UK mergers and acquisitions outlook 2022

After the initial halt that COVID-19 brought to dealmaking, M&A began to recover in the latter half of 2020, as dealmakers rapidly adjusted to working in the “new normal”. Buyers began pursuing deals that had been derailed by the onset of the pandemic and pouncing on the new strategic and distressed opportunities that coronavirus created.

This recovery continued throughout 2021, with UK M&A markets seeing record levels of activity, driven by factors such as pent-up demand among private equity buyers, ongoing COVID-related distress and growing interest in sectors that were responsive to aspects of pandemic life, such as domestic travel and cybersecurity.

As a result of this strong recovery, the M&A market, both globally and domestically, is heading towards the end of 2021 with high levels of confidence and widespread forecasts that 2022 will see the resurgence continue, or even accelerate further.

A survey of 300 global dealmakers by Mergermarket found that two thirds of dealmakers expect increased M&A activity over the next twelve months, while 24 per cent of respondents expect a “significant increase”. Looking at the UK more specifically, an Ansarada survey of UK dealmakers revealed an even higher degree of confidence, with 90 per cent of dealmakers expecting an increase in M&A and over half (54 per cent) forecasting that activity will increase significantly.

As we head into 2022, then, what are the key factors and sectors that could be at the forefront of this potential surge? We’ll also examine some of the possible headwinds that the M&A market could face and consider how dealmakers can best respond to these challenges.

Pandemic-related distress continues to be felt

While we are quickly closing in on two years since the COVID-19 pandemic began, businesses are continuing to feel its effects and business distress is set to remain one of the key drivers of dealmaking. There are numerous reasons for this, as well as the ongoing impact of COVID-19, businesses are also set to struggle with newer issues such as repaying emergency government loans, supply chain issues and Brexit disruption.

Continuing distress from COVID-19 has been evident throughout 2021. Among the key contributors to this has been the need for businesses to begin repaying the government loans they took on earlier in the pandemic. The beginning of repayments came with many UK businesses already suffering from severe financial distress and helped to prompt a 31 per cent increase in company insolvencies in Q2 2021.

This was then exacerbated in October 2021, when the Insolvency Service ended the Corporate Insolvency and Governance Act, which had protected many businesses from creditor action during the COVID-19. Later in October, restructuring firm Begbies Traynor reported that over half of UK firms were struggling with toxic debts that they were unlikely to be able to repay and said that it had seen an increase in inquiries about pre-pack administrations.

These factors suggest that business distress continues to be rife and will play a major role in dealmaking next year. Opportunistic buyers are sure to be targeting undervalued asset sales, turnaround opportunities and much more. Another MergerMarket survey, this time polling European dealmakers, showed that 24 per cent considered undervalued targets to be the most important driver of activity on the buy-side, while 22 per cent identified distress as the key motivator on the sell-side.

According to Ansarada’s survey, 54 per cent of dealmakers expect distressed M&A deals to increase in the UK over the next year. For Europe as a whole, this figure drops to 26 per cent, suggesting that UK companies in particular are facing a perfect storm of pressures.

Digital transformation gathers pace

One of the main impacts of the pandemic has been a rapid acceleration in digitisation. With more flexible working than ever before, increasingly sophisticated cyberthreats and growing uptake of new technologies among rival firms, companies have little choice but to target digital transformation if they wish to compete and grow.

Going into next year, this looks set to continue in a big way. According to the MergerMarket global study, 14 per cent of dealmakers forecast that digital transformation will be the most significant driver of M&A activity in 2022.

Sectors that are expected to see significant M&A activity as a result of this transformation, according to the Ansarada UK dealmakers survey, include telecommunications, media and technology (TMT – cited by 32 per cent of respondents) and business, financial and computer services (cited by 26 per cent).

Two of the significant challenges facing businesses and dealmakers (which we will explore in greater detail later) are lengthy due diligence processes during deals and the increasing regulatory hoops that companies have to jump through. As they look to circumnavigate these issues, it is possible that many companies will consider digital acquisitions.

Covered in one of last month’s BSR insights, it is likely that some dealmakers will target acquisitions that can help them tap into technologies like machine learning and AI, as they up their efforts to conduct due diligence at pace. This may be particularly crucial for dealmakers like private equity firms, which will likely be under growing pressure to deploy the capital they accumulated during the pandemic.

In terms of regulation, this is a growing burden for many companies as new rules governing factors such as ESG continue to increase. For companies looking to ease this burden, regulatory technology (regtech) acquisitions may prove vital to streamlining and automating laborious processes such as compliance solutions, reporting and data protection.

