M&A activity is accelerating. With valuations marching higher and so much capital in play, companies must pay close attention to the fundamentals to create value.
By many indications, the next six to 12 months could be busy ones for mergers and acquisitions. Companies anticipating economic fallout from the global coronavirus pandemic have an accumulated war chest of more than $7.6 trillion in cash and marketable securities—and interest rates remain at record lows. Pent-up demand may kick in as the availability of vaccines increase the trifecta of CEO, investor and consumer confidence. For companies facing imminent distress, consolidation may be inevitable. For others, dealmaking may be the best, and fastest, way to fill urgent gaps in the skills, resources and technologies they need to create value down the road.
Headwinds do remain. Ongoing waves of COVID-19 continue to trigger lockdowns. High unemployment is likely to moderate demand for products and services. Global trade tensions, regulatory pressures and a presidential transition in the US create uncertainties. A strong pipeline of IPOs offers owners an alternative to M&A deals as an exit path. And the economic recovery will likely be uneven across different sectors and regions.
Yet overall, the prognosis for dealmaking in 2021 is marked by opportunity and transformation—and competition for some companies could be fierce. The pandemic and recent geopolitical developments have already led most companies to the same conclusions, pushing both deal volumes and values higher in the second half of 2020, particularly for digital and technology assets. Many stock market indices, including the Dow Jones Industrial Average, NASDAQ Composite, S&P 500, Shanghai Stock Exchange and Nikkei 225, are at or near all-time highs. IPOs are buoyant: DoorDash, for example, closed its first day of trading 86% above its initial list price  and Airbnb closed its first day up more than 112%.
“COVID-19 gave companies a rare glimpse into their future, and many did not like what they saw. An acceleration of digitalisation and transformation of their businesses instantly became a top priority, with M&A the fastest way to make that happen—creating a highly competitive landscape for the right deals.”
Following a turbulent year in dealmaking, 2021 is likely to be marked by growing polarisation in asset valuations, the acceleration of deals in digital and technology, and increasing attention to environmental, social and governance (ESG) matters.
With rich valuations and intense competition for many digital or technology-based assets, dealmakers may feel compelled to take a more proactive—even aggressive—approach to acquire assets they want. Less desirable assets could see distressed sales at lower valuations, particularly assets in sectors more adversely impacted by COVID-19 or with business models that are no longer viable given the structural changes taking place.
Other factors expected to have a knock-on effect on deal valuations and M&A activity include an increase in restructurings and the continuation of a hot IPO market, particularly the use of special-purpose acquisition companies (SPACs) to raise capital.
The valuation of assets remains one of the biggest challenges to M&A success—especially when deal activity accelerates and competition heats up, as we saw in the second half of 2020. Dealmaking rebounded from June 2020 and remained strong through to year-end across all regions. In the fourth quarter of 2020, deal volumes and values were up by 2% and 18%, respectively, compared with the same quarter the prior year. Across Asia-Pacific, EMEA and the Americas, M&A activity increased by between 17% and 20% during the second half of 2020 compared to the first half of the year.
A significant increase in the number of announced megadeals—defined as deals with an announced deal value in excess of $5 billion—contributed to the increase in deal values in the second half of 2020. There were 32 megadeals in the third quarter of 2020, with an additional 25 megadeals in the fourth quarter. The combined deal value of the 57 megadeals announced in the second half of 2020 amounted to $688 billion. In contrast, there were 27 megadeals in the first half of the year, with a combined deal value of $266 billion.
The technology and telecom subsectors have seen the highest growth in deal volumes and values in the second half of 2020 compared with the second half of 2019.
Pricing deals may be more complex today than before COVID-19. Global shocks to the economy have historically led to lower valuations, so that’s what we expected to occur with COVID-19. Moreover, bigger companies have traditionally traded at lower price-to-earnings multiples compared with smaller ones, because investors discounted assumptions of earnings growth and potential value creation relative to a larger company’s size.
Instead, valuations are soaring, thanks to the rebound in global stock markets, an abundance of available capital and the large number of investors competing for deals. COVID-19 has amplified a recent trend of larger companies trading at a premium as they gain market power. That trend appears to hold true across most sectors, not just technology. In fact, the vaccine rollout is restoring confidence in the economy and creating expectations of rising growth rates and margins, in turn adding further buoyancy to strong valuation multiples. Typically, a stronger economy puts upward pressure on interest rates and softens valuations. But most economists expect low rates to continue for some time, and the December communication from the US Federal Reserve supports that expectation.
Based on data from the S&P 500 index, earnings multiples increased across most industries over the past five years. So are valuations getting rich? When it comes to transaction multiples, it isn’t unusual for corporates to offer a 20%–30% premium over a target’s current share price, although the premiums on some recently agreed deals are much higher. For example, Gilead’s $21 billion acquisition of biotech company Immunomedics represented a premium of 108% when it was announced in September 2020. And Salesforce acquired messaging company Slack Technologies for $27.7 billion—a premium of 50% above the closing share price before the talks became public.
