M&A activity during the first half of 2023 can best be described as a mixed bag. Mega transaction and upper/middle market deal activity was lackluster due, in part, to nearly frozen debt markets. Syndication deals, IPOs, exit opportunities, and large mergers were scarce.
Generally, the bright spot for the first half of the year was lower/middle market activity. Sub- $20 million (with a majority being sub-$10 million EBITDA) EBITDA businesses actively engaged in deals. These deals were primarily driven by private equity buy and build strategies, as well as founders/owners looking to exit their businesses due to a lack of leadership, succession and management depth; After surviving a brutal environment brought on by the pandemic and its aftermath, they simply wanted out.
Industry activity was also mixed. Lower/middle market investors tended to be opportunistic; there was ongoing activity in industries including healthcare services, business and residential services, and niche manufacturing; and there was renewed investor interest in the restaurant sector. But the discretionary consumer, e-commerce, and technology sectors, already significantly impacted by the pandemic, continued to exhibit low deal activity in the wake of higher inflation and rising interest rates.
We expect that the M&A environment will remain mooted throughout the second half of this year. The macroeconomic environment continues to be uncertain, and it’s anyone’s guess if the U.S. will enter a recession. There are some positive signs: inflation has declined, unemployment remains low, and consumer spending is still relatively strong. But it’s tough to predict Fed policy around future interest rate hikes and this is weighing heavily on investor sentiment.
CohnReznick’s Value360 advisory group focuses on supporting transactions for clients in many different sectors. So, our own level of activity may be a good benchmark for current and future trends. We have pockets of practice areas that are growing, including parts of our valuation practice (primarily real estate, energy, and trusts and estates valuations), as well as our restructuring and dispute resolution practice. Distressed activity is on the rise as more banks become fed up with providing concessions on covenants and carrying additional risk in their portfolios.
Our core Transaction Advisory and M&A Insurance practices have seen an overall decline in activity year-to-date. What we are finding is that investors are reluctant to proceed with business as usual, primarily for the reasons highlighted above. For them, it’s tough to commit resources and dollars to a potential investment opportunity if they aren’t feeling a level of certainty between the time they commit to a deal and the time of closing.
Our clients have commented on a lack of deal quality and consistency. The number of broken deals has increased significantly, which is not surprising in the current environment. Although sky-high valuations have been coming down, that is not enough right now to drive up deal volume.
While investment banking firms say they have healthy pipelines – better than in the past few years – that’s not enough to translate into actionable deals. These firms initially were expecting more activity in Q3. Then it became Q4. Now, some are writing off 2023 completely and looking ahead to 2024.
It is not for lack of trying. The entire M&A ecosystem is ready to get back to business. While the dry powder for transactions remains high, the amount of capital available for new fundraising is much tighter than we have seen in prior years. So, leveraging dry powder may be good for the short to medium term because investors don’t want to return unused capital to limited partners. However, investors must be disciplined and focus on returns that have a much longer-term impact on investors.
There are many opposing forces dictating today’s very uncertain M&A market. But there are always ebbs and flows in any business cycle and we will certainly emerge from the current situation.
The question no one can answer is: When?