Financial market jitters and a sudden geopolitical shock in the last few weeks buckled the M&A market’s ongoing path to recovery.
“Uncertainty is really the killer of M&A deals,” said Andrew Lucano, co-chair of the M&A practice at law firm Seyfarth Shaw.
With a return to normalcy pushed back, dealmakers’ hopes for upcoming quarters lie in an end to interest rate hikes next year, a narrowing valuation gap between buyers and sellers, and more global stability.
After Labor Day, M&A activity started to pick up across Wall Street. However, the higher-for-longer view on interest rates and war erupting in the Middle East prompted many buyers and sellers to hit the pause button and adopt a wait-and-see attitude.
“We are absorbing those dual hits and figuring out where to go from here,” said Tom Amster, global head of financial sponsors at Macquarie Capital.
For an M&A pickup to fully hit its stride, acquirers would need a clear signal that the Federal Reserve has concluded its interest rate hikes, Amster said.
Since Q2 2022, higher rates have particularly slowed down private equity’s pursuit of acquisitions as they struggle to find cheap debt for financing. In Q3 2023, PE-backed M&A represented 33.1% of the overall M&A volume, marking the lowest level in the last three years, according to PitchBook’s Q3 2023 Global M&A Report.
Corporate buyers, which can have more wiggle room if they are able to finance deals with cheaper investment-grade debt, took up a larger portion of the M&A market, about 67%.
However, even for those strategic buyers, M&A decisions are sensitive to changes in interest rates. High cost of capital impacts business operations, and when it costs a company more to operate, it is less inclined to pursue M&A investments, Lucano said.
There are other factors to consider. Some clarity on the status of the current geopolitical tumult would also uplift the market.
The 2024 US presidential election stands as another significant factor to watch in the M&A market; a change in administration can lead to policy shifts that may accelerate or stall M&A transactions.
For instance, if a Republican is elected president, that may bring about an uptick in deal flow, since the Biden administration has been concentrated on antitrust enforcement, resulting in an inhibitory effect on M&A dealmaking, said Cullen Sinclair, partner and M&A lawyer at Paul, Weiss.
Narrowing valuation gap
A smaller valuation gap between sellers and buyers would also boost deal activity. Currently, the disconnect stands in the way of getting M&A deals signed.
“Prices certainly adjusted, but the bid-ask spread hasn’t completely normalized,” said Jeremy Schein, a partner at middle-market PE firm Corsair Capital.
But he says expectations from sellers to converge next year with those of buyers as the former recalibrate their valuations in response to the new interest rate environment.
Sectors to recover faster
Certain sectors—such as manufacturing; digital infrastructure, including data centers; and renewable energy—are seeing tailwinds that could spur M&A transactions.
More manufacturers are moving production closer to where their products are sold to eliminate supply chain risks, triggering a “reshoring” trend. Sinclair expects that will stimulate M&A activity.
While areas like wind power have weakened, two mega-deals in oil and gas were announced in October and long-term trends point to an increased flow of capital to green energy.
“Ultimately, the trend is moving toward renewables,” said Amster, of Macquarie.
Advisers hold conflicting views on the technology space. Sinclair said the market has experienced a correction in valuations this year, which may continue to stymie deal activity. His position is in contrast to the other advisers, who said a strong desire among PE and corporate acquirers to strike tech deals will likely support a recovery in 2024.
“There are deals getting done in that sector, particularly if the business is strong,” said Sinclair. “But I think overall you’re probably still seeing pushback from the people who got burned by some deals in 2021 that didn’t go the way they hoped.”
Two prominent tech investors, Tiger Global and SoftBank, marked down the value of their investments and scaled down deal activity following a contraction in tech valuations.
High quality assets will still be sold. Take-privates are expected to increase in coming years due to a valuation reset in the public market. Vista Equity Partners epitomized that trend most recently with its $4 billion October takeover of EngageSmart, a profitable and growing payments software vendor.
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