Besides the stock market, mergers and acquisitions are probably the first victims of any crisis, especially when that crisis involves inflation and interest rate hikes. In this brief analysis, we’ll look at how the global M&A market performed thus far in 2022.
The mergers and acquisitions market has had its all-time high in 2021. After the pandemic ridden 2020, during which the global M&A amounted to USD 3.6tn (a decrease of 10% compared to 2019), 2021 marked such a high point that it surpassed all previous years, and by a strong margin. In total, USD 6.1tn went into M&A in 2021, which if we were to put things into perspective, would mean that you could buy approximately 90 Croatian 2021 GDPs at that time. Simply massive amounts.
Even though in 2022, there were also staggeringly large transactions already announced, such as Broadcom’s acquisition of VMware (priced at USD 70.4bn), Microsoft’s acquisition of Activision Blizzard (USD 67.9bn), and the largest acquisition in Europe in 2022, of Atlantia SpA for EUR 41.6bn, by a consortium led by Edizione SpA, these transactions, as with many others, were announced back in the first half of the year. Even the now infamous Twitter deal by Elon Musk, currently valued at USD 36.7bn, was announced back in April 2022. The trend, however, has not been positive for the remainder of the year, and as we can see in the graph below, the deal amount slowed down significantly.
Global M&A deal value (Q1 2015 – Q3 2022, USDbn)
As we can see in the graph, the total value of M&A during the 9M 2022 amounted to USD 3.02tn. This is a decline of 34% compared to the same period in 2021. Looking at the quarterly changes, the trend is even more evident. In Q3 2022, the global M&A deal value amounted to USD 722bn, which represents a decrease of 55% YoY.
So having all of this in mind, what is going on here? To answer this question, we should also take a look at the geographic and industry distribution of these deals, as only then can the whole story be taken in context. This is because for North America (of which the US makes up the vast majority) and Europe, the causes are similar but there are some differences.
According to Mergemarket, the distribution by region is the following: 38% of all deals were done in the North American region, 29% in the European region, and 13% in the North Asian region, making up 80% of the market. 5% goes to India, 4% to Australasia, and 4% to Latin America, meaning that 93% of the global M&A is concentrated in those regions. All of this data is available in the pie chart below:
Global M&A value by region in Q3 2022, %
Furthermore, taking a look at the distribution of M&A deal value by sector, we get the following:
Global M&A value by sector in Q3 2022, %
As expected, the largest M&A is in the technology sector at 20%, 11% is in utilities and energy, 9% is in healthcare, 8% is in the telecom industry, and 6% is in oil & gas, consumer products, and real estate/property, respectively.
Having this in mind, we can explain the factors leading to the decline. Firstly, let’s start with the largest region, North America. In 9M 2022, North America’s M&A amounted to USD 1.3tn, which is 43% down in value compared to the same period in 2021. In Q3 2022, deals amounted to USD 273bn only, which is a decrease of 63% compared to the same quarter last year. In fact, in September alone, only 488 deals were signed, worth USD 107bn. The largest of these include Adobe’s USD 20bn acquisition of Figma and the USD 13.8bn acquisition of STORE Capital by GIC and Oak Street Real Estate Capital. The main reason for this decline is of course the high inflation rates in the US, which amounted to 8.2% in September 2022. It isn’t only the inflation that is the problem however, it is stubborn and persistent inflation that continues month over month. Even if it’s slightly decreasing or growing, it’s still way above the Fed’s target of 2%. This brings us to the 2nd reason, and that is the interest rates in the US. Currently, Fed funds target rate stands between 3 – 3.25% and is expected to increase to over 4% in 2023. Higher interest means two things: Debt is more expensive, and exports are more expensive. Combined with the negative sentiment on the market, the companies are focused more on maintaining their current margins and reducing costs.
Despite this, however, according to Mergemarket, bankers they’ve interviewed say that firms are still willing to transact despite the inflation, higher interest rates, and the increased likelihood of a downturn. The only issue for them is settling on the price. In terms of the value by sector, technology contributed to 40% of overall M&A in North America in 9M 2022, but this was skewed by Microsoft’s Activision Blizzard deal, and VMware’s sale to Broadcom, as well as Elon Musk’s Twitter buyout. Healthcare was the 2nd most active sector with 228 deals worth USD 39.4bn, led by Pfizer’s USD 5.3bn acquisition of Global Blood Therapeutics, ChemoCentry’s USD 4.5bn acquisition of Amgen, and Amazon’s USD 3.7bn purchase of 1Life Healthcare. So despite the slowdown in M&A, the current environment also presents an opportunity for further consolidation.
Taking a quick glance at the EMEA (Europe Middle East Africa) region, the M&A activity amounted to USD 227.4bn in Q3 2022, its lowest quarterly value since Q3 2020, when economies were only just starting to recover from the pandemic. In fact, this represents a decline of 35.6% compared to Q2 2022. In total, EMEA had 10,029 deals this year worth a combined USD 861.7bn, which is a 21% decrease in value against the same period last year. The M&A market is facing a lot of macroeconomic issues in this region. First of all, the primary debt market is almost at a standstill, with the M&A increasingly dependent on direct lending. The difficulties with financing, combined with the challenges surrounding inflation and valuation expectations have created a perfect storm leading to an inevitable collapse in M&As. Because of this, deal makers are likely to focus on continued corporate divestments and private equity in order to sustain faltering M&A activity, while currency fluctuations could also trigger a rush in foreign interest. Given that the macroeconomic situation is not likely to improve anytime soon in Europe, the prospects for the M&A market are also not so bright, and as such, 2022 could end up being at or below 2020’s level overall.
