Market Eye: Our snapshot of the M&A backdrop

It is clear that 2023 was a year that lacked confidence but we are just starting to see a thaw in mood.

Shareholders are showing signs of frustration at lack of growth and activism cannot be far away. It is hard to see where strong organic growth is going to come from in 2024 and, potentially, even into 2025. Inorganic growth through M&A activity is increasingly what we are hearing to be on the minds of CEOs.

Boards need certainty and longer-term finance rates are already coming down. Deglobalisation is a myth, companies are seeking duality of supply to avoid exposure to one country given geopolitical tensions and new customer markets are as attractive as ever.

Economics and backdrop – Central banks and policy makers have prioritised tackling inflation and at the end of 2023 we saw a near uniform drop in inflation rates and the plateauing of central bank interest rates. We believe that interest rates will generally hold steady in the early part of 2024 while policy makers gain confidence that inflation is firmly under control, following which interest rates will reduce steadily over the course of 2024.

Consumers have seen an erosion of their relative earning power and this has weighed on confidence but a more positive economic outlook will help instil confidence in households. This improving economic backdrop as we move through 2024 will help raise confidence in current trading and business plans, which will aid the pricing of deals and deal activity more broadly.

The debt markets are critical to underpinning a more positive outlook in 2024. Interest rate hedging is expected to become an agenda item again as the yield curve falls and Corporates are able to lock into the expectation of falling rates and the certainty to future funding costs. There being continued rigour from credit committees who are setting a higher bar for new propositions, and seeking a need for real conviction in due diligence findings.

Elections over the next 12 months are set to make 2024 the year of change. The impact of this is very jurisdiction specific, a number of economies are operating under historically high tax levels but with little room in public finances to allow wholesale cuts.

Shareholder activism is expected to be on the increase and will revolve around the question of remuneration for senior management and whether remuneration plans are linked appropriately. Shareholders will want to see a fair balance between the lack of growth and phased remuneration that does not instantly reward only modest, short-term improvements.

M&A Landscape – After 12 months of vendor expectations being too high on valuations, H2 of 2023 started to show some balance, reflecting greater confidence. Tech M&A has held up more strongly than other sectors and is likely to lead the way and we are encouraged to see valuations rebounding. We believe this will continue into 2024 but at a modest rate, more encouragingly this should spread to other sectors and eventually this will result in an increase in deal volume.

The valuation gap will remain one of the key deal issues to settle on transactions and we continued to see this being bridged with deal structures such as put and call options and other legal methods of sharing economic risk that can benefit sellers in the long run if there is continued performance.

We have seen the M&A lower mid-market being more resilient than the upper mid-market. The latter will always dominate headlines and if boards see regular $1bn plus deals it will naturally instil confidence. Bigger value transactions have declined in the short term but when looking at longer trends they are not out of line with historic activity and 2024 is likely to follow the median numbers rather than being an outlier and this should be seen as a positive by the market.

Market Participants – Corporates are doing off-market deals and those who are able to acquire without debt funding are in pole position. However, there is a mixed dynamic with some companies seeing the current market as an opportunity to snap up companies in a less competitive environment. Other companies are on pause, focussing strategically on core assets as they wait to see with more certainty what is happening to interest rates and economic activity.

Financial Sponsors continue to have capital to deploy but are being selective and sometimes choose to write all-equity cheques with a view to refinancing in the medium term. Deal processes are generally becoming elongated, with more preparatory work required to satisfy internal and external diligence requirements. Sponsors have also preferred to focus more on accretive add-on activity in 2023, rather than acquiring new platforms. As the market settles in terms of both interest rates and the macro environment, we expect an uptick in private equity transactions from this historic low base. There is a material backlog of quality assets being prepared for sale, with private equity firms under pressure to deploy capital after a prolonged period of inactivity and others needing to crystallise exits.

