Despite headwinds, interest in attractive opportunities remain
Commentary by Jim Zipursky, Chairman & CEO of Corporate Finance Associates Worldwide, a Strategic M&A Partner of TSG
Riffing on Charles Dickens: These are the best of times and the worst of times. After 12 years of unprecedented strength in the global M&A market, 2023 will be a challenging year for M&A worldwide.
Rising interest rates, soaring energy costs, inflation, labor shortages, and widespread recessionary fears are sending mixed signals to companies contemplating M&A activities.
I recently completed a trip to Europe. I met with the senior management teams of more than ten large-cap European-based, global companies. Over the last several months, I have spoken with over 100 U.S.-based senior leadership teams of companies across various industries. My meetings and interviews led me to the following thoughts as to how M&A activities will be impacted in 2023:
- Rising interest rates will negatively impact transaction values. Over the last six months, interest rates have been up 3%. This directly affects the amount of leverage buyers can place on deals and puts pressure on expected ROI, causing buyers to lower purchase offers. We have seen deal multiples down by one to two turns of EBITDA.
- Availability of capital will continue to feed the M&A machine. North American and European Private Equity (PE) groups collectively have more than $1 trillion of investible capital on their balance sheets; capital which “needs” to be deployed in the next five to 10 years. Couple this with record amounts of cash on public company balance sheets, and there is plenty of capital to support inorganic growth efforts.
- Too much money chasing too few “good” deals. PE firms and public and private companies are flush with cash, yet a constant theme we hear across industries is the lack of “quality” deals in the market. Not necessarily “bargain” deals, but opportunities where sellers and buyers have mutually reasonable value expectations.
- The recession will hit Europe harder than North America. Energy costs are a leading driver of a slow recovery in Europe. Consider electricity: in the U.S., residential electricity prices are, on average, 18¢/kwh, while in Europe, the cost is close to 40¢/kwh (with expectations that prices could increase to 80¢/kwh in 2023). Additionally, gasoline prices in Europe are 2x to 3x more than in North America. Energy costs will significantly impact European consumers and businesses, deepening the recession there. The EU vs. North American energy price disparity is tied directly to the continuing war between Ukraine and Russia.
- Many European business leaders will turn their attention to investments and acquisitions in North America. Many of the executives we met with stated the vibrancy of the consumer market in the U.S. is more attractive to them than the investments they made in Russia and China. Specifically, the per capita GDP in the USA rose by 42.7% from 2008 to 2021 while the per capita GDP in the European Union increased by just 3.2% for the same period. The per capita GDP in the U.S. in 2022 was ~$69,000 compared to ~$12,000 in China.
- The ongoing global supply chain issues will force companies to source deals more “locally.” We are seeing a trend towards “near-shoring” where companies purchase more of their products and services from suppliers and vendors, not constrained by geo-political, shipping, or related issues.
- Valuations on recurring revenue businesses will drop from their record highs. Recurring revenue businesses remain in high demand but are not impervious to valuation decreases. According to the SaaS Capital Index, valuation multiples for SaaS/recurring revenue companies declined by 50.4% from December 2021 to October 2022. Buyers are very keen to acquire businesses with recurring revenue streams, but given recessionary pressures, buyers are pricing these concerns into their offers.
- Finally, global inflation is real and will impact all consumers. We are seeing this impact across many industries. Surprisingly, restaurants have not been as heavily impacted as they continue to raise prices to match increased costs. However, leisure industries such as boating and recreational vehicles are seeing inventories increase as demand for these products decrease.
To steal a line from “Game of Thrones,” winter is coming. 2023 will see continued M&A activity, but it will become more of a buyers’ market. We expect valuations to decline, and deals will take longer to close.
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