M&A Report 2023: United Kingdom

Compared to 2021, which had record-breaking levels of M&A activity in the UK, leading to a strong seller’s market and extremely competitive deal processes for resilient assets (and even for less obviously attractive assets), the 2022 UK M&A market experienced a cooling in terms of deal value and volume.

Data from Dealogic shows 2022 inbound UK M&A deal value (based on target nationality) was down 34.7% to $112,216 million from $171,903 million in 2021. Inflation, currency declines, energy prices, the downturn of the high-yield market and geopolitical tensions (including the Ukraine–Russia war) impacted equity markets. Despite the slowdown, the 2022 volume figures demonstrate meaningful market resilience overall because the inbound UK M&A deal value (based on target nationality) increased 18.5% from pre-pandemic levels of $94,706 million in 2019.

2022 was a tale of two halves for M&A activity. There was a continuation of the high-intensity activity trend of 2021 in early 2022, which was driven by renewed optimism underpinned by the success of the vaccine rollout, the low-interest environment, private equity sponsors seeking to deploy ‘dry powder’, and strategic divestment and consolidation across the wider market (particularly within the high-tech industrial and infrastructure sectors). A marked difference was felt in the second half of 2022, however, as the Ukraine–Russia war, inflation, tightening debt markets and political change in the UK weighed on the market.

Take-private transactions (i.e., when a publicly traded company returns to private company status as a result of a sale), a firm feature of 2021 and the first half of 2022 (and, in fact, the past decade), also slowed in the latter part of 2022.

In terms of M&A market drivers, public and private M&A transactions play an important part in the UK market, but private M&A deals make up a significant majority of UK-target M&A deals. Public takeovers have a prescribed process under the City Code on Takeovers and Mergers (the Takeover Code), as administered by the Panel on Takeovers and Mergers (the Takeover Panel), whereas the structure and process of private acquisitions are a matter of negotiation between the buyer and seller.

Latham & Watkins advised on a number of significant M&A transactions in 2022, including acting as lead legal counsel to the consortium led by Todd Boehly, chairman and CEO of Eldridge, and Clearlake Capital Group, L.P., on its £4.2 billion acquisition of Chelsea Football Club, which was a landmark transaction and represents one of the largest sports M&A deals in history. Latham also advised Whirlpool Corporation on its strategic joint venture with Arçelik A.Ş., as part of its portfolio transformation, and EIG on the $19 billion joint venture with Repsol Upstream.

Each of these transactions highlights how large-scale M&A deals remain strategically important, particularly for experienced acquirers, as a means to achieve scale, extend capacity and expand product portfolios while consolidating industry position in an uncertain market.

Although high-profile transactions did complete in the previous 12 months, the difference between the M&A environment of 2022 and the stimulus-fuelled M&A boom of 2021 is stark, with 2022 inbound UK M&A deal value (based on target nationality) down 34.7% compared with 2021. However, the market also demonstrated resilience, and there was an overall increase of 18.5% in deal value in 2022 compared with pre-pandemic levels in 2019.

Looking forward to the next 12 months, the macro headwinds that hampered UK M&A in the second half of 2022 are likely to persist in Q1 and Q2 of 2023. However, reasons for optimism exist, and activity can be expected to accelerate towards the latter part of the year. The private markets have demonstrated a marked resilience, many investors are still sitting on record levels of capital that needs to be deployed, and interest rates are expected to stabilise and open debt markets, which should pave the way for increased deal flow. That said, the M&A playbook that has dominated the past few years will likely need to be tweaked. It is anticipated that buyers will readjust their valuation processes, demand increased investor protections through creative structures, and be wary of ambitious closing timelines, with dealmakers likely to spend additional time completing processes as they navigate choppy market conditions.

ESG-related factors are also set to be increasingly significant drivers for change in M&A in the next 12 months, driven initially by investor and consumer demand, and followed by legislative developments across multiple jurisdictions.

The most significant trends relate to:

• Industry consolidation, M&A-driven growth, financing considerations or other factors;

• Distressed M&A work – takeover reorganisations, bidding, post-M&A closings;

• The impact of COVID on M&A-related disputes;

• The use of indemnity provisions.

The most significant factors influencing deal structures in 2022 were the introduction of new regulatory red tape and the low availability and high cost of traditional debt financing. The new regulations that are having an impact on M&A activity are discussed in detail below.

In terms of debt financing, the challenges faced by firms in sourcing debt at reasonable rates have meant that private equity and venture capital bidders have struggled to put in place long-term financing arrangements in the post-completion phase, impacting bidder returns and capital availability. As a result, private equity and venture capital firms that could not fully fund transactions pressed the pause button on investments in the latter part of 2022. Strategic bidders with committed but undrawn capital, however, could afford to be more flexible in how they deployed capital and were therefore more active in this space.

In the public M&A context, more difficult financing markets during 2022 led financial sponsors to look to non-traditional lenders and equity co-investors to finance deals.

Private equity acquirers continued to be very active in the UK M&A market in Q1 and Q2 of 2022, which was driven by the need to deploy funds and the relative weakness of the pound sterling versus the US dollar. However, this activity noticeably trailed off in the last two quarters of the year due to market-driven hesitancy.

