Mergers and acquisitions activity was robust in 2021, up over 60%1 from the COVID-induced slowdown in 2020. However, a large portion of the activity was either outside the investment grade credit market or less credit-negative due to increased use of equity—an attractive currency at high stock valuations. As we moved on from the more conservative days in 2020 and 2021, we knew the potential for increased M&A activity in the IG market was a risk, which we highlighted in our 1Q22 Fixed Income Investment Outlook.
Turn the page to 2022 and we’ve received several data points indicating that companies are willing to use their balance sheets for large M&A. Microsoft announced a $69 billion all-cash deal to acquire Activision, Unilever reportedly bid £50 billion for GlaxoSmithKline’s consumer unit (but was ultimately rejected) and BHP expanded its deal-making team to pursue transformational M&A, according to reports—all single-A or higher-rated issuers. Management teams are incentivized to act given that financing costs are still relatively low, the Federal Reserve is on track to tighten monetary policy and the macro backdrop is steady. In addition to higher deal volume, we are seeing trends normalize toward a higher mix of cash-funded deals.
Although corporate activity is increasing, we don’t think this is a structural shift in the market that would cause IG spreads to reset wider. Rather, increased M&A volume typically means a healthy macro environment, and we believe the deals will be more idiosyncratic in nature. In many cases, these are single-A or higher-rated issuers willing to use their balance sheets to adjust business models or pursue growth. We don’t see particular risk of BBBs being downgraded below IG or of a return to exuberant leveraged buyouts.
In addition, increased scrutiny in the regulatory environment should be an offsetting factor to M&A in 2022. We think that, as the regulatory environment becomes more strict, especially for industries such as technology, M&A activity has the potential to be more tempered than it otherwise might be. Given the currently limited cost-of-capital penalty for issuers who go from A to BBB ratings, we are being especially thoughtful about investments in higher-rated credits. That said, we continue to find BBBs to be a more attractive part of the market, and we believe that, as the IG universe migrates in that direction, there could be new investment opportunities.