Some companies in this sector are facing financial difficulties. for example, food manufacturing businesses have been hit with higher commodity prices and wage inflation and this has resulted in a number of companies entering into administration. Other sub-sectors, such as the luxury sector are faring better and luxury businesses (certain products seem less sensitive to the cost of living crisis such as perfume) are getting high valuations. We see more M&A deals happening in the fragrance space and this area will continue to be very active in 2024.

Evidence of Private Equity interest has waned and there is a reliance on trade competitors as acquirers in the sector. 2023 was a strong year for the luxury brands but market is slowing down in the US and this is likely to continue into 2024 and be replicated in a number of regions.

Specific sub-sector trends that are noteworthy:

• Hospitality & Leisure

The sector has seen a bounce-back post-COVID but remains in a delicate position as the cost of living in a number of jurisdictions remains volatile.

A number of travel businesses are getting ready to come to market in 2024 as revenues return and there is more evidence of performance to

• Food & Beverage

This sector has been hard hit by the cost of living crisis and supply chain issues. Coupled with an increasing regulatory burden affecting businesses in the sector and with more on the horizon, for example the new EU regulation on packaging and packaging waste, the UK extended producer responsibility legislation and the restrictions on the promotion of products high in fat, sugar and salt, is dampening confidence and makes holding valuations in the current climate very difficult.

These additional costs and responsibilities may cause businesses to look to raise investment to fund operational change, reconsider producing certain SKU’s/modify methods of production and ingredients and, potentially, divest non-core business lines.

• Retail

The retail sector (except luxury) is struggling with a number of volatile cost areas. M&A activity in the sector tends to be driven by distressed scenarios as Boards continue to grapple with the key strategic decisions and the blend of online presence and physical stores.

There are some bright spots, for example Kering and LVMH continue to acquire many locations for their luxury shops (in Paris, for example) which bucks the trend of the other retailers.

It remains difficult in the retail subsector for businesses to find the right time in bringing assets to market.

Energy transition and decarbonisation is critical for all of our clients and is driving energy related M&A activity. Corporates are continuing to think of how to decarbonise their power with no easy solution for many.

M&A continues to be very busy. Funds are becoming more active and looking at buying more than single sites and single companies, the strategy is looking for a suitable platform that will allow them to deploy capital on more than just a single asset which is seen as the better strategy for future growth. Fundraising has been more challenging in the last 6-12 months, however a number of funds are coming towards their end with investors needing to deploy their cash from earlier fundraising.

Utilities are becoming increasingly active and we are seeing them outbid a number of funds in areas where they would traditionally have not been able to achieve parity. There is a showing of financial muscle and desire to get into the clean energy space. COP 28 recently provided a platform to show the intent, with 25 leading utility companies from across the globe joining forces with IRENA and the UN Climate Change High-Level Champions to launch Utilities for Net Zero Alliance which we see as further evidence of the focus on M&A.

We are still in an increasingly regulated environment. It is unlikely that new subsidies will come into play in the majority of global territories but governments everywhere are seeking to make changes that will allow investment and change to happen quicker. For example in the UK grid connection is a focus, zombie projects can be removed and others can jump up the line so things can happen more quickly.

We are seeing less W&I on transactions which we interpret to be a function of investors protecting their yields, they are self-insuring to squeeze as much yield our of assets as possible.

Specific sub-sector trends that are noteworthy:

• Clean

There has been significant growth in off-shore wind and regulatory changes have provided opportunities in this area. However the last round of off-shore wind contracts was not taken up as the prices were too low.

We see a continuing trend of solar facility development, intense competition in this sub-sector and the ambitious growth plans of incumbents and new entrants means that an increase in M&A activity is likely.

• Hydrogen

Hydrogen is a critical component in achieving net-zero goals. The technology is still developing so we see joint ventures and strategic alliances increasing in this sub-sector as capability increases.

We have seen much more activity in this field in the last 6 months which has been driven mainly by the big utilities and oil and gas majors, rather than funds.

Supportive government policies in Europe and Asia make these regions more active but this is an area with global focus.