The UK M&A market has also experienced a significant increase in shareholder activism seeking to secure higher offers for a target company before backing a bid. Despite a decline in activity by activist shareholders during the pandemic, activism is expected to play a key participative role in, and present a challenge to, M&A transactions in the next few years.

In terms of legislation and the regulatory bodies that govern M&A activity in the UK, the UK Companies Act 2006 applies to public and private companies registered in the UK. While the Companies Act 2006 does not govern M&A activity as such, its requirements dictate the way that deals by UK companies are effected.

The acquisition of private companies is a matter of negotiation between the buyer and seller, and no regulated offer process is required. In non-regulated industries (i.e., other than financial services, telecoms, media, and pharmaceuticals), deals are not typically subject to input from regulatory bodies, save for competition and foreign direct investment (FDI) matters.

Public acquisitions are governed by the Takeover Code, a principles-based set of rules issued and administrated by the Takeover Panel.

The end of the Brexit transition period on 31 December 2020 marked the end of the European Commission’s status as a ‘one-stop shop’ for the review of mergers relating to the UK meeting monetary thresholds. This means that if a merger satisfies the jurisdictional thresholds of the EU Merger Regulation and the UK’s Enterprise Act 2002, the Competition and Markets Authority and the European Commission may conduct parallel assessments of the same merger in their respective jurisdictions.

Certain regulatory changes in 2022 had an impact on M&A transactions and will continue to do so. In particular, the introduction of the National Security and Investment Act (the NSI Act) and the agreement of the Foreign Subsidies Regulation (FSR) will impact the structure and timelines of deals.

The NSI Act came into force on January 4 2022, granting powers to the Secretary of State for Business, Energy and Industrial Strategy (BEIS) to screen a broad range of transactions on national security grounds and allowing the BEIS to block or impose conditions on deals. Due to its retroactive application, the NSI Act is already affecting deals. Early consideration of NSI Act-related timing implications is likely to impact M&A timelines going forward.

Additionally, the European Parliament and European Council agreed the FSR in 2022, a regime introduced to control foreign subsidies that distort the EU internal market. Under the FSR, the European Commission will have the power to review a wide range of M&A transactions involving a company that has received a subsidy from a non-EU country and impose remedies against any market distortion created by such subsidies. This new regulatory layer will apply in addition to existing merger control and FDI scrutiny of M&A.

Although the FSR is expected to result in more costly and time-consuming deal processes, there is no suggestion that the European Commission intends to use the regulation to block all deals involving a company that receives a state subsidy from outside the European Union. Thus, while the FSR is certainly a new hurdle for corporate acquirers to contend with, it is not seen as an insurmountable one.

2022 also brought with it a number of amendments and consultations regarding amendments to the Takeover Code. These changes on the whole, however, are not expected to have a material impact on public M&A.

COVID caused significant challenges for companies in the UK, as it did globally, but overall the lasting impact of COVID on deal terms appears limited. ESG issues, however, have become increasingly important for corporates in recent years.

A wider range of deal provisions are being considered in light of their potential to enhance the ESG outlook of acquisitions. While ESG-linked M&A deal terms such as ESG warranties and indemnities have largely remained off the table for auction processes (often due to the compressed timetables imposed on bidders), in certain deals there has been early interest in the private equity space for ESG-linked terms, such as ratchets to help to foster stakeholder alignment on the importance of post-completion ESG enhancements to an acquired business.

In terms of upcoming policy framework changes that may impact M&A in the UK, merger control scrutiny is tightening. In particular, agencies are scrutinising the suitability of buyers and market dynamics more closely and imposing greater evidentiary burdens on merging parties. Strategic management of merger control from the outset is key to ensuring successful deal execution.

Rising regulation of tech innovation is also noteworthy. In the UK, for example, the Financial Conduct Authority is pursuing a formal transformation programme and intends to be more assertive. As such, stakeholders should expect a more interventionist approach from the regulator.

A common misconception about the UK M&A market is that transactions cannot be consummated by way of merger. The Companies Act 2006 does, in fact, provide for merger by absorption for UK public companies, but these provisions are generally not used and a scheme of arrangement is more commonly seen. This approach is in contrast to other jurisdictions, in particular the US, where mergers are frequently encountered.

An area that is often overlooked by parties involved in M&A transactions is that buyers do not usually attend to consolidation of group companies immediately after closing, resulting in continued administrative and financial burdens (for example, filing annual accounts) to maintain dormant or inactive subsidiaries.

Dealmakers are increasingly using artificial intelligence technology to conduct more efficient due diligence in M&A transactions. During the pandemic, dealmakers made extensive use of virtual meeting technology and electronic signature platforms to negotiate and close transactions, and this trend looks set to continue.

The acquisition of control of a public company is regulated by the Takeover Code and the Takeover Panel. A bidder may choose to stake-build to obtain a toehold in a public company. However, depending on the timing of such acquisition and the form of consideration, stake-building may set a floor price and fix the form of consideration for any future offer. Furthermore, acquiring 30% of the voting rights in a public company will require a bidder to launch a mandatory cash offer for the remainder of the shares it does not own.

