M&A Update Summer 2023: When Will the M&A Dam Break?
By Jason Wallace, Head of Citizens M&A Advisory | Published July 20, 2023
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While 2021 was a historic year for middle-market M&A activity, buyers have eased off the pace of frenetic acquisitions — causing an overall M&A decline in 2022 and leading to a slow start in 2023. Middle-market M&A volume has now experienced declines for five straight quarters. The positive news is the backlog of engaged deals which have not yet entered the market is near all-time highs for middle-market M&A firms. Clearly, dealmakers are evaluating uncertain market conditions and evaluating the right time to re-enter.
In our last M&A Update published in Fall 2022, we forecasted that softening of the M&A landscape would continue as volatility in the financial markets persisted. Market uncertainty always injects a level of financial paralysis, and M&A activity has not been immune. The Federal Reserve's (Fed) effort to curb inflation through aggressive rate hikes has dominated business headlines over the last year. The effective federal funds rate has jumped from nearly zero in March 2022 to almost 5% today.
To re-start deal making and a period of more robust activity, greater certainty is needed as it relates to:
- The Fed Tightening Cycle: Buyers and sellers must have confidence that the interest rate tightening cycle is nearing an end.
- Economic Clarity: Market participants seek clarity into the economic impact from interest rate hikes. Currently, market sentiment seems to be building around a soft landing or a short and shallow recession.
- Lending Stabilization: Financing markets need to stabilize — that seems to be occurring as debt arrangers are more confident underwriting transactions at current financing rates.
- Valuation Reset: Sellers must accept the impact the above factors will have on valuations. What goes up must come down — and they will come down. The market is seeing bid/ask spreads beginning to narrow, an indicator of what is to come in terms of valuations.
While market activity has slowed, expected broad-based declines in valuations have not followed suit through the first half of the year. The flight to quality has continued, and those high-quality businesses have traded at multiples consistent with the last two years.
Looking ahead, we remain bullish. Capital from private markets continues to be plentiful. Dry powder from private equity — along with balance sheet cash from strategics — is ready to be deployed for high-growth, well-managed companies. In our last M&A Update, we noted that the number of middle-market PE-backed businesses increased 5x over the last 20 years. Private equity firms have both substantial financial resources and industry expertise, providing them the ability to work in partnership with their portfolio companies to accelerate growth in unique ways. This characteristic will not only drive sponsor assets to be traded more frequently, but will also bolster the middle-market economy for decades.
Although 2023 has had a slower start, we believe that market activity will improve for the next 12 months until the focus shifts to the 2024 election. While the impact of the election on market activity remains unknown, we have near-term optimism for the second half of the year and a strong conviction in long-term secular trends.
Jason Wallace is Head of M&A Advisory at Citizens bringing 25 years of M&A experience advising companies and their senior management teams on critical strategic issues. Historically Jason has been a leader for Citizens' M&A efforts in Business Services, with expertise in commercial and industrial services.
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