M&A Update: 2022 in Review and What to Expect in 2023

Here's our Q1 M&A update: both a short version (for those of you stretched for time!) and a long version (for those of you ready to dig into the detail).

The 60-Second Read!

What Happened in 2022

• North American deal activity was down on 2021 levels, with a total deal count of ~18,576 (-3%) and an estimated aggregate deal value of $2,231BN (-21.6%). Q1 started promisingly, but as the year unfolded hopes faded that 2021's boom year would be repeated.
• Both economic concerns (inflation, interest rates & recession fears) and geopolitical concerns (Ukraine, trade tensions & U.S. domestic political flux) cooled CEO’s enthusiasm for M&A. An EY pulse survey just prior to the start of the year?found that 59% intended to pursue M&A in 2022 but by the end the year, this had slumped to 46%.
• Globally, deal valuations were down significantly, with average EV/EBITDA multiples falling from 11.1x EBITDA for 2021 to just 8.8x for 2022. Corporate acquirers were the main beneficiaries, with the average EV/EBITDA multiple they paid dropping to 8.1, their lowest level since before the global financial crisis.
• Private equity ‘add-odd’ acquisitions continued their relentless growth, accounting for 77% of PE-backed deals last year.
• Deal flow was down across most sectors.?B2B product & service companies again provided the largest number of targets, followed by B2C and then tech.

What to expect in 2023

• The new year starts very much as a buyer’s market: expect low deal values/multiples (compared with 2021) and for deals to take longer as cautious buyers tread carefully with due diligence.
• ?Despite this, the ‘supply’ of businesses being actively marketed will remain high; most sellers simply don't have the luxury of waiting for M&A market dynamics to swing back in their favor.
• Fast-moving corporate buyers with healthy balance sheets will be some of those best positioned to take advantage of this market.
• The Fed’s ‘higher for longer’ interest rate stance and persistent recession concerns will mean subdued deal activity until at least the 2nd half of the year.?But expect a rapid rebound when buyer confidence returns. ?
• While higher interest rates remain, expect to see: (1) more distressed M&A, and (2) greater use of seller financing and equity consideration – potential sellers, take note!

The Five(ish) Minute Read!

What happened in 2022: from a roar to run-of-the-mill

M&A market sentiment started the year positively, with 59% of CEOs telling EY’s leadership pulse survey that they planned to pursue M&A during 2022.?It was anticipated that the record levels of activity seen in 2021, where 19,139 deals closed in North America (Pitchbook ), would be exceeded. However, activity quickly flattened out and the deal count for the year ended slightly below 2021.

Economic conditions and their impact on management sentiment damped-down what had promised to be a record year for M&A activity in North America. The headline issue was inflation which, as we know, rose steadily through much of 2021.

At the end of 2021, consumer prices were up 7% year-on-year (BLS ). It was clear that the U.S, Federal Reserve (Fed) would intervene by increasing interest rates.

The Fed's first, albeit modest, move came in the middle of March 2022 and was followed in quick succession by a series of rate increases that left the Federal Funds Target Rate at 4.5% by the end of the year.

Rate hikes had two detrimental impacts on the M&A market: Firstly, because the Fed's intent was to 'cool' economic activity, many business analysts and CEOs began to anticipate a recession. Secondly, the market landscape for investors relying on debt to fund their acquisitions changed materially with the prospect of interest costs materially eroding investment returns.

Concerns about the economy and higher borrowing costs quickly translated into downward pressure on prices buyers were willing to pay for acquisition targets. The average enterprise value (EV) to EBITDA multiple across all transactions tracked by Pitchbook dropped dropped from 11.1x EBITDA in 2021 to just 8.8x EBITDA for 2022. This was primarily driven by a drop in valuations paid by corporate (rather than PE) buyers.

All sectors saw the average EV to EBITDA multiples drop. The outlier, if there was one, was financial services where globally average multiples across all deals tracked by Pitchbook dropped to 11.4x from 12.3x the proceeding year, a relatively small decline.

A defining feature of middle market M&A over the past 20 years has been the growth in private equity-backed deals.

In 2022, Pitchbook estimated that 35.6% of the transactions that it tracked globally were directly or indirectly backed by these financial sponsors, the first decline since 2013 albeit a decline of less than one percent.

Overall PE deal count was down globally from 14,592 to an estimated 12,337.

One interesting M&A market dynamic from 2022 related to the other end of the PE investment cycle. Trade sales were the dominant exit route last year, the data suggesting that PE fund managers steered more deals to corporate buyers as other exit options narrowed, according to S&P Global . It calculated that trade sales accounted for more than 77% of overall exit value, a far greater proportion than any of the previous four years, when trade sales sat between 46% and 55% of exits by value.

What to expect from M&A in 2023: "It's the economy, stupid!"

Deal activity and transaction trends in 2023 will be driven by the economy and buyers' management perception of it.

The year has started off as one that squarely favors buyers. In January the economy added 517,000 jobs and the unemployment rate dropped to 3.4 percent, a rate last seen in May 1969 (Bureau of Labor Statistics ). This is 'bad news' in that economics (specifically the Phillips Curve) tells us that lower unemployment means people spend more, leading to more pressure on prices, increasing/sustaining inflation. In turn, we expect further interest rate increases from the Fed and for those to potentially last longer, fueling recession concerns.

That said, as soon as the Fed signals an end to interest rate rises and businesses regain confidence in the economy (or at least some certainty about the duration/depth of the much-anticipated recession), we expect acquisition activity to be reinvigorated and for the swing in M&A sentiment to be rapid, just as it was in Q3 2020.

So what to expect in this buyer's market?...

Firstly, expect purchase multiples to remain relatively depressed (and perhaps dip further from Q4 2022 levels).

Secondly, cautious buyers will take more time and be likely go deeper with their due diligence. That will see transactions take longer to close.

Thirdly, expect an increase in seller-financing in small/middle market deals and the use of buyer equity in public transactions. Buyers will be looking to leverage their increased bargaining strength into the deal structure and to minimize the impact of higher interest rates in leveraged buy-outs.

Lastly, expect to see an increase in distressed M&A as cash-strapped businesses are forced to divest or seek new ownership.

One thing that we don't expect to see is a significant reduction in the 'supply' of deals coming to market. Few PE funds have shown an appetite to extend investment hold periods over recent years. Similarly, founders and other non-sponsor owners have seen so much turmoil in the last three years that few will be willing to further delay an exit in the hope that perhaps they can pick a better time to sell further down the line.

Corporate buyers with cash on hand and PE platforms that can wholly or largely self-fund add-on acquisitions will be well-placed in the H1 2023 M&A market. Although purchasers may be afforded the luxury of a cautious approach, the ability to move at pace (especially in the pre-LOI phase) and to make high quality, data-driven decisions about deal opportunities will remain a vital factor in successful M&A.

Do you have questions about the acquisition market, or need help to plan and execute acquisitions? The CNP team has deep expertise in all aspects of buy-side middle market M&A. We can help you to:

• Undertake market analysis and strategic planning in preparation for M&A
• Design and implement M&A programs that implement your strategy
• Scope target selection and evaluation criteria

• Identify sources of potential acquisition targets
• Locate and reach out to acquisition targets
• Put in place efficient M&A 'pipeline' management
• Build customized acquisition pipeline management tools
• Identify the right deal structure and help you to negotiate deal terms
• Value potential acquisition targets (including locating comparable acquisitions)
• Plan and undertake confirmatory due diligence
• Plan and execute the integration of acquired businesses in a way that captures and grows value
• Assess, track and capture cost and revenue synergies

Reach out to Chris today by email: [email protected]

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