M&A health-check: will favourable conditions and regulatory easing drive M&A growth in 2025?

2024 was a mixed year for dealmaking, with deal values, if not volumes, increasing compared to 2023. Whilst private capital saw a moderate increase in activity, 2024 has been notable for the significant uptick in larger corporate-to-corporate activity in the UK, as companies have pursued strategic acquisition opportunities and a degree of business confidence has returned. UK public M&A has returned with vigour, led by multiple single-figure billion-pound transactions (albeit no £10bn+ megadeals) and a large number of small-to mid-cap public-to-private deals.

The “problem” stories dominating the M&A headlines in 2024 have included increasing regulatory scrutiny and concerns around deliverability of transactions, private capital sponsors’ struggles to exit their investments and stubborn valuation gaps – bridged, in many cases, by corporates using share consideration.

However, the outlook for 2025 is encouraging. Falling inflation and anticipated central bank rate cuts early this year should result in further improvements to the interest rate environment. Political uncertainty caused by the US, UK and other significant elections around the world is now in the rear-view mirror and there are signs of greater flexibility being shown by key regulators. And several significant M&A drivers, from strategic transition imperatives to private capital value realisation, are converging.

The private capital conundrum

The private capital industry has been under the microscope on multiple fronts throughout 2024 – sponsors have been under pressure from investors both to return capital as funds extend beyond their expected investment horizons and to deploy record levels of committed “dry powder” raised over previous years.

The backlog of portfolio companies primed for exit is well-documented, as the unfavourable interest rate environment, financial shocks such as COVID-19 and the Ukraine war, and weak capital markets have stunted sponsors’ exit processes for investments made using cheap debt at the peak of the market. Even if expected returns cannot be realised, there is now an acceptance that the industry needs to normalise by completing the life cycle of these investments through exit processes. Stop-gap measures, such as the use of fund leverage facilities and continuation funds to return cash to investors, have eased some immediate pressure, but as we enter 2025, the onus on sponsors to exit investments and return capital is stronger than ever.

However, questions remain regarding the exit route for these investments. While there are signs that the US IPO market is strengthening and will offer an exit route for high quality assets in 2025, the same is unlikely to be true in Europe, at least in the first half of the year, as the European IPO market continues to search for positive momentum despite listing regime reforms both in the UK and on the continent. Corporate buyers remain selective, and sales to corporates continue to fall relative to secondary transactions to other financial sponsors. We expect to see this trend continue as the private capital industry continues to expand and institutionalise. The cheaper cost of debt associated with the improving interest rate environment should assist exit processes meaningfully by enabling buyers to offer more compelling prices and reduce the valuation gaps that have persisted throughout 2024. However, the general trend is unlikely to be universal – while some asset classes such as healthcare and med-tech are likely to see high levels of engagement, others such as consumer and real estate may take longer to emerge fully from the valuation challenges they have faced recently.

Alongside exiting investments, private capital sponsors continue to focus on deploying their record levels of committed “dry powder”. Over recent years, higher interest rates have increased the cost of leveraged transactions for sponsors, exacerbating valuation challenges – with an important “lesser written” story of 2024 being the number of private capital buyers who have failed to meet sellers’ expectations on value. The improving financing conditions expected to prevail in 2025 will assist, but, in any event, sponsors are likely to seek creative solutions to structure transactions and allocate capital with precision. For example, we expect to see stub equity offerings employing more complex capital structures in UK public-to-private transactions, and sponsors deploying capital in more structured transactions such as minority investments.

Corporates continue to shape the market

We expect corporate-to-corporate dealmaking to continue to play a significant role in 2025, as companies look to grow and evolve through strategic transactions.

Energy and natural resources is likely to be a leading sector, where larger players look to re-shape their portfolios and smaller players seek synergies through consolidation. We also expect to see continued high levels of activity in financial services, where financial institutions look to modernise offerings, digitalise services, improve their digital infrastructure and compete against emerging players.

Whilst stabilising, the higher cost of debt during 2024 has favoured corporates able to execute deals with existing resources or their own equity – we have advised on public deals involving equity consideration for Direct Line, DS Smith, Redrow and Centamin. However, falling interest rates, coupled with an evolving and increasingly competitive financing market in which private credit providers are expanding offerings to corporates, could result in a greater number of corporates being able to use debt to pursue transactions in 2025.

Despite greater availability of funding, corporate buyers are likely to maintain their opportunistic approach to M&A with a tight focus on capital allocation. We expect conditions to continue to favour buyers, with truly competitive private M&A sales processes remaining generally challenging to construct.

Transatlantic dynamics

Another headline of 2024 has been the valuation gap between UK and US indices, even if that is exaggerated by the different sector weightings of leading indices on either side of the Atlantic, as well as other factors such as accounting practices.

That has not – yet – led to a tide of US corporate bidders looking to acquire UK companies (with DS Smith’s takeover by International Paper being an outlier on this front), although it has arguably made UK companies more attractive to private capital.

Our expectation is that high levels of confidence in the US market will see an increase in US outbound M&A in 2025, although the inflation and related currency impact of anticipated US tariffs remains uncertain.

The disparity in trading multiples has also not led to a flood of UK PLCs seeking to switch their listing venues to the US, but M&A driven by companies seeking a “reverse” merger with smaller US peers cannot be ruled out.

An easing regulatory burden?

A significant trend of recent years has been the increasing regulatory scrutiny over deals and the resulting impact on transaction deliverability, especially in certain sectors. This tougher approach was perhaps best exemplified on both sides of the Atlantic by the initial cross-regulatory opposition to Microsoft’s takeover of Activision in 2023.

However, with leadership changes at the European Commission and the US DoJ and FTC, and some political pressure to soften approach, there are signs that regulatory scrutiny will ease and predictability of review processes will improve. In the UK, the CMA’s recent decision to clear the Vodafone / Three UK joint venture subject only to behavioural remedies has been widely regarded as demonstrating that change in tack.

Nevertheless, from a transaction perspective, we expect the lengthened timelines now associated with regulatory review processes (including multiple foreign direct investment regimes) to remain a feature in 2025, with regulatory conditionality, buyers’ regulatory commitments and associated deal protections continuing to be of paramount importance in transaction negotiations.

2025 outlook

Against that backdrop – expected improvements in debt market conditions, multiple constituents with transactions to execute and a potential lowering of regulatory hurdles – we see positive signs for M&A activity in 2025. Whilst confidence remains fragile, early momentum should provide a platform for M&A growth throughout the year.