According to the latest government regulation of fuel prices for oil derivatives, price caps were put for petrol standing at HRK 10.72 and diesel standing at HRK 12.3. Premium fuel prices remain market-driven. If the interventions were not put in motion, petrol prices would amount to HRK 13.02 and diesel to HRK 15.61. Petrol warns this model is unsustainable.
For the past week, Petrol was again under influence of the Croatian government’s cap on fuel prices for oil derivatives. Petrol warns this model is unsustainable. Price caps were put for petrol standing at HRK 10.72 and diesel standing at HRK 12.3. Premium fuel prices remain market-driven. If the interventions were not put in motion, petrol prices would amount to HRK 13.02 and diesel to HRK 15.61.
Government intervention and capping of fuel prices on all Petrol markets made the company operate with negative net income in 1H 2022. Since the Russian invasion of Ukraine took a toll on oil prices, governments started to regulate retail fuel prices. In turn, Petrol has experienced losses as a cap on prices was put below their input prices for certain time periods.
Regulation of electricity and gas prices from September in Slovenia and Croatia are to put further strain on profit. In times of strong inflation, governments have fixed prices for gas and electricity.
Further, Petrol’s subsidiary, Geoplin, which is three-quarters owned by Petrol and state-owned with the remaining part, is currently under a magnifying glass due to the regulation of the prices of gas imposed by the government. From September the regulation imposed by the Slovenian government requires suppliers to sell gas prices at maximum of EUR 0.073 per kWh for households and at EUR 0.073 per kWh for small entrepreneurs. There was recent media information that Petrol’s subsidiary, Geoplin, might need additional capital and liquidity, which you can read here. The calculated loss of c. EUR 100m in this year for two months of gas procured was according to media calculated at price of EUR 200 per MWh. On the other hand, the gas prices stabilized during October and 1M forward price when we look at Dutch TTF stands at EUR 116 MWh. On October 20, a meeting of the shareholders of Geoplin has been held, where all these important decisions were discussed and more information should be available soon.
Gas prices in Europe in MWh
Source: Bloomberg, InterCapital research
On Friday, Moody’s Investors Service affirmed the long-term issuer and senior unsecured bond ratings of Slovenia at A3, while at the same time, maintaining a stable outlook.
The affirmation of Slovenia’s A3 ratings is based on the following key drivers:
- Public finances challenged by the energy crisis and medium-term demographic outlook
- Slovenia’s relative economic resilience to shocks, as reflected in a switch recovery from the pandemic and solid medium-term growth prospects.
Furthermore, Moody’s says that the stable outlook balances Slovenia’s robust economic resilience and solid policy capability as well as favourable debt affordability, with a higher than peers debt burden and the significant challenges posed by the energy crisis and a rapidly ageing population. Moreover, the stable outlook reflects Moody’s expectations that Slovenia’s economic and fiscal metrics will perform in line with similarly rated peers. Also, Moody’s view is that the pension reform is unlikely to make significant progress in the next 12 to 18 months, which poses a credit constraint.
Slovenia’s long-term local and foreign-currency bond country ceilings remain unchanged at Aaa. For euro area countries, a six-notch gap between the local currency ceiling and the local currency rating as well as a zero-notch gap between the local currency ceiling and foreign currency ceiling is typical, reflecting benefits from the euro area’s strong common institutional, legal and regulatory framework, as well as liquidity support and other crisis management mechanisms.
The first driver of the rating affirmation is based on the challenges Slovenia’s public finances face in light of the energy crisis and the adverse medium-term demographic outlook. In 2021, the decline in the debt burden to 74.5% of the GDP from 79.6% in 2020 reflected a reduction in the deficit, as revenues accelerated and pandemic-related expenditures receded. Debt affordability continued to improve in both years, with a decline in the cost of issuance despite higher borrowing needs as the ECB’s very accommodative monetary policy supported euro-area sovereigns. As a result, the interest payments-to-revenue ratio reached 3.7% and 2.8% in 2020 and 2021, respectively. However, Slovenia’s fiscal metrics compare unfavourably to the A3 median due to the country’s higher debt burden, while debt affordability is in line.
Looking ahead, Moody’s forecasts Slovenia’s general government deficit to reach 3.8% of GDP in 2022, 5.6% of GDP in 2023 and 3.5% of GDP in 2024. Revenue growth should remain dynamic, benefitting in the short term from higher inflation. On the spending side, phasing out of pandemic-related support measures is expected to take off 3% of GDP of public spending in 2022 compared to 2021. As a result, Moody’s expects Slovenia’s debt-to-GDP ratio to reach 70.6% in 2022 and 71.2% in 2023.