Digital transformation remains a priority for many companies. As society has recentred around the home, the underlying technology to support remote working, education, shopping and entertainment has become essential, not just nice to have—and the speed at which demand has grown favours a buy-versus-build strategy for most companies. This increases the competition to acquire the necessary business infrastructure and forces premium valuations.
In a recent PwC survey, 76% of business leaders said they plan to allocate more resources to digital transformation, particularly in data analytics, automation, the cloud, customer experience, and product and service transformation. Furthermore, 53% indicated they would allocate more to M&A activity as a way to achieve their key strategic priorities. As one might expect, acquiring more digital assets leads to a more aggressive approach—and requires more discipline from dealmakers to avoid overpaying.
While higher valuations often imply higher risk and lead to more selective dealmaking, M&A is currently trending towards greater competition for premium assets. Fierce demand—particularly for digital and technology companies or for companies with transformational and disruptive industry impact—is creating an urgency to win at almost any cost. The speed of dealmaking has also increased.
Competition for assets can get so intense that some buyers may be tempted to shortcut traditional steps in the dealmaking process or even jump the auction process with pre-emptive bids. Whether that means spending less time on due diligence, accepting target projections at face value or agreeing to deal terms they may not otherwise have signed off on, these trade-offs to get a deal create risk. In a hot market for companies with technology-oriented, innovative or disruptive business models, companies should instead focus on honing their approach to win these highly sought-after, mission-critical deals. Among other things, they need to challenge pre-COVID-19 assumptions about strategic fit, value creation and organizational compatibility to confirm the deal rationale. Boards and investment committees need to understand the impact of COVID-19 and ESG considerations for any transaction if they are to create value in the long term.
“With so much capital out there, good businesses are commanding high multiples... and achieving them. If this continues - and I believe it will - then the need to double down on value creation is now more relevant than ever for successful M&A.”
This is not the first time we’ve seen this level of exuberance. In the late 1990s, for example, companies also faced enormous uncertainties, paradigm-shifting technologies and stiff competition for M&A transactions. Companies clamoured to acquire digital businesses, even those that lacked proven business models or had yet to generate revenue. Ultimately, many overpaid for acquisitions that fell far short when the tech bubble collapsed in 2000. We think this market is different, because today’s companies have proven business models and broad customer bases. They are generating revenue and, in some cases, profits. The challenge facing companies today is whether they can scale, given the pace of growth and disruption.
The fundamentals for successful dealmaking haven’t changed. Companies that have built clear strategies, identified acquisition targets that fit those strategies and developed relationships with those companies’ executives are well placed to accelerate their acquisition processes and create value from the deal—whether those deals are traditional M&A or joint ventures and alliances.
From a due diligence perspective, dealmakers need to consider how COVID-19 has affected the target’s financial statements to establish a reliable baseline EBITDA for valuation purposes. But assessing a target’s financial projections is even more difficult than assessing the impact of COVID-19 on historical earnings. The good news is that disciplined acquirers are conducting robust due diligence, including detailed scenario analyses addressing a multitude of commercial, operational and financial variables.
Moreover, paying a high price on M&A transactions, even a premium over currently traded market values, doesn’t necessarily mean overpaying—as long as the acquirer has a clearly defined strategy for value creation. In addition to considering financial sources of value, dealmakers are increasingly attributing value to non-traditional sources such as resilience and purpose. The COVID-19 crisis clearly demonstrated the value of a resilient supply chain, for example. Greater commitment to ESG factors is also changing the way businesses are valued and their attractiveness to investors.
“The heightened importance (and difficulty) of getting comfortable with top-line growth is front of mind for dealmakers in the current environment. Identifying the structural changes which will result from COVID-19 in the longer term is particularly challenging at a time when the effects are still making themselves felt.”
Ultimately, success is defined less by what a company acquires than by what it plans to do with that acquisition. The plan must align with the overall strategy for a company to create incremental value beyond what was apparent at the time of the transaction. PwC research has shown that companies that have well-thought-through business strategies, M&A plans to pursue transactions which align with those strategies, and a view to long-term value creation will be successful and outperform the competition.
Deal and tax structuring can help minimise exposure to certain risks. Value gaps between buyer and seller, often caused by uncertainty over whether the company can achieve its financial projections, may be effectively addressed through a variety of structuring options. These include earn-outs, entering into a minority stake investment (with an option to acquire the remaining stake at a later date) or using an acquirer’s stock as part of the consideration. These types of deal structures can help keep buyer and seller interests aligned and offer sellers the opportunity to share in the potential upside.
