“If buyers are unable to accurately forecast companies’ earnings or determine valuations, it’s going to be difficult for them to commit capital,” said Tyler Silver, a partner at New York-based investment firm Apex Capital.

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Deal flow is already hurting. During the second quarter, the total value of pending and completed transactions involving US targets reached roughly $347 billion, down 18% from the first quarter and 36% from the same period last year, according to data compiled by Bloomberg.

Distressed Spreads

Average annualized US merger arbitrage spreads spiked above 15% in May and June from roughly 10% at the beginning of the year, according to Frederic Boucher, a risk arbitrage analyst at Susquehanna International Group. That’s a similar to what the market saw in early 2020, when the pandemic derailed confidence in deals being completed, he said. Rising interest rates and lower downside assumptions caused by the stock market slump also drove spreads wider across the board.

Among the deals considered most at risk were Nielsen Holdings Plc, Citrix Systems Inc and Tenneco Inc, survey respondents said. They are in the most bruised corner of the tech sector and have private equity buyers, who tend to be more focused on financials than strategic buyers, who are more concerned about regulatory and antitrust issues.

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Those three deals once had some of the widest spreads among all takeovers, with shares trading at steep discounts to their offer prices, though that in Citrix and Tenneco tightened over the past few days amid closing updates. The spread in Nielsen’s proposed sale to a consortium including Elliott Investment Management and Brookfield Asset Management is still holding around 20% after touching 29% in mid-June — it was 3% in March, when the $16 billion buyout was announced.

However, wide spreads and the threat of repricing doesn’t necessarily mean investors should expect a wave of cancellations. During the pandemic two years ago, five transactions were renegotiated but the deals ultimately got done, according to Julian Klymochko, founder and CEO of Accelerate Financial Technologies Inc.

“The strength in definitive merger agreements is a testament to low termination rates,” he said.

Since 2008, merger contracts have become fairly tight in terms of preventing a would-be acquirer from wriggling out if market conditions sour, Klymochko added.

Deal momentum

“I think some fears priced in the current market are irrational, and the spreads have widened out more than risks have increased,” said Roy Behren, co-chief investment officer at Westchester Capital Management.

For Behren and some other survey respondents, private equity’s pile of money is a key driver for dealmaking in the second half of the year.

“Dry powder is looking for a home, particularly so the PE firms can begin earning their carry on it,” Behren said. “The cash on corporate balance sheets doesn’t have to be spent on transactions, but the whole point of a cash hoard for a PE investor is to use it to make an acquisition. There is no other purpose.”