversify and utilize their assets in this dynamic business environment.

Lastly, other trends and factors to consider in 2021 are ESG and inclusion and diversity. In 2020, we saw a great number of companies come out to set ESG targets. ESG is now being viewed as an essential element of a business that can drive long-term success and value creation. Part of these initiatives includes an enhanced focus on inclusion and diversity. As more than 50% of executives in PwC’s November survey said they plan to increase diversity and inclusion training for employees, and nearly 60% of consumers said that a company’s purpose or values play an important role in purchasing decisions.¹¹ This is important for deals because as investors conduct due diligence, they will be considering the construction of the management team, board of directors, brand image, and commitments to ESG.

At the end of June, the buyout industry had $1.45 trillion of dry powder. ¹⁵ This record level of capital is ready to be deployed and can also help fuel deal activity in 2021. Further, banks have record levels of cash that can be used for acquisitions. Specifically, Canada’s big banks have C$70 billion of cash available above their minimum regulatory requirements.¹⁶ Analysts expect that Canada's Office of the Superintendent of Financial Institutions (OSFI) will remove restrictions for share buybacks and dividend increases in mid-to late-2021. Once the restrictions are lifted, many hope that Canadian banks will allocate capital toward long-term growth with M&A, rather than dividends.

The low-interest-rate environment is also a driving factor that will fuel deal growth in 2021. Forward guidance from central banks shows investors that there will be a low-rate environment for the foreseeable future. In the US it was announced that interest rates will stay near zero during the Federal Reserve’s (FED) December meeting. The Federal Open Market Committee (FOMC) will work to remain accommodative to meet their goals of maximum employment and long-run inflation of 2 per cent. The FED also announced that they will increase purchases of treasury securities by $80 billion per month and mortgage-backed securities by at least $40 billion per month.¹⁹ In Canada, Tiff Macklem the Bank of Canada (BoC) Governor announced that “borrowing rates will remain at historic lows for the foreseeable future”.²⁰ This accommodative monetary and forward guidance will drive deal volume and gives investors more confidence about deal assumptions.

Another factor that is driving deal volume is the increased usage for special-purpose acquisition companies (SPACs). The growing number of SPACs help support fundraising as there are now more alternatives to raise capital. In 2020, a dramatic increase was seen for these blank-cheque companies. In 2020, there was $83.02 billion raised via SPACs, this compared with the $13.6 billion in 2019.²¹ In 2021, these investment vehicles will continue to grow as Pitchbook predicts that in 2021, there will be at least 20 private equity-backed companies that go public using a SPAC. Reverse mergers will continue to grow as more investors become comfortable with the acquisition vehicle. It is also important to remember that these SPACs usually have two years to complete a transaction before they must return capital to the investors. This is important because it means that the over 200 SPACs launched this year will be completing deals in the near future which will drive deal volume.²²

In 2021, we will see both proactive and reactive acquisitions. The proactive deals will be investors that are taking advantage of struggling businesses, while reactive acquisitions will be those that are looking to stay alive and stay relevant with these new circumstances. The uncertainty regarding fiscal policy with potential changes in capital gains tax rates, instability for entrepreneurs, favourable valuation environment, supportive monetary policy, record levels of dry powder, and increased SPAC activity are all factors that will help drive M&A growth in 2021. Expect to see investors completing more deals that strengthen and diversify their business models as they seek to remain agile and navigate through the pandemic. Overall, in 2021 M&A activity is expected to grow, and will be driven by reduced risk, increased certainty, enhanced sentiment, low-interest rates, record dry powder, and greater access to capital.

 References

1 John Hopkins University. Coronavirus Resource Centre. December 31st, 2020. Source. Accessed December 31st, 2020. 

2 Financial Times. UK and EU agree historic Brexit trade deal. George Parker, Peter Foster, Jim Brunsden. December 24th, 2020. Source. Accessed December 31st, 2020. 

3 Napthens solicitors. Impact of Brexit on Mergers and Acquisitions. N.d. Source. Accessed December 31st, 2020. 

4 Financial Times. EU and China agree new investment treaty. Jim Brunsden, Mehreen Khan, Michael Peel. December 20th, 2020. Source. Accessed December 31st, 2020. 

5 Forbes. M&A May Boom In 2021—Here’s Why. David W. McCombie. November 16^th, 2020. Source. Accessed December 30^th, 2020. 

6 CNN Politics. Senate Results. December 31^st, 2020. Source. Accessed December 31^st, 2020.

7 EY. 2020 Canada M&A report. Doug Jenkinson. June 12^th, 2020. Source. Accessed December 31^st, 2020.

8 BizBuySell. BizBuySell Insight Report. N.d. Source. Accessed December 30^th, 2020.

9 Duff & Phelps. Canadian M&A Insights. Summer 2020. Source. Accessed December 30^th, 2020.

10 Fortune. Stock valuations have been this high only three times in history. What happened next should give investors pause. August 6^th, 2020. Source. Accessed December 30^th, 2020.

11 PwC. 2021 outlook: M&A leads the economic recovery. Colin Wittmer, John Potter, James Marshall. N.d. Source. Accessed December 30^th, 2020.

 

12 Pitchbook. North American M&A Report. Stephen-George Davis. Q3 2020. Source. Accessed December 30^th, 2020.

 

13 Yahoo! Finance. What Canadian politeness means for M&A in the oil patch. Jeff Lagerquist. November 16^th, 2020. Source. Accessed December 30^th, 2020.

 

14 Reuters. M&A spikes in record third quarter as boards go on pandemic deal spree. Pamela Barbaglia, Joshua Franklin. September 30^th, 2020. Source. Accessed December 30^th, 2020.

 

15 The Wall Street Journal. Private Equity’s Trillion-Dollar Piggy Bank Holds Little for Struggling Companies. Chris Cumming. June 28^th, 2020. Source. Accessed December 30^th, 2020.

 

16 Reuters. Investors prefer Canadian banks to put record excess capital into M&A over share buybacks. Nichola Saminather. December 23^rd, 2020. Source. Accessed December 30^th, 2020.

 

17 Stock Analysis. IPO Statistics. December 24^th, 2020. Source. Accessed December 30^th, 2020.

 

18 Pitchbook. US PE Middle Market Report. Dylan Cox, Wylie Fernyhough. Q3 2020. Source. Accessed December 30^th, 2020.

 

19 Federal Reserve. Federal Reserve issues FOMC statement. December 16, 2020. Source. Accessed December 30^th, 2020.

 

20 BNN Bloomberg. 'Interest rates will be low for a long time': Macklem. July 15^th, 2020. Source. Accessed December 30^th, 2020.

 

21 SPACInsider. SPAC Statistics. N.d. Source. Accessed December 30^th, 2020.

 

22 Pitchbook. Pitchbook 2021 US Private Equity Outlook. Dylan Cox, Wylie Fernyhough, Andrew Akers, Mara Potter. December 15^th, 2020. Source. Accessed December 30^th, 2020.