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Overview
Overall M&A activity in the first half of 2022 fell substantially from comparable 2021 activity levels. In the first six months of 2022, US merger values dropped by approximately 35 per cent to US$827 billion compared with the 2021 first half amount of US$1.3 trillion.2 The number of deals involving US companies fell approximately 25 per cent from comparable first-half 2021 numbers, with the second quarter showing a greater decline than the first. Of course, this decline is from a record-breaking full 2021, and 2022 will likely remain in the top five years even for M&A activity absent a disastrous second half. US M&A activity accounted for roughly 47 per cent of global M&A by value.
When looking at sector performance, the technology, media and telecom (TMT) sector accounted for roughly 47 per cent of North American M&A by value but suffered a percentage decline of approximately one-third from comparable 2021 figures.3 Middle market deals with a value of US$251 million to US$5 billion dominated by number.
The technology sector has done remarkably well4 on a comparative and absolute basis since the ‘dot-com’ bust. Its giants, Apple, Facebook, Microsoft, Amazon, Netflix and Google (FAANGM) continue to make significant acquisitions in 2022.5 The private equity segment has been quite active, with many funds combining to accomplish mega-deals that neither could fully commit to alone, though activity levels and exits dropped in the second quarter of 2022, and that trend looks to continue in the third quarter of 2022. Special purpose acquisition companies (SPACS), the darlings of 2021, have fallen off precipitously from 2021 levels owing to poor performance, stock market declines and enhanced regulatory pressure from the Securities and Exchange Commission (SEC). There is growing evidence that venture capital is shifting capital away from technology ‘growth’ sectors, at least in additional round fundings, which could have a negative impact on the number of available targets for sale in the future. Despite the relative activity decline from the record 2021 year, in the first half of 2022 technology still accounted for the lion’s share of all North American M&A by value, so it is the largest (but less ‘hot’) sector.
If anything, covid-19 (and its variants) has continued the acceleration of the digital, online and virtual transformation of Western society, with software and its necessary hardware infrastructure enabling a continuation of business on a scale unimaginable 20 to 30 years ago. A very large portion of these businesses and their employees, markedly in the technology sector, have been able to continue functioning relatively unscathed by working remotely and remaining connected enough to pursue and achieve their business plans. Software, social media, cybersecurity, remote access and virtual meeting companies have flourished during the covid-19 crisis, and these changes in behaviour will be lasting, as has been evidenced in Ukraine’s defence against Russia. As of 30 July 2022, FAANGM accounted for 20.4 per cent of S&P 500’s market capitalisation with a 13.6 per cent share of its forward earnings.6
It is not surprising that the telecom and media prongs of the TMT sector have also fared relatively well in 2022. A large portion of the digital world travels through telecom pipes and networks, and while the elixir of the melding of technology and content has never concluded its convergence into a separate business category (see the Warner/Discovery deal for an example of decoupling the segments), digital content streaming and content providers have all had a relative uptick as people get relief and entertainment at home, perhaps binge-watching while working remotely. Intense competition and advertising sensitivity in this sector will continue to put pricing pressure on Netflix and all other larger players.
Although technology has its own vulnerabilities in terms of high valuations, security, government regulation and the ‘world should be smaller’ political attacks, as has been the case since the 1920s, it will continue to take on a larger share of GDP, transform society and be subject to physical and political attack given its predominant role in Western society.
The technology sector is flypaper for political, activist and regulatory attention. In large part, the areas of interest or attack involve:
The relative size and influence prongs involve an age-old argument that large company X either stifles competition or, less analytically, is too big. On the political side, this generally involves congressional hearings where the main theme is, in effect, that Facebook or Google, etc., is ‘just too big – let’s break them up’. This is akin to earlier arguments in the 1980s about breaking up AT&T and to those in the 1990s about breaking up Microsoft. It is a particularly US habit to reflexively want to break up success stories.7
A second area of sector vulnerability on the political and social side relates to the vast amount of data collected and stored in, and easily retrievable from,8 the cloud’s exponential repository of structured and unstructured information. In the United States (see Section X), there are 50 separate privacy regimes and federal privacy controls. In a paper world, to have a data breach someone had to steal or copy an actual piece of paper or, better yet, (from the spy’s and movie producer’s perspective) copy it with a tiny camera hidden in a pen. Today, users of technology voluntarily expose, share, publicise and give away vast amounts of information and expect it to remain private. The technology sector has to navigate the maze of collecting the data it does, informing its users of its policies and, at some level, telling and assuring users that ‘their’ data is safe. Given the inherent value of some of that information, this is impossible to achieve. Technology companies, and most Western companies of size, are always on the defence side of cybersecurity because, in effect, they have a treasure that others cherish, and invading the cloud does not generally involve taking or ruining someone’s physical territory or assets.9 While this is why security software and cybersecurity companies are doing well, it does not mean that a shift to the defender will occur. Acting offensively has its own risks.10
The expansion of both jurisdiction and funding for the Committee on Foreign Investment in the United States (CFIUS) under the Foreign Investment Risk Review Modernization Act (FIRRMA) of 2018 strongly delivered on the promise to create an even more robust foreign direct investment review environment in the United States and globally.11 Most notable has been CFIUS’s ‘activist’ approach to reviewing Chinese and other foreign investments in technology start-ups, including those not voluntarily notified to the CFIUS.12 This development has been coupled with a proliferation – fuelled by pandemic-induced supply chain security concerns – of similar foreign investment screening mechanisms in other major economies, focused on protecting domestic technology and other critical industries from foreign influence.