• Infrastructure

Battery storage remains a good investable structure and remains strong. We see this continuing throughout 2024.

M&A transactions are becoming larger, there is trading of portfolio assets and a general trend of larger and larger projects will continue.

We expect greater focus on portfolio optimisation as shown by ongoing reinvestment of capital in key strategic priorities.

Change of political regimes mean some people are thinking about how to manage sale mandates. Upcoming elections in certain geographies around the world in 2024 is leading to investors analysing whether potential new governments are known as ‘infrastructure heavy’ spending. Particularly those with a real focus on de-carbonisation.

As with many other sectors, there will still be pent up demand to do deals in 2024 and we expect activity to increase as the year progresses. Regulatory change is still a big driver in the sector. We have not seen material changes in behaviour from regulators in the sector, however it is a buyer’s market and inevitably deal terms are hardening around termination rights as a result gaps between signing and closing, often driven by the requirement for regulator consent. 2023 was still the third biggest fundraising year on record. However, we are on a down period in the investment cycle and we were still seeing less deals being done towards the end of 2023.

Although M&A activity levels have dropped generally in Q4 of 2023, we have seen our Financial Services sector clients as a whole having performed marginally better than the market. Within the sector, high value deals have declined as risk appetite is tempered and that is likely to continue into Q1 of 2024. We have seen more resilience in low to mid-market deals and some large insurance companies taking opportunities to grow by acquisition. Certain businesses have an inverse relationship to interest rates and will continue to be buoyed by rates around the globe, pensions administration businesses are a classic example and where we see our clients still active in M&A.

Corporate investors have been active in the fintech space and where there is a strategic angle, such as access to a customer base or a particular technology, those deals have been particularly competitive. Private equity funds have remained very interested in financial services businesses and we see this continuing.

In the UK we expect 2024 M&A activity to feel the impact of the BVCA Venture Capital Investment Compact, the campaign to get more pension money into UK venture and part of a move to use pension fund assets that is common place in markets like the US.

Specific sub-sector trends that are noteworthy:

• Banking

Challenger banks will be consolidating quite a lot over the next few years as we have seen by a number of US banks struggling with the devaluation in government bonds. US investors are eying up Europe as a place to consolidate given the strength of its economy compared to some EU member states.

• Asset & Fund Management

Asset management, wealth and insurance are remaining strong. We are seeing acquisitions of alternative assets becoming a trend and expect this to continue.

• Insurance

We see a lot of insurance activity and it is a real bright spot. There is a good market for life companies/broker work, companies are being more selective but there is still plenty of activity and a desire for more. Life insurance work is busy on the asset side rather than M&A, however we predict that this will follow through and result in corporate work in the short term.

Insurance broking is consistent and has stayed busy. The consolidators are still busy consolidating and valuation discussions can be leveraged by those in a strong position.

Mansion House Reforms in the UK now allow more pension scheme money to go into private capital triggering big players (such as insurance companies) to consider private equity/fund management.

• Crypto Assets

Regulation of crypto and crypto assets is being implemented in Europe and other jurisdictions, such as the UK, anticipate doing likewise next year. This is often a driver for activity as participants in the sector look to deal with the additional regulatory burden.

The drivers for M&A in the sector remain incredibly strong. Healthcare systems remain under pressure having experienced extreme stress throughout the COVID-19 pandemic and beyond. Coupled with growing demand for healthcare (both public and private), the ability or capacity of health systems to deliver through traditional care models is challenged and the industry is looking at new innovation to adapt to delivering more personalised care.

Technology is helping drive this change in a number of different ways, including through the adoption of different care models and in accelerated drug development and delivery.

Inflationary cost pressures and a scarcity of supply in the labour market are driving care providers to find tech-enabled solutions to deliver more personalised care more efficiently, to help bridge the gap left by a shortage of skilled employees. Companies providing telehealth-enabling services will be attractive investments. Analytics technology will also be important as the private sector in particular focuses on digital solutions to deliver consumer-centric solutions to enhance personalised care.

