Cleary Gottlieb | UK public M&A outlook

2022 was a significantly more subdued year in global public bid markets than 2021, with aggregate deal volumes in the first three quarters of 2022 falling by approximately 70% by some measures.

For the UK public bid market, 2022 was also a more subdued year than 2021. In particular, average deal value shrank materially compared to 2021. However, at least by deal volume (number of firm bids), the UK bid market held up reasonably well in 2022 notwithstanding a very challenging backdrop – the number of firm bids fell by approximately 15% compared to 2021.

The leveraged finance market for UK bids softened materially – in 2022, the number of bids financed wholly or partly by debt fell by approx.. one third compared to 2021.

PE bids fell by approximately 20% compared to 2021 but PE bidders continued to make up a significant proportion of bidders despite challenges in obtaining bid finance. There were also some notable larger deals in 2022, including Schneider Electric’s £9.5bn recommended offer bid for AVEVA Group.

Headwinds

Notwithstanding reasonable activity levels, it is evident that the UK public bid market continues to face a number of headwinds, many of which are well know and have been discussed in our previous writings.

These headwinds include high inflation and the consequences of central bank action, including rising interest rates and quantitative tightening.

Other headwinds also include macroeconomic instability, strikes and potential recession in the UK, geopolitical risk in Europe, and general regulatory uncertainty, including increasingly interventionalist competition regulators and significantly enhanced national security laws.

The traditional leveraged finance market for public bids also appears to be now largely closed. Even direct lending funds, which were taking up some of slack when traditional lenders dropped out of the market earlier in 2022, are becoming less active.

In addition, it appears that a number of deal participants are intending to sit on the side-lines for the time being and to wait until asset prices have fallen further before re-engaging.

Headwinds

These headwinds include high inflation and the consequences of central bank action, including rising interest rates and quantitative tightening.

In addition, it appears that a number of deal participants are intending to sit on the side-lines for the time being and to wait until asset prices have fallen further before re-engaging.

Countervailing Forces to the Headwinds

On the other hand, as we have discussed in our previous writings, there have been some other countervailing factors which may explain why the UK public bid market has held up relatively well compared to other major markets.

Firstly, the UK stock market remains materially cheaper than many other developed stock markets and the pound has fallen significantly in 2022, particularly against the US dollar.

Secondly, PE bidders continue to have significant dry powder, and continue to be reasonably active in the UK market.

Thirdly, strategic bid activity in the UK remains relatively muted. There could be interesting opportunities for strategic bidders with strong balance sheets in the UK market, which could materially lift bid activity.

Fourthly, the UK market is made up of significant proportion of energy, mining, and financial services companies. These companies may be able to benefit from a high interest rate and inflationary environment and may attract interest from bidders in the medium term.

Challenging Environment for UK Targets

This environment remains a very challenging one for UK targets, many of whom feel their (depressed) share prices do not reflect their prospects. In particular, boards of potential UK targets will be concerned to ensure that they can control their fate and not be forced into an unattractive bid by opportunist bidders at an inopportune time. Boards of target companies will also be wary of the reaction of restive long term shareholders and shareholder activists, who are increasingly willing to challenge bid prices in the UK market as we have covered in our previous writings. In particular, there have been a number of instances of target shareholders having concerns about the bid processes adopted by target boards, and we believe that this will continue to be an area of heightened focus for UK target boards over the new few years.

What Is in store for 2023?

Predictions about the future are always difficult and fraught.

However, we would not be surprised to see in 2023:

A continued reasonably robust UK bid market and in particular, reasonably robust PE bid levels;

An increase in activity from foreign bidders, particularly from North American bidders;

An increase in activity from well capitalised strategic bidders; and

Continued robust interest in FTSE 250 targets, which have accounted for a significant proportion of bids over the last few years in the UK. In share price terms, the FTSE 250 has significantly underperformed vis-à-vis the FTSE 100 in 2022, and bidders may now find a number of attractively priced targets in the FTSE 250.