“The pandemic has compelled firms to reassess their strategic positions, rethink their operations, recalibrate their expectations for growth and revise their longer-term vision—and all at what seems like warp speed.”
Dealmakers should also place a high priority on the following factors, which are likely to have an impact on both availability of potential M&A targets and valuations:
Corporate leaders, governments and investors considering mergers and acquisitions are paying close attention to environmental, social and governance factors. Both society and the investment community are increasingly accepting the need to address sustainability and climate change, in particular. In 2020, an increasing number of companies (including PwC) and countries made commitments to reduce carbon emissions and announced net-zero targets. In addition, several banks, institutional investors and private equity funds have made commitments to reorient their strategic directions and evaluate both existing and future investments through an ESG lens. These commitments will impact all sectors. We are already seeing investors allocate more capital to new investments in energy and renewables, reducing exposures to carbon-intensive assets, and managing the value chain in a more sustainable manner. Societal issues such as wage inequalities, diversity and inclusion, public safety, and privacy are also a focus of greater attention and transparency. The message is clear—ESG is now being built into the core of organisations, through their purposes and missions. It is now a factor in both investment decisions and value.
“PE firms have historically led the dealmaking world—creating value by taking out costs, playing the cycles effectively, and using leverage and efficient capital structures. As carbon and other ESG factors are increasingly seen as a cost, whether through direct taxation or limits on output, or investor and consumer demand for reductions, PE has the opportunity to lead in this new value creation arena.”
Companies moved quickly to focus on a combination of liquidity, loan forbearance and government relief measures such as loan guarantees, paid furloughs, tax holidays and moratoria on insolvency actions. The early action resulted in lower levels of distress than anticipated in many territories and sectors. While these actions may have eased the pressure to restructure and turn around troubled businesses, we expect a sharp increase in restructuring activity once support ends. In the US, where the Chapter 11 process provides a framework and protection to help companies restructure their operations, 2020 has seen more corporate bankruptcies than in any year since 2010. Consumer discretionary, industrials and energy have experienced the most restructuring.
Historically, strong IPO markets compete with M&A, as company owners may choose a richer exit through the equity markets. In the second half of 2020, investor demand for innovative, high-growth technology-oriented businesses spilled over into the IPO market. In the third quarter of 2020, 481 IPOs raised $122 billion, more than in the first two quarters combined. The fourth quarter of 2020 outperformed the third quarter, with 528 IPOs and $129 billion in proceeds.
In 2020, special-purpose acquisition companies (SPACs) raised about $70 billion in capital and accounted for more than half of all US IPOs. Private equity (PE) firms have been key players in the recent SPAC boom, finding them a useful alternative source of capital. We expect more SPAC activity in 2021, especially involving assets such as electric vehicle charging infrastructure, power storage and healthcare technology.
 Erin Griffith, ‘DoorDash Soars in First Day of Trading’, New York Times, 9 December 2020, accessed 13 January 2021, https://www.nytimes.com/2020/12/09/technology/doordash-ipo-stock.html ↩︎︎
 Luisa Beltran, ‘Airbnb Stock Closes at $144 After Pricing IPO at $68 a Share’, Barron’s, 10 December 2020, accessed 13 January 2021, https://www.barrons.com/articles/airbnb-prices-ipo-at-68-a-share-raising-3-5-billion-51607560437 ↩︎︎
 Cara Lombardo, ‘Gilead reaches $21 billion deal for Immunomedics’, MarketWatch, 13 September 2020, accessed 13 January 2021, https://www.marketwatch.com/story/gilead-reaches-21-billion-deal-for-immunomedics-2020-09-13 ↩︎︎
 Aaron Tilley, ‘Salesforce Confirms Deal to Buy Slack for $27.7 Billion’, Wall Street Journal, 1 December 2020, accessed 13 January 2021, https://www.wsj.com/articles/salesforce-confirms-deal-to-buy-slack-for-27-7-billion-11606857925. ↩︎︎
 Tayyeba Irum, Chris Hudgins, ‘US bankruptcies surpass 600 in 2020 as coronavirus-era filings keep climbing’, S&P Global Market Intelligence, 15 December 2020, accessed 13 January 2021, https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/us-bankruptcies-surpass-600-in-2020-as-coronavirus-era-filings-keep-climbing-61734090 ↩︎︎
About the data
We have based our commentary on M&A trends on data provided by industry-recognised sources. Specifically, values and volumes referenced in this publication are based on officially announced transactions, excluding rumoured and withdrawn transactions, as provided by Refinitiv as of 31 December 2020 and as accessed on 3 January 2021. This has been supplemented by additional information from Dealogic and our independent research. This document includes data derived from data provided under license by Dealogic. Dealogic retains and reserves all rights in such licensed data. Certain adjustments have been made to the source information to align with PwC’s industry mapping. We define megadeals as transactions with a deal value greater than US$5 billion.