These days, the world of mergers and acquisitions seems quiet, but below the surface there is a buzz of activity, investment bankers say.

Buyers, both companies and private equity firms, are analyzing scores of acquisition targets, hoping to take advantage of cheap recession prices. Sellers are eagerly waiting for the payday only a deal could provide.

And yet the deals aren't getting done. Claire Gruppo, managing director at boutique investment bank (Gruppo, Levey & Co.), says the M&A environment in the past year is "the most difficult I've ever seen."

In the first half of 2009, U.S. M&A volume was $365.7 billion, down 45% from the first six months of 2008, according to Dealogic. Global M&A volume was off 35% to $1.14 trillion.

M&A activity would look even worse if not for a couple blockbuster deals in the pharmaceutical industry. Pfizer (PFE) is buying Wyeth (WYE) for $68.1 billion, while Merck (MRK) is acquiring Schering-Plough (SGP) for $45.9 billion—the two biggest deals in the U.S. in 2009.

There have also been big deals sparked by companies' economic difficulties, such as Barclays' (BCS) sale of its Global Investors unit to BlackRock (BLK), or Chrysler's sale to (Fiat).

But outside of a few industries, M&A nearly stopped in late 2008 and early 2009. "There is a huge pent-up supply of deals because deals were just not getting done in the past year," says Hiter Harris of middle-market M&A firm (Harris Williams). He estimates his firm has about two years of deals built up.

The problems for the M&A market are the same ones afflicting the world economy. For example, "Private equity buyers are looking at everything," Gruppo says. But because of problems in the credit markets, these firms can't borrow enough to complete deals. "At the end of the day, we can't make it work."

Beginnings of a Rebound?

For strategic buyers—companies buying other companies—the problem is that boards are being "massively cautious," Gruppo says. Many firms are too worried about their own financial situation to consider buying a competitor, even if the price is cheap.

Nonetheless, some are optimistic the M&A market could begin to come back. "It feels like an M&A market that is starting to wake up," says Howard Lanser, an investment banker at (Robert W. Baird). "We've got the beginnings of a rebound in place."

A rebound for M&A requires two ingredients, bankers say, and both could be present in the second half of the year in many industries.

First, buyers need financing. "We're only now seeing signs that the debt market is coming back," says Harris. He and other bankers have noticed that credit investors are taking more risks lately, especially on riskier high-yield debt often used to finance M&A transactions.

Also, buyers need to be able to confidently predict the profits of the companies they want to acquire. This has been difficult in a declining economy.

"If there is no stability in your cash flow, you can't sell your business now. Period," Lanser says.

The stock market rallied from March to June on hopes the economy had stopped its slide and corporate profits had begun to stabilize. As a result, Lanser says, there has been an uptick in conversations among dealmakers—though it could take three to six months before those deals are announced.

But a worse-than-expected report on the June labor market report has raised worries the economic pain isn't over. "There is still skittishness about the economy," Lanser says, calling the state of the economy "the key wild card" for M&A.

Gruppo expects M&A activity will remain slow through the rest of 2009. In retrospect, this may be a perfect time to make an acquisition, she says, but buyers just aren't willing to take that risk yet. "I think that will open up some in 2010," she adds.

Whenever the M&A market recovers, expect it to recover quickly as participants work off pent-up demand, Harris says.

But it could take a while before that recovery materializes, as dealmakers wait impatiently for the economy to get back on its feet.

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