The sector is a bright spot in the M&A landscape and we hope that policymakers do not stifle the optimism. We are seeing instances where a divergence of regulation and policymaking between differing jurisdictions is causing complications in cross-border M&A. For example, when it comes to medical devices we have seen significant legislative changes in both the UK and the EU since 2021 which are yet to be fully implemented and have led to additional considerations between buyers and seller when it comes to structuring changes of control.

We are seeing an increase in the number of smaller transactions due to foreign investment screening and merger control and a tendency for corporates to acquire IP, technology and R&D assets at an earlier stage of development.

Specific sub-sector trends that are noteworthy:

• Pharma

As drug substances become increasingly complex, more rapid innovation and production is needed to bring solutions to market faster, and keeping expenses in check, or even reducing costs, is top of mind for many pharmaceutical companies. Contract development and manufacturing organization (CDMO) or contract manufacturing organization (CMO) should remain attractive from an M&A perspective as their services are used to help pharmaceutical companies bring new products or formulas to market quicker without investing in additional infrastructure to support it.

• Bio-Tech

We see high levels of activity in bio-tech and this will continue for the foreseeable future as the continuous stream of technological advances (in part fuelled by AI) and scientific breakthroughs shows no sign of slowdown. Biotech valuations have also rebalanced in the previous 18 months and come down from extreme highs, making assets more attractive for acquisition. These factors, combined with the general need on behalf of Bio-Tech businesses to raise funds, should fuel activity in 2024.

• Healthcare services

M&A is being driven and activity will continue to increase as a result of consumerisation of healthcare services. In particular we are seeing this in private clinics, vets and dentistry. These areas remain quite fragmented and are likely to see consolidation.

• Life sciences

There are more strategic development agreements and joint ventures being considered by life sciences businesses as a way of pooling resource and sharing risk. They are effective tools in boosting R&D activity without companies potentially shouldering the sole cost on their balance sheet.

There is a shortage of skilled employees for life sciences and specialist healthcare providers (whether in relation to human or animal health) and therefore there is a need for acquirers to attract and retain talent to operate and scale up businesses in fragmented markets. This will be a relevant area of focus, particularly in roll-up and consolidation programmes. We see a number of companies offering competitive equity and/or remuneration incentivisation packages to key operational staff to ensure the success of add-ons to existing platforms.

The sector is still being impacted by variables outside of the interest rate/debt issues (financing costs being macro factors which do also have a material impact, as with all sectors). Clearly Energy price inflation, and the ongoing semi-conductor chip shortages, are having the most pronounced impacts in the Industrials sector. Wages are proving a difficult tight rope to walk; key talent is essential to retain but inflationary pressures are already squeezing margins/earnings, and something will have to give.

The Inflation Reduction Act is encouraging the US to be more domestically focussed, which is weighing down on deals, and this is unlikely to change in the early part of 2024. However, in the middle of 2024 we expect to see an uplift. China is also proving to be something of a drag, with lacklustre (at best) growth coming out of China (based on anecdotal evidence of activity, rather than the numbers being released officially).

OEMs are having to be much more active in managing their supply chain and, in an increasing number of instances, stretching creditors as a source of short-term finance. We have seen several instances of customers providing bridging finance to suppliers where there is no alternative source of supply.

Many companies are looking at vertical consolidation along the supply chain to address concerns and this is driving some M&A activity. Cash is king and we have seen a rise in semi-distressed M&A, with corporates looking to offload loss-making or less profitable areas of their business (particularly in regions which are non-core and a management distraction).

Specific sub-sector trends that are noteworthy:

• Automotive

Electrification, autonomous driving and connected vehicle technology, as themes, will continue to be the driving factors as participants need to develop the capability and skills required. Acquisition of digital technology may be an easier option than internal development.

ESG initiatives remain a focus as the net zero pledges of governments around the world are heavily dependent on the carbon emissions driven by the industry.