In addition, any dealing giving rise to speculation, rumour, or an untoward movement in the public company’s share price may mean an announcement is required (if the acquirer is considering making an offer for the whole company), while disclosures will also be necessary once certain thresholds of ownership are crossed.

A takeover offer will usually be subject to an extensive set of conditions, including:

• Securing acceptances carrying more than 50% of the voting rights in the target (or, in the case of a court-sanctioned scheme of arrangement, the requisite 75% target shareholder approval);

• Antitrust and regulatory approvals;

• The bidder’s shareholder approvals;

• Listing of consideration shares (when applicable); and

• Conditions dealing with the state of the target’s business.

A bid cannot be subject to conditions that depend on the judgement of the bidder. Additionally, bidders seeking to rely on a material adverse effect or similar bidder protective condition to not proceed with an offer require the consent of the Takeover Panel, which applies a materiality test with a high bar (requiring the circumstances to be of considerable significance and aiming to strike at the heart of the purpose of the transaction) before it will permit an offer to be lapsed.

In public takeover offers, break fees (when the target pays the prospective buyer) are now largely prohibited, whereas reverse break fees (when the prospective buyer pays the target) are not prohibited. Only in limited circumstances can a break fee be offered; for example, a break fee may be offered to a ‘white knight’ making a bid in competition with a hostile offer that has already been announced (subject to such fee being de minimis and payable only upon the first offer becoming, or being declared, wholly unconditional).

If the bidder is a UK public company and subject to the UK Listing Rules, and the total value of the reverse break fee exceeds 1% of the market capitalisation of the bidder, the bidder’s directors will need to treat the reverse break fee as a material transaction (which, among other things, requires shareholder approval). If the bidder controls more than 10% of the target, a reverse break fee may also constitute a related-party transaction for the purposes of the UK Listing Rules.

According to the eighth edition of the Latham & Watkins Private M&A Market Study (the Latham & Watkins Market Study), 49% of deals included a locked-box mechanism, 26% of deals included a completion accounts mechanism, and 25% of deals did not provide for price adjustment. This trend is consistent with results from the previous four editions. However, as antitrust scrutiny increases (which may lead to delays between signing and the completion of transactions) and we generally move towards a more ‘buyer-friendly’ M&A environment, the completion accounts mechanism could see a comeback.

Earn-outs are often employed to bridge the gap between buyer and seller expectations. The proportion of deals that included an earn-out increased in 2022 in light of the uncertain economic environment. As per the Latham & Watkins Market Study, earn-outs featured in 13% of the UK deals analysed. Given the challenges with the valuation of assets in the economic climate predicted for 2023, earn-outs will likely continue to play a material role in UK M&A transactions to align valuation gaps between the parties.

In private M&A, the conditions to closing that are included in a purchase agreement will vary based on the circumstances of each transaction. Historically, conditionality beyond regulatory and antitrust clearances has been uncommon, but the increasing role of regulation in dealmaking is having an impact in this regard.

The prevalence of FDI approval conditions continues to increase, corresponding with the increased number of jurisdictions with FDI regimes and the high-value, high-profile and strategically significant nature of a number of deals included in the Latham & Watkins Market Study – 15% of deals analysed included FDI approval as a condition.

In the UK, it is not common practice to provide for a foreign governing law and/or jurisdiction in private M&A share purchase agreements. Such agreements relating to UK companies and assets are typically governed by English law and are subject to the jurisdiction of the English courts. In fact, for global transactions, depending on the location of the parties and their advisers, purchase agreements are also often governed by English and Welsh law, because it is viewed as stable, impartial and commercial, with a developed litigation infrastructure.

The exit environment in the UK across 2022 was mixed. The beginning of the year was active for financial sponsors as an abundance of dealmaking carried over from 2021, but this slowed in the second half of the year as economic uncertainty, rising interest rates and stock market volatility created hesitancy among acquirers.

Such macroeconomic conditions also played a major role in muting UK and global IPOs. Pent-up demand, however, may lead to an increase in IPOs and trade sales in the second half of 2023.

Although it is difficult to predict how the current macroeconomic trends will play out in 2023, there are reasons to expect that some of the significant headwinds that impacted UK M&A activity in the second half of 2022 may give way.

While UK M&A activity levels will likely continue to lag in the first two quarters of 2023, consistent with the environment in the second half of 2022, deal activity is likely to accelerate at the end of the year as investors continue to hold record levels of cash and inflation and interest rates stabilise. Nevertheless, factors that suppressed M&A activity in 2022 remain, and it is unlikely that the 2023 market will be as seller-friendly as it has been in previous years.

While investors will likely return to the market to attempt to take advantage of a reset in valuations and generally depressed competition for deals, they will likely proceed with caution and be particularly focused on the greater regulatory burdens when they target UK companies. Latham & Watkins expects that this will result in longer deal processes overall as the risks and benefits of potential transactions are more carefully considered, enhanced diligence is requested, and deal structures and terms are adjusted in response to perceived risks.