Regtech is among the key drivers in the growing significance of the wider fintech sector, as companies and financial institutions increasingly target emerging firms offering innovative financial technology products. Such acquisitions can be expected to continue to grow throughout 2022, with buyers looking to tap into the latest tech solutions for their financial structure or customer offering.

UK continues to attract inbound investment

As we’ve highlighted in numerous recent insights, UK businesses are proving immensely attractive to foreign investors and international companies in emerging and rapidly growing sectors such as childcare, video games, CBD and health food.

Heading into 2022, this is another trend forecast to continue and to drive dealmaking within the UK. As well as the fact that numerous popular and trend-setting sectors are thriving within the UK, an increasingly attractive investment environment is also seen as a major factor behind the popularity of UK businesses.

According to the Ansarada study, 58 per cent of dealmakers expect the UK to remain more or less as attractive to foreign investment in 2022 as it has been this year, with private equity funds, in particular, finding bargains in the low valuations of UK companies.

Furthermore, 40 per cent of dealmakers polled by Ansarada expect the UK to become an even more attractive market for inbound foreign investment next year, driven by the fact that buyers can now acquire UK companies at a more favourable FX rate post-Brexit.

Private equity appetite grows

Since M&A began to recover from the initial impact of the COVID-19 pandemic, a constant trend has been the growing interest of private equity firms in deploying the capital they accumulated during months of relative inactivity.

This has been prominent in a broad range of UK M&A sectors throughout 2021 and, again, all the indications are that this will continue next year. In MergerMarket’s global study, 37 per cent of private equity respondents said that COVID-19 had increased their dealmaking appetite and 20 per cent said their dealmaking appetite had “significantly increased”, compared to 11 per cent among corporate respondents.

COVID-19’s ongoing impact was reflected in the fact that 19 per cent of PE respondents said their dealmaking appetite had decreased (compared to 16 per cent of corporates). However, just 4 per cent of PE dealmakers surveyed said that they had “significantly less dealmaking appetite” since the pandemic, a figure that again stood at 16 per cent among corporate respondents.

In terms of the scale of dealmaking that private equity houses will target next year, the MergerMarket study showed that 52 per cent expected to undertake between 1-3 deals over the forthcoming 12 months, while 36 per cent expect to target 4 or more. Just 12 per cent of private equity respondents said they expected to make no deals next year.

As we mentioned in the inbound investment section, private equity firms are arguably the foremost drivers of foreign investment into the UK. With the UK offering both an attractive investment environment and droves of high-performing companies in sectors currently popular among PE firms, it seems certain that many will head to the UK to quench this dealmaking appetite.

Along with strong appetite, private equity firms also have the capital to go and execute these deals. According to S&P Global Data from October, the pandemic has enabled private equity houses to accumulate around $2.3 trillion (£1.7 trillion) in cash reserves. Looking closer to home, data from research group Prequin has shown that EU private equity houses alone have around £263 billion in cash reserves.

Clearly, as the impact of the pandemic continues to recede, private equity firms will come under increasing pressure from investors to deploy this capital. Combined with their appetite to complete deals and the UK’s highly favourable M&A environment, significant private equity-fuelled dealmaking seems a near certainty for UK companies in 2022.

What potential headwinds does the dealmaking revival face?

Due Diligence
Despite this wave of optimism and eagerness to pursue dealmaking in 2022, there remain significant challenges for both buyers and sellers to rise to if they hope to fulfil their ambitions and expectations.

A key worry cited by dealmakers in numerous studies is the impact that COVID-19 has had on due diligence processes. In the Ansarada study, 36 per cent of those polled said that they expected due diligence to be the most challenging part of the overall deal process over the coming 12 months.

Ansarada’s Chief Revenue Officer Stuart Clout said that “extenuating situations”, such as driver shortages, supply chain disruption and potential local surges in COVID-19 cases could all impact dealmaking. He added: “Deal speed, preparation and quality due diligence is going to be essential if the expectations from the Dealmakers we surveyed are to be met.”

In the MergerMarket study, 16 per cent of respondents said that more complex due diligence processes were the most challenging aspect of post-COVID-19 M&A, while a further 14 per cent cited it as the second biggest challenge.

One of the reasons due diligence is seen as such a major challenge, particularly at this time, is that COVID-19 has massively increased the number of acquisition opportunities requiring quick timeframes (for example, distressed sales), whilst also lengthening the due diligence process due to factors including the sheer disruption of the pandemic and a greater hesitancy among sellers to share sensitive information during due diligence.

In our recent insight on AI and machine learning in M&A, we discussed how dealmakers expect these technologies to cut due diligence times from their current average of 3-6 months down to under a month by 2025. While the influence of these technologies may become more pronounced during 2022, we remain a long way from widespread adoption.

