GRACE MATTHEWS INSIGHTS

In retrospect, the step-down in M&A activity in 2022 should have been obvious. While we cannot have record M&A activity every year, the drop-off from the record levels of 2021 to 2022 felt stark and tangible, particularly given 2021’s activity was very secondhalf weighted. Interestingly, the M&A headwinds that emerged in 2022 were clear to us at the start of the year: rising inflation, geopolitical instability, and a decade-long bull market in public equities inevitably due for a correction. While deal-makers were aware of these at the start of 2022, few anticipated the pace at which these challenges would unfold. For example:

• Rapidly rising interest rates quickly resulted in increased lending costs and, in some instances, temporarily reduced supply of debt financing as some lending institutions chose to remain on the sidelines for periods of 2022 
• Russia’s invasion of Ukraine and the resulting war, which still has no conclusion in sight, has fostered enormous political instability and contributed to volatility in demand patterns, raw material costs, and energy prices on a global basis, with a particularly challenging impact in Europe 
• Public equities worldwide pulled back between ~10-30%,(1) and the general expectation in the equity markets is that levels will trend sideways for the near and medium-term (2)

We could write a newsletter on each topic above, but you understand the point—M&A in 2022 was hit by a variety of challenges. Obstacles persist as we begin 2023, though we also see reason to view the glass as half-full. Further interest rate hikes are expected, but the rate of increases is likely to slow. While debt will continue to be relatively expensive, the record amount of dry powder that private equity funds have amassed (nearly $2 trillion as of December 2022) remains ready to be deployed, particularly given the fact that many of these well capitalized buyers sat on the sidelines throughout 2022 (3). Similarly, inflation in the US appears to have peaked in the second half of 2022, which should begin easing cost and price increases. Globally, while the Russia-Ukraine war continues, Europe is seeing energy prices gradually return to late 2021 levels, and we expect demand in Asia-Pacific to return closer to normalized levels via the gradual reopening of China.(4)  Despite constant chatter of a looming recession throughout 2022 and beginning this year, US GDP grew 3% in Q3 2022.(5)  Moreover, within the North American chemicals industry, overall output managed to increase by nearly 4% throughout 2022.(6)

Through all the challenges of 2022, deal-making continued, which is why we are encouraged heading into the new year. Simply put, to borrow from IntraLinks and MergerMarket’s 2023 Global M&A Dealmakers Sentiment Report, “Optimism persists,” as they note that 62% of respondents “expect overall levels of M&A activity to increase over the year to come.” (7)

Specific to the chemicals & materials industry, we expect M&A activity to be driven by a focus on quality, fit, and geography.

• Quality: Businesses that maintain a positive outlook for 2023 and performed well over 2020-2022 by managing through supply chain issues, inflation and raw material cost increases, and other headwinds will continue to command attention in M&A processes.  
• Fit: Strategic acquirers will continue to deploy capital towards inorganic growth should they see strong fit, alignment with core strategy, and/or synergy potential within their organization.  
• “We remain confident in the quality of our portfolio and its growth potential, and we’ll look to be opportunistic with select and targeted M&A moving forward.” 
  – Edward D. Breen, DuPont CEO & Executive Chairman, DuPont Q3-22 Earnings Call 
• “We’ll continue to invest materially in the coming years in the U.S., including if we have the opportunity on M&A.” 
  – Thierry Le Henaff, Arkema Chairman & CEO, Arkema Q3-22 Earnings Call 
• Geography: M&A in North America is likely better suited for a more active 2023, as the region has not been as exposed to the energy price shocks and demand uncertainty that Europe is currently facing. In the Asia-Pacific region, the re-emergence of China after altering its ‘Zero-COVID’ strategy will unfold over time, and this may give economic fits to the region similar to what the US and Europe saw throughout 2021.  

We remain cautiously optimistic that 2023 will present opportunity for both buyers and sellers in chemicals & materials M&A. As previously mentioned, one segment we expect strong activity in is corporate divestitures, an area where Grace Matthews has substantial expertise.