Mergers and acquisitions bring huge opportunity for organisations bold enough to embark on the journey – brave expansion into new markets, growing market share, or building adjacent capabilities to diversify products and services. But have we reached the end of “easy” M&A, as a more complex deal environment emerges for those pursuing these previously fertile avenues of value creation?
This year, increased global disruption and market uncertainty has upped the ante in terms of successfully completing transactions, ultimately reflected in depressed deal flow data for much of 2022. Refinitiv reported a 55% drop in year-on-year global deal value during Q3 2022 – the largest fall since the global financial crisis – while year-to-date deal value at the end of September sat at $2.7trn, around a third smaller than in 2021.
The boom of the past few years has taken advantage of the ‘easier’ deals available to complete. While most M&A professionals expect deal flow to pick up again in 2023, executing and realising the value thesis and returns in M&A transactions will be harder, with a significant proportion of the ‘easy’ deals already done.
The impact of geopolitical volatility on supply chains, regulatory friction, and continued mismatches in bid/ask expectations have all contrived to create a highly challenging ecosystem in which to execute M&A successfully. Nothing has affected this more than the challenges faced in the financing market. As M&A returns in 2023, clarity around value creation and cash conversion will be critical.
How have the levels of complexity compounded?
The macroeconomic gear change from a historically high growth environment to flat or recessionary conditions has achieved more than simply pumping the brakes on deal volume and value.
The assumptions around post-COVID high growth have ‘hidden the sins’ in many business plans. They now face much greater difficulty in meeting budgeted and forecast margin performance due to structural inefficiencies in commercial, operational, and technology performance – all of which will increase the difficulty in providing certainty on future business plans and place committed investments on deals undertaken in the last 12 months at risk. Understanding the interface of commercials, operations, and technology is key to this.
Having had the benefit of more operationally straightforward divestments for several years, extracting value through the realignment of PE portfolios or corporate carve-outs will require buyers to take on more highly entangled and operationally complex deals and divestments now, as vendors look to protect and create value themselves in their moves towards their targeted portfolio end state.
The prevailing macroeconomic conditions may also require sellers to address parts of their portfolio that have slipped underwater. An M&A market flooded with distressed assets will demand a very different skillset to realise value, generate appropriate levels of liquidity, and satisfy shareholders with reasonable returns.
This scenario may well create opportunities, but the overlay of such profound technological, societal, and geopolitical disruptive factors – all sitting outside of the traditional M&A playbook – will complicate how the path is plotted to taking full advantage.
Value creation (and protection) via revenue and growth – and accurate forecasting of this – will be critical in the first three years of deals, as businesses battle against contracting consumer confidence and soaring input costs. This will force strategies to switch up and dive deeper into the minutiae of margin and cash management to meet more challenging financing commitments. Meanwhile, growth plays are likely to concentrate on roll-up and buy and build activities that seize the opportunities presented by the industry-specific impacts of the past three years of persistent disruption – in the automotive and aerospace industries, for example.
Five strategies for success in 2023
In preparing strategies for 2023 and beyond, articulating value, increased scrutiny during diligence, and regulatory knowhow will all be areas of high priority:
- Sellers must initiate and embed longer lead times to prepare businesses for market. The days of merely providing overly promising sales pitches have passed, and a compelling value story backed by evidence of action already under way will be vital in building confidence amongst potential buyers at this early stage.
- On the buy-side, more robust diligence and forecasting is essential. Greater scrutiny must be placed upon the EBITDA and cash plans for the first 12-24 months to protect value and cash conversion, in addition to clear margin upside plans that will assist in managing the increased volatility and risk in such an uncertain, rapidly evolving environment.
- Detailed drilldowns into the post-merger integration of commercial, operational and technology levers. Leaving no stone unturned during such a critical, time-pressured period for catalysing value creation will prove a key component in driving performance improvement at pace.
- Increased reliance on regulatory advisory expertise. Making this a more fundamental part of early-stage M&A strategies will go a long way to countering the additional complexity likely to arise in deals as they are more frequently viewed through the lens of ESG impact – emissions intensity, political instability, and supply chain integrity could all place weighty obstacles in the way of timely execution.
- A more repeatable and structured approach to roll-up/buy and build strategies. A highly disrupted landscape that may be further buffeted by factors beyond dealmakers’ control demands processes that will stabilise a business quickly and significantly improve the chances of an accelerated multiple uplift.