94 per cent of dealmakers surveyed by Ansarada said that COVID-19 had lengthened the dealmaking process, with due diligence, in particular, now taking far longer. This is something that is expected to continue and, as buyers and investors are largely targeting quicker deals, it is easy to see why due diligence is viewed as the main challenge.

ESG and mounting scrutiny
Another challenge to dealmaking’s continued recovery next year is the increasing regulatory scrutiny that dealmakers are facing. This is particularly true with regards to environmental, social and corporate governance (ESG), which has risen to a position of major prominence in the dealmaking process.

Especially in the wake of the COVID-19 pandemic and growing concern and awareness regarding the climate crisis, issues such as social responsibility, diversity and inclusion, climate change, energy efficiency and business transparency have become vital considerations in the M&A strategies of many companies.

Naturally, this is also leading to greater scrutiny being placed on deals, as governments around the world exert pressure on businesses to, for example, reduce greenhouse gas emissions. While this may not be as large and immediate a challenge as due diligence, it’s still one that dealmakers clearly feel will increasingly feature in M&A.

According to the MergerMarket survey, 62 per cent of dealmakers expect scrutiny of ESG to increase over the next three years. This will naturally have a knock-on effect on the process of conducting deals and, accordingly, 48 per cent expect ESG-related due diligence to become more prevalent over the next three years.

Could protectionism threaten inbound dealmaking?
Protectionism is another issue that dealmakers around the world feel could impact M&A during 2022, given the numerous tense and volatile geo-political situations currently present around the world and their potential implications for business and trade.

While the UK has regularly trumpeted itself as being “open for business” post-Brexit, this is a particularly salient concern for international dealmakers considering UK acquisitions. Following widespread outrage over the sales of some long-standing and important UK firms to international buyers, the government has (perhaps reluctantly) moved to tackle this.

In November 2020, the government introduced new legislation that would enable it to intervene and block takeovers and other deals that potentially threaten the UK’s national security. The legislation covers 17 strategically important sectors, including defence, energy, transport, AI, satellite and space technologies and data infrastructure.

While the government sought to quell possible concerns among dealmakers by saying that the vast majority of deals would not require intervention, the introduction of the rules pointed towards a somewhat stricter approach to inbound investment.

This was further backed up last year, when it was announced that the Competition and Markets Authority would review the proposed takeover of British defence tech firm Ultra Electronics (a key Royal Navy supplier) by Cobham Group, which had itself been the subject of a highly controversial takeover by US defence firm Advent in 2019.

This is by no means to suggest that buyers will struggle to acquire UK firms and inbound investment is still expected to be a major driver of UK M&A in 2022. However, there are indications that scrutiny of international takeovers of some domestic companies is increasing and that some deals may face barriers to completion.

Will digitisation create problems?
Progress is not without its problems and, as the worlds of business and M&A become ever more digitised, there are bound to be bumps in the road. For that reason, given the pace of digitisation currently taking place in M&A, tech has to be counted as a potential challenge, as well as a major advantage.

As MergerMarket points out, while only ten per cent of dealmakers consider tech inefficiencies one of their top two M&A concerns, the reliance on technology throughout the process nowadays means that any inefficiencies, whatsoever, could have major implications for deals.

Of particular concern to dealmakers will be the increasing threat posed by cybercriminals. M&A deals, particularly at the due diligence stage, involve significant amounts of sensitive information being exchanged. Technological advances, such as shared data rooms, have helped improve the efficiency of dealmaking, but they have also created a wider attack surface for hackers.

The great irony of cybersecurity is that, as it advances and security improves, hackers adapt and become even more sophisticated in their attacks. As M&A becomes increasingly tech-based throughout 2022, dealmakers will need to be more wary than ever of the threat that cyberattacks pose to their deals and their data.

Finally, another potential tech-related issue, and one that could become increasingly significant over the next few years, is the gulf that might open up between the most technologically adept dealmakers and those that haven’t yet taken up new technology in the same way.

An obvious example, again, is the use of AI and machine learning in M&A. While it may currently be rare, it is expected to be widespread by as soon as 2025. Such technology will no doubt deliver great benefits for those that harness it. However, those that are perhaps unable to financially or don’t act quickly enough to incorporate it into their M&A strategy may soon find themselves left behind.

Despite a raft of issues facing dealmakers, not least the pandemic, the M&A market enters 2022 looking more optimistic than it has for years. Crucially, appetite among buyers to complete deals is extremely high and, as a result of factors such as ongoing COVID-related distress, there are a huge number of deals out there to be done.

Heading through 2022, the key things for dealmakers on both sides to focus on to ensure that deals complete successfully are deal preparation, solid due diligence processes and, as M&A moves even further into the decade, technological adoption.

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