For its part, the United States continues to ramp up supply chain security measures, including both the carrot of a US$52 billion-plus subsidies in domestic semiconductor manufacturing and the stick of restrictions against foreign content and, particularly, Chinese involvement in key technology and R&D sectors.
The unprecedented scope and scale of economic sanctions, export controls and financial restrictions unleashed by the United States and its allies in the wake of Russia’s invasion of Ukraine heralds the West’s major response to Russia’s worldview. The major Western economies have undertaken a highly coordinated ‘whole of governments’ approach not previously thought possible to try to choke off technology, energy and industrial exports to and investments in Russia. Every agency of the US government is playing a role, ranging from the Treasury Department’s Office of Foreign Assets Control and Financial Crimes Enforcement Network, to the Department of Commerce’s Bureau of Industry and Security and to the Department of Homeland Security’s Customs and Border Patrol, with the various divisions of the Department of Justice preparing to pursue enforcement actions against violators. The combined impact of the global economic contraction caused in part by the effects of the invasion and the complex global trade landscape created by increased regulation are formidable headwinds for cross-border technology M&A activity.
Year in review
Consistent with the general decline in M&A activity from 2021, mega-deals declined by a third in the first half of 2022 compared with 2021.13 The largest include Microsoft’s acquisition of Activation Blizzard (US$68.7 billion), Broadcom’s acquisition of VMware (US$61 billion), Twitter’s pending and uncertain acquisition by Elon Musk (US$44 billion) and Vista Equity Partners’ acquisition, together with Evergreen Partners, of Citrix (US$16.5 billion). In the technology sector, software acquisitions continue to dominate deal volume. IT services, streaming, social media and e-commerce also remained active. The initial public offering (IPO) window slammed ‘closed’ in the technology sector as SPACS crashed and investors rotated out of growth stories primarily driven by inflation fears and concomitant effects on ‘growth company’ valuations.
In the United States, SPACS, which played an outsized role in M&A in general and a large role in the technology space in 2021, predictably crashed as the stock markets fell from their record high and the performance a SPAC-purchased targets lagged. A SPAC, glossing over a host of regulatory rules, is essentially a company that raises equity and then goes public on a securities exchange and with the SEC in the United States. It has no business other that seeking out acquisition candidates to purchase. Because SPACS are generally under a two-year deadline to find and close a target acquisition before losing equity funding, they are perceived to be aggressive bidders in terms of price. As a public company, a SPAC, which can pay for an acquisition in its own stock or cash, and more frequently, a mix, needs its own shareholder vote to approve a transaction. There were 589 SPAC IPOs in 2021; in the first half of 2022, there were 27 SPAC IPOs. As mentioned above, SPACS suffer from increased SEC actual and proposed regulation, a fair number are under investigation and that, coupled with the decline in equity markets, prompted many SPAC investors to demand redemption, which led to a decline in the SPAC stock prices. SPACS, as buyers, are unlikely to be a meaningful buy-side M&A force in the near future; they themselves will be potential targets if they purchased a viable business (albeit at a steeply discounted price from 2021 values).14
During at least the height of covid-19, US M&A lawyers were fearful, when on the ‘sell side’, that buyers could or would invoke a ‘material adverse effect’ clause to terminate or modify acquisitions agreements in the buyer’s favour. Although there were some notable renegotiations, the US courts (in particular, the Delaware Court of Chancery) essentially took the position that covid-19 was not a material adverse effect (MAE) because its effects were not durationally significant (i.e., covid is a transitory phenomenon that does not per se affect long-term value). The US-style MAE clause continued its long-term evolution to prefer deal certainty by effectively excluding any covid-19 effect from the MAE definition, as well as tax and operating covenants. The result of this practitioner conformity to deal certainty in any large deal is that any covid-19, pandemic or related effects are the buyer’s risk unless expressly negotiated out of the contract.
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