Through mid-year 2022, closed middle-market M&A activity has held up well even with volatile public markets, inflation concerns and abundant uncertainty overriding the U.S. economy. The dollar volume of closed M&A deals in the first half of 2022 was off about 15% from 2021’s first half, with the number of closed deals falling about 22% from the first half of last year. Globally, closed M&A deal value was off by 20%, slightly higher than the declines seen in the U.S. middle-market volume data. M&A Deal activity in 2021 was at record levels which makes comparisons to last year challenging. However, it is not the volume declines but the trajectory of the declines that is of concern. We are seeing escalating reductions in closed deal activity each quarter as we proceed through 2022. Providing an offsetting positive element, most investment banking advisors are reporting very robust new business pitch activity in 3Q22 which implies potentially strong late 2022 and 2023 new deal activity. Current M&A deals take longer and have more business issues, so pitch activity may not lead to more closed deals, but at least it provides positive momentum to the market.
The key to our current market dilemma is described in one word, inflation. The rapid post pandemic return to normalized business activity resulted in sudden demand for goods and services while the supply of these goods and services remained low. This led to supply chain issues, labor shortages, more demand for energy and other factors. As a result of the normal laws of supply and demand, prices increased as consumers and businesses competed for the limited supply and bid up the price of everything. The extra stimulus provided by massive government spending bills only made matters worse by adding fuel to the inflation fires. In combination, all these factors contributed to 40-year high rates of inflation that to date have not shown signs of abating. Happy talk, blaming others and wishing inflation away are not viable strategies to fight this issue. The Fed, while late in starting its interest rate hikes, has stepped up and is now single minded in its devotion to reduce inflation. Fed chair Powell and other Fed governors have all indicated that they will continue to aggressively hike interest rates until inflation is under control. Eventually this will work but, not without economic pain along the way.
Interest rates have climbed more than 300 basis points through September and are expected to rise another 150 basis points by year end. Increased interest rates are an added burden on business and consumers but are necessary in these circumstances because it is the only significant Fed tool to combat inflation. Increased interest rates will affect the costs of borrowing and the amount of debt that can be borrowed, both of which will eventually lower valuations of M&A deals. If buyers are limited in the amount of debt they can borrow and that debt costs more, then that will have a negative impact on their price offers. Our preliminary 3Q22 valuation data shows we are beginning to see this happen in the deal market.
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