The M&A market needs stable economic, political and financial conditions in order to thrive. Liquidity remained, but as for the others, let’s just say as 2022 unfolded the headwinds increased.
The M&A market lacked the required confidence for buyers and sellers to transact and the risk appetite needed for M&A did take a significant hit. That’s perfectly reasonable given the macro issues we have had to navigate. From the war in Ukraine, the long-tail impacts of Covid-19, right through to supply chain issues and inflation and drastic interest rate rises. Just as we sensed confidence returning slowly but surely, we have the hints of a banking crisis. Markets, understandably, are liable to over-react. Conditions are fragile, we need certainty to return for confidence to grow.
In our teams, we are beginning to see a slow and steady rise in M&A processes as risk appetite starts to return. Many of the issues outlined above, continue to wash through and that continues to throw up some challenging dynamics for corporates and the wider M&A community.
Value
For corporates and private equity sponsors alike, the financial considerations of doing deals are complex. The effect of recent events is most keenly felt in the differences in valuations between buyers and sellers.
In our experience, some of the valuation expectations of sellers have not fully adjusted to the new market realities. Sellers will not get 2021 prices in a 2023 market. This is causing the flow of deals to be stymied, as negotiations are taking far longer and often cause processes to fail. Part of the reason for this is the impact of inflation and rising interest rates on the demand and revenues of target businesses. Current high prices and the unknown impact on medium-term demand, makes it difficult to map EDITDA and place a value on shares and assets. Leveraging the transactions means paying interest at rates not seen since 2007/8. And whilst the cost of borrowing is rising, what we are seeing is corporates and sponsors waiting until later in the year when rates are expected to have levelled out/come down, before committing to deals. This is a large reason for our belief that the market will gradually become more active throughout 2023 and for H2 to be far busier than H1.
Structural differences
Outside of financing of deals, levels of activity and what is impacting deals varies by sector. Whether or not you’re doing deals is largely down to how quickly market sentiment is reacting or affected by the prevailing economic conditions. The consumer sector is an interesting barometer. This time last year, we were talking about deals in the luxury market being particularly active. That has not necessarily gone away, but we are seeing more and more deals in the retail space, particularly food retail and a number of distressed deals in the general retail segment. This shows just how much the macro themes of the day can influence deals in particular sectors and sub sectors. Another case in point is the aerospace and defence sector, where we are seeing more activity and interest than in recent times for obvious reasons.
For many reasons, the regulatory context in which corporates and sponsors operate has become increasingly complex. The ultimate impact is the cost of doing deals and the length of time it takes to get deals done. The sector you operate in has a large degree of influence on this, as well as how many countries the deal spans. Recent regulations around merger control, foreign investment screening and data/cyber are all well known by now, but less well known will be the extent to which new and emerging regulations around ESG will manifest in terms of the choice of target and regulatory process. It’s certainly one we are keeping a close eye on and are having more and more conversations with our clients.
Distressed deals have been a topic of discussion ever since the onset of Covid-19 and, as yet, have not really materialised to the extent expected. There are a number of examples to point to, as in general retail, but we are not seeing volume, largely because failures are going on at the smaller end of the market, and the case for M&A is just not there, which is ultimately leading to insolvency and wind-up.
In closing, our view is that whilst we won’t see 2021 levels of deal activity, we’ll see a market that steadily increases over the course of 2023 and accelerates in H2. Valuations will clearly be a considerable hurdle to overcome, and buyers should factor in additional time to diligence regulatory hurdles and get underneath the numbers. The return of collective confidence is the key that will unlock the deal market – we are not there just yet.
Contact information:
1 Wood Street
London
EC2V 7WS
T +44 (0)20 7919 4500
