2025 is Shaping Up to Be a Banner Year: Here’s Why

If you’re a regular reader of The Braff Report or have attended any of our presentations over the past two years, you’ve read or heard a steady stream of less than favorable mergers and acquisitions news. Total deal flow down more than 40% since the record output of 2021. Private equity investment off nearly 50%. High interest rates, inflation, and staffing shortages, oh my!

But we’ve also laid out why the market would absolutely, positively, no-doubt-about-it, return.

And return in a big way.

Well, we’re at the precipice of the big bounce back.

Here’s why.

Let’s go to the tape.

2019

2019 was a strong year with total deal flow modestly below the record set in 2018. Of course, who knew what would be in store for us in 2020.

2020

Enter COVID in March of 2020. Predictably, deal volume fell substantially in the second quarter. That said, deal volume recovered quite nicely. In fact, the output in Q4 was a new quarterly record. But here’s the thing. Amidst worldwide lockdowns and escalating cases and deaths, the mood was anything but giddy.

2021

Despite strong results in the third and fourth quarter of 2020, we actually entered 2021 with what amounted to pent up psychological demand. Buyers wanted to distance themselves from the bleakness of 2020, and propped up with extremely low interest rates, they had the buying power to do it. Deal volume rocketed in 2021, and wit it, valuations rose to unprecedented levels. Across all industries, the volume of deals completed by private equity in the US eclipsed the previous record by an astounding 50%. At this point, the Fed rate remained effectively zero.

But, and this is a big but (unintended pun), the seeds of the inflation to come began to take root. The great resignation began, creating staffing shortages that drove wages soaring. Supply chains were disrupted, and scarcity inevitably led to increased prices. And amidst it all, massive spending programs designed to prop up the economy provided business with the resources to survive a higher cost environment – the kindling that lit a firestorm of inflation.

2022

Overhang from deals that didn’t close in 2021 due to backlogs of quality of earnings reporting, legal, and other deal related services, propped up deal flow in the first quarter of 2022. But then in March the Fed initiated the first of 11 rate increases to tame inflation, which peaked at 9.1% in June. Notably, compared to other hikes in the Fed rate to fight off inflation, the increases this cycle were the steepest over the shortest period. Buyers, especially private equity, froze, not only due to increased cost of capital, but also to focus on stabilizing their inflation-ravaged portfolio companies. Deal volume fell off dramatically, and unspent dry capital began to rise, a development that will prove extremely critical later on.

2023

Deal flow continued to drop with four consecutive quarters below 2019 levels.

With PE accounting for more than 50% of all health care services transactions since 2014, their influence on the M&A market cannot be understated. While we track both new market-entry platform activity as well as subsequent follow-on transactions, we pay particular attention to platform trends as they are often early indicators of what we might expect in the future. And until the final quarter of the year, the results in this key metric were decidedly down for seven consecutive quarters.

As a result, by the end of 2023, the unspent dry capital that began to accumulate in 2022 reached record levels.

According to Bain and Company, the portion of global dry powder more than four years old rose to a record 26%, increasing the pressure on private equity to deploy capital. Moreover, with PE funds generally having a ten-year life span to invest in companies and grow them to generate outsized returns upon exit, the slowdown not only created a backlog of unspent capital, it also reduced the amount of time funds would have to increase the value of their investments.

On a positive note, while inflation remained above the Fed’s target of 2%, by mid-2023, it was holding steady at plus/minus 3%.

First Half 2024

In the first half of 2024, we began to see several developments converge that would suggest the beginnings of an upturn in the market.

• Inflation continued to slow, falling from 3.5% in March to 3.0% in June.

• Quarter over quarter changes in US payroll fell from COVID highs of about 5% in 2020 to pre-pandemic levels of 1%.

• Despite no changes in the Fed Rate, US institutional loan volume soared in the first quarter of 2024, largely on refinancings at more favorable terms and conditions.

• Based upon economic conditions and comments from the Federal Reserve Board, the consensus opinion was that the Fed would cut rates by .25 to .50 in September.

• Previously, the last sustained fall-off in deal flow began prior to, and following, the global financial crisis from 2007-2009. The decline lasted 9 quarters before it began a steady climb to a new record high at the end of 2012. Q1 2024 was the 9th quarter of the slowdown in transaction volume. So, if history is any indicator, there was ample reason to anticipate an upswing to meet pent-up demand.

Outlook for the Remainder of 2024 and 2025

So where are we right now, and how will it impact M&A activity over the next 15 months? Remember that aging dry powder we highlighted in 2023? Well, it’s even older now. So,

Private equity simply must get back into the game.

And for many funds, after losing two years in the fund’s life cycle to buy, build, and bid adieu,

PE has to buy fast.

With inflation falling and lingering concerns that high interest rates could upend the much hoped for “soft landing,”

The Fed will almost certainly phase in additional rate cuts in Q4 and into 2025.

With the ability to, once again, leverage debt to boost returns,

The amount of capital – both debt and equity – chasing deals will be substantial.

With a lot of money to spend and a short time frame to do it,

The competition for deals will be fierce, driving up both volume and valuation.

So, taken together,

2025 is shaping up to be an extraordinary year for mergers and acquisitions.

The downside, however, is that after bulking up on deals in 2025, buyers will likely need to take a pause to integrate their acquisitions and fully realize their value enhancing potential. Accordingly,

Deal volume and valuations may dip in 2026.

So, if you can suspend for a moment the inclination to discount our reading of the tea leaves because we are an M&A advisory firm and rely solely on the logic of it all, if you postponed an exit or want to capture a little bit of the magic that was 2021,

The time is now.