Talent, tech and trade – the triarchy dictating M&A in 2022

July 2022 | SPECIAL REPORT: MERGERS & ACQUISITIONS

Financier Worldwide Magazine

July 2022 Issue

M&A activity in 2021 reached record highs after being briefly depressed as a result of the pandemic and, in 2022, we have seen continued high levels of activity, albeit with softening as a result of inflation and sadly the Ukraine conflict. Deals have not been aborting, rather processes are taking longer as the impact of inflation is diligenced.

While some of the key trends currently driving the M&A landscape may be predictable, others may not be what we would have expected 12 months ago. In a recent report, we found that seven in 10 business leaders are focusing on a new ‘M&A triarchy’ to deliver future business success: talent, tech and trade.

Talent: the people factor

It is recognised that there is a global shortage of talent, with many businesses struggling to find the right people in the right location. In fact, our survey found that 72 percent of business leaders see talent retention and acquisition as important in their organisations’ business strategy over the next year.

Arguably, the biggest impact of the pandemic (in terms of workforce at least) is the global nature of recruitment. Anyone, anywhere in the world can now work for any company which has embraced remote working. We are seeing a fight for talent with companies being squeezed on pay for fear of losing key employees who can now be poached by any organisation in the world.

Such hunger for talent has led to companies using M&A to resolve staffing issues, in a way that is similar to securing the supply chain. Our research showed that three in five (62 percent) believe the ‘Great Resignation’ is acting as a catalyst for M&A as the battle for talent continues. As such, we are seeing, for example, that organisations looking to establish a local supply base for a particular geographical area may choose to do this via acquisition where it would be difficult to set up their own establishment and recruit in the particular location.

Companies are also using acquisitions as a route to fill talent gaps at a more strategic and senior level. We are seeing deals being done where, relatively speaking, the buyer is less focused on the fundamentals of the underlying business. Rather, what they are buying is a successful management team who, on the buyer’s platform, will be able to add further value. Finally, some locations which had been attractive from a cost point of view pre-pandemic now have the most acute labour shortages. Even outside of the M&A process, a number of multinationals are having to revisit their own internal retention policies.

Tech

Our research also found that tech has become one of the most important factors to organisations’ business strategies over the past year, with 78 percent of business leaders seeking to improve their cyber security and three-quarters seeking digital transformation. Seventy-four percent also see digital transformation as important to their organisation’s business strategy over the next year.

As such, technology, media and telecommunications (TMT) deals set a high-bar in that pricing for such transactions has been soaring for many years, and TMT was one of the few sectors largely unaffected by the pandemic (and, if anything, multiples increased after March 2020 as the need for technology in a home-working enabled environment became clear). Tech deals have again been fuelled by many key M&A trends.

Certainly the industrial supply chain push has led to a desire for smart supply chains and therefore utilising the latest technology to maximise efficiency. Similarly, the large macro trends of environmental, social and governance (ESG) and the move away from fossil fuels is benefitting the TMT sector because every company is a now a tech company. All of these factors add fuel to the flames of TMT business valuations. TMT is also at the sharp end of the fight for talent.

Valuations in this sector continue to be supported by the intangible benefit to the acquirer of scooping up a dynamic new team. On the flip-side, TMT sector businesses are feeling the pinch in terms of wage inflation, particularly because many of their teams can work fully remotely such that all technology businesses are now competing with the West Coast for talent and pay. We are not seeing such wage inflation impact valuations which suggests that, one way or another, such increased costs are being passed on.

One headwind that is impacting the TMT sector is government oversight through FDI regimes. Cyber security is paramount, and governments are now actively protecting national interests by closely monitoring and controlling the sale of their prized technology assets to overseas acquirers.

Trade

As you would expect, our survey also found that 72 percent of business leaders indicate that increasing supply chain resilience will be a strategic M&A priority over the next year.

In recent times, the impact of the coronavirus (COVID-19) pandemic (including the recent lockdowns in China), the Brexit transition period coming to an end and, most recently, the conflict in Ukraine and the associated disruption to certain markets have all demonstrated the fragility of supply chains.

Despite the increased globalisation of their customer base, organisations have adjusted their practices, and are having to look to secure multiple local suppliers to minimise the risk that a localised crisis or issue may cause disruptions to their supply chain. Such uncertainty has translated into a driver of M&A activity.

Moreover, the impact of inflation in the wider economy is leaving businesses in all sectors grappling with increasing costs. This is particularly the case for manufacturing and retail businesses that incur high energy costs and those with high transportation costs. Deals are not necessarily aborting due to rising inflation. However, deals are taking longer to sign as the burden of financial and regulatory diligence increases. Current economic uncertainty may therefore impact valuations.

Regulatory scrutiny and foreign direct investment

The regulatory environment for M&A is becoming more complex in many jurisdictions. In recent years, jurisdictions worldwide have introduced new foreign direct investment (FDI) screening regimes or have expanded existing regimes to enable governmental control of inbound investments into certain sectors.

In some jurisdictions, this has been driven by an increased desire to protect domestic assets from what has been seen as opportunistic foreign acquisitions. However, security of the supply chain is also a relevant factor. These foreign investment regimes no longer focus solely on the military and defence sectors, impacting, for example, the TMT, life sciences and agri-business sectors.

Governments and corporations alike were exposed by the pandemic as it became clear that the world’s supply of personal protective equipment (PPE), for example, was manufactured in China. Similarly, many countries lacked the ability to quickly manufacture vaccines. Governments are keen to close such gaps and are utilising their regulatory powers to make their influence felt. In the UK, by way of example, the new national security and investment screening regime came into force in January 2022. This means that a wide range of transactions will be required to make a mandatory notification and obtain clearance before the deal can close.

Similarly, the European Union (EU) also has introduced a new regime which encourages cooperation between EU countries and the European Commission (EC) in relation to foreign investment screening. Twenty-four of the 27 EU countries have, or are in the process of implementing, such regimes. We are also seeing competition regulators across the globe heavily scrutinising deals involving potential competitors.

FDI regimes need to be looked at now across all jurisdictions and a clearance of FDI in one jurisdiction does not necessarily mean clearance in another. Failure to abide by the new rules can lead to significant penalties. As the UK regime can apply to transactions completed since 12 November 2020, we are seeing that historic acquisitions may need to be diligenced. Organisations will therefore need to ensure they factor in additional delay to their transaction timetables in order to comply with both competition and FDI regulations.

Ukraine

Our research revealed that the war in Ukraine is fundamentally impacting appetite for M&A, with 67 percent of business leaders indicating the conflict has reduced their organisation’s investment in M&A activity. As expected, extra caution has resulted in deal timelines slipping.

That said, geopolitical events tend to be digested quickly by the market as business leaders reassess and reposition. We are therefore cautiously optimistic that markets will adjust, and that transactional activity will continue. Indeed, the fundamentals of the economy remain strong (with individuals, corporates and private equity sitting on high levels of cash). Whether this dry powder is deployed immediately, or we see a slowdown in activity, remains to be seen.

Eric Knai is a partner at Eversheds Sutherland. He can be contacted on +33 (1) 55 73 41 38 or by email: ericknai@eversheds-sutherland.com.

Eric Knai

Eversheds Sutherland