In 2020 and 2021, record activity levels for transatlantic M&A were reported, which finally came off the boil in Q2 2022. In 2021 alone, M&A transactions from the Americas into EMEA were worth an estimated US$553 billion (the highest value since 2006), while EMEA into Americas M&A was estimated at US$331 billion in aggregate value (the third highest since 2006).
That boom—spurred by the post-COVID-19 economic rebound, fiscal and monetary stimulus, and cheap and abundant debt—came to a shuddering halt in Q2 last year with Russia’s invasion of Ukraine. High energy prices and downstream inflation, rising interest rates, and recessionary fears caused public market volatility last year, valuations coming under pressure as the era of free money drew to a close.
As a result, in the second half of 2022, M&A activity in the Americas overall fell 23% year-on-year by volume, while EMEA M&A saw an 18% decline over the same period. Drilling further into the data, transatlantic deals from the US to Western Europe were down 26% year-on-year by volume, while deals flowing the other way were down by 21% during the same period.
Considerable economic headwinds persist in 2023. There is still geopolitical and economic volatility and uncertainty and, while inflation has shown signs of decelerating, it remains at its highest level in more than 30 years. Interest rates could rise further, and markets continue to digest potential liquidity issues in the banking sector following the bailout of Silicon Valley Bank and UBS’s rescue of Credit Suisse in March.
A fresh perspective
However, a degree of certainty is returning to markets. Supply chain disruption is settling down, for now at least. Interest rates have temporarily stabilized, and central banks may need to issue cuts to maintain confidence in the banking sector. Inflation is predicted to fall sharply in the second half of the year.
Sterling and the euro have slightly strengthened from their lows of September 2022 but still look weak against the US dollar. UK and EU assets therefore look cheap to prospective US buyers. US strategic buyers still want to find new avenues for growth and scale outside their saturated domestic market. Meanwhile, financial sponsors still have record stores of dry powder to deploy.
The valuation gap—an opportunity for US buyers
The valuation gap between US and European listed stock indices is at its largest in decades. Companies in some sectors, such as technology and healthcare, buck this trend and trade on similar multiples on both side of the Atlantic. However, the European consumer discretionary sector has seen the widest discount compared to its US counterpart. The picture is similar for energy companies and financial institutions.
Some analysts argue that this perceived valuation gap is, in fact, only a growth gap—company earnings are rising faster in the US, they say, due to its favorable demographics, generous government subsidies, and the more dynamic and entrepreneurial approach taken by companies in this market.
Regardless, there is no doubt that valuations overall are sharply down from 2021 in Europe across most sectors, the worst hit being consumer discretionary, communications services, and information technology, followed by real estate, financial services, materials, industrials and healthcare. Only the energy sector has increased in value, while consumer staples and utilities are flat. Overall, 2023 is likely to remain a buyers’ market in Europe.
The European landscape
Europe is a compelling hunting ground for US buyers. The combined GDP of the UK, Germany and France alone is approximately US$10.2 trillion, similar to that of California, Texas, Illinois, New York and Florida combined.
There are around 5,000 listed companies in Europe (with approximately 2,000 of those being listed in the UK) and an average company size of US$7.2 billion. By comparison, there are approximately 5,600 listed companies in the US (2,000 on the New York Stock Exchange and 3,600 on the Nasdaq), and an average size of US$10.3 billion. Europe has several major financial centers, including London, Paris, Frankfurt, Amsterdam, Zurich and Stockholm. Of the top 600 companies in Europe, 57% of the capital is already owned by US shareholders.
The UK and Brexit
Despite the challenges Brexit presents, London remains the largest market in Europe for M&A activity and the second highest overall globally after New York. Seventy percent of all non-UK European deals with a value of over US$200 million involve London bankers or lawyers, and 50% of those transactions are run out of London. The UK capital remains the key European hub for US banks and law firms, and approximately 40% of finance workers based in the City of London were not born in the UK.
The growth in UK-based technology companies has surpassed all expectations, and the UK digital economy now exceeds US$1 trillion, making it the third largest globally after the US and China. In 2020-2022, UK-based technology companies attracted more venture capital funding than their counterparts in Germany, France and Sweden combined.
Some complexities arise
As Europe does not have a single, unified legal system, buyers must contend with a complex mixture of domestic and Europe-wide laws, depending on the location of the target, its corporate structure, operations and assets. These are heavily regulated markets and require careful consideration on a country-by-country basis for critical matters such as corporate taxation, issuing securities, antitrust, foreign direct investment, data privacy and ESG-related issues.
