M&A Today: Will CEOs Continue to Watch and Wait?

Solomon's Head of M&A Jeff Jacobs and M&A Director Chris Moynihan discuss the slow start to dealmaking in Q1, including the impact of tariffs, market volatility, and interest rates across the market, as well as the outlook for the rest of 2025.

Transcript

Jeff Jacobs (00:01):

Welcome to Solomon Partners Presents. This is our M&A monthly podcast where we discuss the latest trends driving M&A activity in the market. In this episode, we are going to discuss why M&A is off to a slow start and how that could change. I'm Jeff Jacobs, head of M&A and COO of investment banking at Solomon Partners.

Chris Moynihan (00:20):

And I'm Chris Moynihan, a director in the M&A group. So, Jeff, we've seen a lot in the news, tariffs, market panic, retraction of tariffs, all buzzy stuff that's keeping us as deal makers on our toes. This seems to be a very different environment from where we were post-election when there was a lot of euphoria, a lot of interest in dealmaking, it's been a stark change. Today, expectations seem a lot more muted and we're wondering exactly how we ended up in this environment compared to the one post-election. What are your thoughts?

Jeff Jacobs (00:52):

Well, Chris, it's true that post-election business leaders and deal makers expected a surge in M&A activity due in part to the perception that the incoming administration would be more business-friendly. The future seems bright as folks look forward to corporate tax cuts and a relaxation of antitrust regulations, interest rates that continue to decline. And it's not to say that all these things won't still come to pass, but the stop-and-start policies around tariffs. The extreme market volatility that we've been seeing, plus the slower than hoped for decline in interest rates have left a lot of companies in this wait and see mode when it comes to M&A. If we look at the data Q1, US M&A volume came in at about 478 billion. That was down compared to Q1 2024, and the number of transactions has also declined, and mostly what we're seeing in activity is being driven by the larger strategic combinations.

(01:44):

Big deals like Elon Musk with his merger of X and xAI, Google had a big deal for Wiz, the cybersecurity company strategics were about 72% of the total M&A deal count in the first quarter. They've really dominated activity so far this year, and there actually have been some larger sponsored deals as well, but private equity and particularly middle market private equity has been fairly quiet. I think a lot of them are simply putting new sale launches on pause. Everyone came into the year with these ambitious plans, but so far many have gotten cold feet in this environment.

Chris Moynihan (02:20):

I agree. We've seen some larger sponsor deals but still haven't quite seen the activity in the middle market. What other kind of macro trends are you seeing that are impacting M&A activity today?

Jeff Jacobs (02:31):

Unemployment remains low. It's hovering around 4%. Inflation continues to decline down to about 2.8% in February. That being said, we're still facing some headwinds. Consumer sentiment dropped to its lowest levels since 2022, and people are still waiting to see how moves in interest rates unfold. Interestingly, while the market sellers have added some pressure, they're also creating new opportunities where valuations may have gotten a little too frothy for folks. The biggest issue really though, is the lack of a clear message or a plan. I think business leaders crave certainty. They want predictability, and that's something the market is still working through. We know that dramatic change often requires bold actions, so we'll have to wait and see how things shake out, but until we get a little more stability in the system, I think we can expect folks to continue to remain in this wait and see mode.

Chris Moynihan (03:18):

The uncertainty in the macroeconomics definitely seem to be influencing these corporate decisions. As recently as the recording of this episode, we saw that the administration has been negotiating new tariffs with China, so it's a lot for all these companies to digest. There's a lot of noise right now, and I know it's tough to make any predictions in these types of markets, but can you give us a few thoughts on what we think the back half of the year could look like for M&A activity,

Jeff Jacobs (03:46):

Clearly, many companies have taken a hit on their equity values and this will undoubtedly affect sentiment if things don't level off soon. I think reduced valuations undermine the confidence of CEOs of boards, and it also has a real impact of decreasing a public company's acquisition currency. Think about folks who are planning to use stock as part of their currency to acquire another company if those values decline, that impacts what they can afford in the market. That said, many of the fundamentals that supported M&A before are still in place. Corporates have cash balances well above pre-pandemic levels. Sponsors have plenty of dry powder and many PE portfolio companies are way too long in the tooth to hold indefinitely, and we are still seeing activity in the market. Sycamore picked up Walgreens after its stock dropped pretty significantly over the past year, so we could see more tie-ups like this as people take advantage of market volatility.

Chris Moynihan (04:41):

Before we wrap, I just want to return to sponsor activity. As you mentioned, it's a big part about why the number of M&A transactions are down so far this year and in general over the last few years. I'm sure many of us feel like broken records each year predicting the return of sponsor activity only to see it be relatively low during the year. All the factors are there, right? There are 29,000 portfolio companies that are sponsor owned in the US. Many of them have been held for five-plus years, and you can blame stubbornly higher interest rates or high valuation expectations, but the fact is the volumes just haven't materialized to date. Are we seeing any more pressures on sponsors to look for exits and how are they managing this current environment?

Jeff Jacobs (05:23):

Well, I fully agree with your sentiment there. The pressure on sponsors to exit continues to grow. If you look at median hold periods, they're now approaching about six years. That's a significant jump from historical norms. Last year, private equity funds returned on the order of 400 billion to LPs about half of their target annual distribution levels. And at the same time, as you note, there are all these sponsor owned companies that figure you quoted 29,000 and that's worth about 3.6 trillion of value sitting in those portfolios. So the backlog is real. The challenge is that many of these assets were bought at peak market levels when interest rates were lower and accepting a new normal on valuations won't be easy for sponsors. With that said, sponsor activity has ticked up recently with some of the larger transactions that have been reported, but the total number of deals continues to decline, and I think private equity will need to start exploring all exit options. Last year we saw roughly 14% of exits going to continuation vehicles. That was a record high. Even with the current volatility, sponsors are going to need to get creative. They're going to need to test the waters to find solutions to return capital to their LPs. The risks though, in this environment is that they may hold off longer while waiting for some of these storms to pass.

Chris Moynihan (06:40):

For sure, and I'm sure we'll see other creative solutions like preferred equity and other alternatives to find liquidity for their limited partners. Jeff, as always, thank you so much for joining me. It was great to hear your insights on the current M&A market and what we can expect for the rest of 2025. To our listeners, thank you for tuning in. Be sure to visit solomonpartners.com for more insights and takeaways from the M&A market, which we'll be updating on a quarterly basis. We hope you can all join us next time.