However, Moody’s believes that risks to the fiscal projection are to the downside considering the elevated uncertainty and the government’s policy response to smooth the impact of the conflict in Ukraine through energy prices on consumers and businesses. The govt. estimates the direct fiscal cost to reach EUR 1.8bn (2.9% of GDP) in 2023. Additionally, the authorities have put forward guarantees and liquidity mechanisms to support energy companies worth around EUR 3.2bn (5.2% of GDP). While these measures do not present a direct cost for the budget, the materialization of adverse scenarios due to further shocks in the energy market would eventually lead to the crystallization of these contingent liabilities onto the government’s balance sheet.
Slovenia’s large cash bugger (16.4% of GDP at the end of Q2 2022) supports the government’s comfortable liquidity position. The forward-looking debt management by Slovene authorities largely shields the country from an abrupt rise in interest payments, with the lengthening of Slovenia’s debt average maturity to 10 years in 2022 from 5.7 in 2013. However, the shift in monetary policy by the ECB will raise Slovenia’s interest payments over time. Under the baseline scenario, Moody’s forecasts Slovenia’s interest-to-revenue ratio to rise from 2.8% in 2021 to 3.3% in 2024, and the interest-to-GDP ratio from 1.2% in 2021 to 1.5% in 2024.
In the medium term, Slovenia’s ageing population represents a substantial challenge for the country’s financial sustainability. According to the 2021 EC ageing report, Slovenia will see the EU’s third largest increase in the total cost of ageing over the next five decades, after Slovakia and Luxembourg: total cost of ageing could reach about 30% of GDP in Slovenia in 20270, up from around 20% of GDP. Because of this, Slovene authorities included a pension reform project in the National Recovery and Resilience programme (NRRP) to ensure fiscal sustainability and adequacy of pensions, as well as a labour market reform to incentivize older workers to stay active for longer. Moody’s doesn’t anticipate a swift implementation of the reform given the topic’s sensitivity and the completion timeline (end of 2024).
The second driver of the affirmation of the rating reflects Slovenia’s economic resilience to a succession of shocks and the country’s support by European Union funds inflows in the context of the Recovery and Resilience Facility (RRF) and the regular funding under the 2021 – 2027 cohesion policy.
Before the pandemic, the reduction in Slovenia’s macroeconomic imbalances had enhanced economic actors’ shock absorption capacity, as reflected in more robust balance sheets for households and corporates, and significantly sounder financial institutions amid the authorities’ large-scale recapitalization and privation programme.
Against this backdrop, the 2020 pandemic-induced recession, with a 4.3% drop in real GDP, was mild and short-lived, followed by a robust 8.2% rebound in 2021. Moody’s forecasts Slovenia’s real GDP to expand by 5.5% in 2022. Domestic demand and export services have supported the recovery, with private consumption benefitting from the rebound in the tourism sector as both domestic and international travelling resumes. Data for January to August 2022 show that overnight stays reached their 2019 levels. The rise in employment and investment activity is also supporting domestic demand.
However,r in the context of the war in Ukraine, the balance of risks tilted to the downside. While Slovenia’s energy dependence on Russia is relatively low, high gas and oil prices, coupled with rising food, goods and services inflation is negatively affecting household incomes and corporate margins. Moody’s forecasts Slovenia’s average inflation to reach 7.6% this year, mainly driven by energy and food prices.
In 2023 and 2024, Moody’s expects Slovenia’s real GDP growth to reach 1% and 1.8%, respectively, below the economy’s potential of around 2.5%. At the same time, average inflation is expected to reach 7% and 3.3% in 2023 and 2024, respectively. This projection assumes a significant slowdown in the euro area, Slovenia’s main export market. Domestically, the forecast assumes gradual implementation of public investments under the RRF, with public investment set to reach above 6% of GDP in 2023, well above the 1995-2021 average of 4% of GDP. Under the RRF, Slovenia is set to benefit from EUR 2.2bn (4.2% of GDP), including EUR 1.5bn in grants and EUR 0.7bn in loans. This comes in addition to EUR 3.3bn in EU cohesion policy funds for the 2021-2027 period.
As a result, Slovenia’s potential growth will likely be driven by capital investment and total factor productivity in the coming years. Overall, potential growth in Slovenia is estimated by the EC and the govt. to hover between 2.5% and 3% and has been largely unaffected by the pandemic.
Lastly, Moody’s commented on the factors that could lead to an upgrade or downgrade of ratings. To get an upgrade, the following would have to happen: There would have to be a firm decline in Slovenia’s debt burden, reflecting a steady reduction in the deficit despite the impact on public spending of higher interest rates. The adoption of a pension reform clearly mitigating the consequences of ageing on public finances would be credit positive, as would policies raising the participation of workers above 55 years in the labour force.
On the other hand, things that would lead to a downgrade are the following: If Moody’s sees a sustained weaker-than-expected economic performance against the backdrop of the energy crisis in Europe. In such a scenario, evidence of permanent scarring would compound pre-existing challenges for Slovenia’s public finances, raising the likelihood of a significant increase in the debt trend. In the context of the pension reform, unfinanced new benefits implying additional budgetary costs would be credit negative.