Domestic European economies remain under pressure from high inflation, impacting supply chains and employee wage demands. There have been widespread industrial actions and union strikes in parts of Europe over wages, particularly in public sectors such as transport and healthcare. European labor laws and employment rights are, on the whole, far more protective of employees than those in the US, which can make post-closing M&A restructuring and group integration more challenging and costly.
The change in accounting standards due to IFRS 16 presents issues for US buyers of some European companies since (unlike with US GAAP) all leases must now be placed on the balance sheet by recognizing a right-of-use asset and a lease liability, creating a substantial impact on the financial statements of lessees of property and equipment. Corporate synthetic sale-and-leaseback structures can offer a solution to retain the off-balance-sheet status.
For private deals, US buyers will expect to use completion accounts for any post-closing price adjustments, whereas in European deals the use of locked-box structures has also been popular in recent years. US-style purchase agreements are usually more buyer-friendly, with more termination/walk-away rights favoring the buyer before deal closing than are typically offered in an English law governed agreement.
US agreements typically put all the representations and warranties on an indemnity basis, which is not usual for many European deals, in which indemnities tend to be individually negotiated for specific issues. Some continental European jurisdictions also have notarial formalities on execution and delivery of documents. However, the deal landscape and process for private European deals is not unlike a typical US transaction in terms of structure, timing, key documentation and outcomes.
Take-privates
Publicly listed deals are a different matter altogether and need to be carefully coordinated with local advisers to avoid regulatory pitfalls. The relevant rules and regulations will largely be specific to the particular exchange where the target company is listed and the jurisdiction of its incorporation, which in some cases is different.
There were a record number of European take-privates in the first half of 2022, but this number fell off a cliff in the second half of the year due to constraints on financing and uncertainty over borrowing costs, with many deals put on hold. However, sponsors have continued with small and mid-sized add-on M&As to scale up existing assets and this deal volume is likely to increase as financing markets improve.
In the public markets, European shareholders have learned well from their US cousins, with shareholder activism becoming more widespread. This is driving increased scrutiny over companies and their boards in relation to matters such as corporate governance, simplification of corporate structures, M&A strategies and general operational issues. Activists are also a regular feature on public M&A transactions, variously pushing for the company to sell itself and opposing bids that are seen as too low. Some activists are teaming up with financial sponsors, taking matters into their own hands by launching take-privates themselves.
Opportunity for M&A
The valuation gap, strength of the dollar, and vast deal pool will contribute to an uptick in US-to-European M&A activity and we are already seeing signs of this. Healthcare, consumer discretionary and financial services will be popular sectors due to the discounted valuations on offer. The energy transition continues to attract capital to renewable and clean energy solutions and US buyers will participate in this trend.
Particularly following the fallout from Silicon Valley Bank, some European fintechs such as neobanks and open-banking solution providers may need to attract investors or acquirers to gain sufficient scale and stay competitive. There may also be an increased availability of high-yield financing in the market in the second half of 2023, together with reduced interest rate volatility and more predictable valuations and economic conditions, which would all help to unlock deal flow.
However, there will not be an immediate return to 2021 deal levels. Buyers are now focused on profitability over growth. Large cap M&A will continue to face headwinds from weaker debt markets and challenges in leveraging capital. We will likely see more bilateral strategic acquisitions on more balanced negotiated terms. There will likely be fewer rushed auction processes on seller-friendly terms and, on the whole, a slower pace to deals.
An underutilized feature in deal making, which may interest some US buyers, is the opportunity for cross-border corporate mobility in order to migrate the eventual holding company of both the target and buyer groups into a more favorable corporate tax and listing location within the EU. This presents plenty of challenges but can be an attractive outcome to the M&A process.
The competition and future outlook
US buyers won’t have things all their own way. Private market valuations are adjusting, but median valuation multiples by sector are still just above 2020 levels and so any discount is relative. Distressed assets remain relatively few in number and the appetite for quality assets remains strong, albeit finance-constrained at the moment.
Interest from Asian buyers in European assets has generally receded for now, although that may shift again as their economies reopen following the easing of pandemic measures. Sovereign wealth funds remain highly active across Europe, are acquisitive and have deep pockets. Whereas ten years ago most focused on big ticket and high profile assets, many have since diversified their investment teams and portfolios and now pursue deals in a range of different industries and deal sizes, and targets in various lifecycle stages. This will provide competition in the market for prospective US buyers.
Nonetheless, absent further geopolitical or economic shocks, inbound M&A from the US into Europe looks poised for a resurgence. If leveraged finance finally becomes more widely available, allowing for a rise in sponsor-led activity, expect an even fuller recovery as investors capitalize on the strength of the dollar and what continue to be comparatively attractive valuations.