The US Inflation Reduction Act continues to reverberate across economies and has driven governments to race to offer subsidies to attract key investment, such as the UK Government enticing JLR to develop a battery factory.

Direct to consumer marketing in the automotive subsector will remain a key theme, and likely heat-up in 2024. The genie is out of the bottle. OEMs will need to improve their customer experience performance and dealers will need to ensure an agency model can sit alongside their more traditional business.

The rise of luxury car sales will continue to drive profitability throughout the supply chain and premium sales will be key to margins.

• Aerospace, Defence & Security

The geopolitical landscape means that defence spending is a priority which should drive activity as companies look to increase capability and find a technological edge. Regulatory scrutiny will continue to impact the sub-sector and that will not change in the foreseeable future.

R&D spend continues to be challenging for a number of companies due to lead times and the cost of capital and so they are looking to joint ventures/strategic collaborations as an alternative to product development.

• Chemicals

As a very energy intensive industry many participants are prioritising cost optimisation to protect margins. This will lead to reviews of non-core assets and rationalisations will drive M&A.

• Building Products

Deal activity is likely to remain slow as the sub-sector is particularly impacted by interest rates and the level of infrastructure projects slows in some western nations. Government infrastructure projects create deal flow and certainty is needed as to deliverability and cost.

Regulatory reform in jurisdictions can jolt participants and impact on M&A processes such as the Building Safety Act in the UK.

The wider M&A market in the sector is not as strong as it has been but is still seeing a good amount of activity. There is a lot of money available to be put to work in both financial investors and the major technology companies that is awaiting a return of confidence to allow it to be unlocked, with many market participants foreseeing an increase of activity in Q1/Q2 2024. Throughout the year, deal terms have remained relatively stable, although valuations have been hit harder - there has not been much translation into ‘oppressive’ deal terms save for in a few isolated examples.

The reduction in activity at a macro level means deals are taking longer. We have seen more put and call type deals as buyers take a majority stake but vendors retain an interest that can be realised in 3 to 4 years’ time which we think will continue into 2024. This is longer than a traditional earn out structure and gives more of a bridge to valuations and longer term earnings, and is often used alongside a traditional earn-out over a shorter period as well.

Generative AI has been the most active vertical for VC investment activity and will become a more important vertical for M&A activity as it matures. AI also highlights the impact of regulations on the technology sector, it continues to be a topic of conversation as regulators grapple with the societal impact of rapidly advancing technology. The EU is implementing the AI Act and whilst it is not coming into effect until 2025, many will be grappling with the implications throughout 2024.

In 2024 we are going to see some consolidation in maturing sectors, fintech for example. There will be some mergers out of necessity as capital allocation is constrained and businesses could hit a wall when unable to raise their next round of finance. Some will have to merge and some will be acquired by major corporates which are likely to see picking up in pace towards the end of Q1 2024.

We have seen US investors look a little more inwards in the last 12 months, compared to historic activity as shown by the investment statistics; in Europe and $82bn was invested in 2022 which was down to $45bn in 2023. This cannot continue as there are too many funds that need to do deals.

Specific sub-sector trends that are noteworthy:

• Technology

Large technology companies are still looking for good assets of modest size with the strategy of adding valuable capabilities that will improve their core business. We see this trend continuing, particularly as many transactions are not debt financed. The intrinsic geopolitical value of technologies will continue to drive M&A with strategic technologies, such as semiconductors, expected to generate a lot of M&A activity.

Integration remains a key focus and those proficient serial acquirers have repeatable success in swift integration. A failure to do so efficiently will be a limiting factor in transactions.

The mid-market and lower mid-market deals market is expected to remain resilient.

• Digital Infrastructure

Digital infrastructure is an M&A hotspot for corporates and funds. We are seeing an increasing trend which has moved from data centres to the whole landscape, connectivity both onshore and sub-sea fibre. The increasing demands of AI will only place additional pressure on infrastructure which will require substantive investment. Infrastructure is increasingly being looked at as the whole landscape, not just data centres, including connectivity through onshore and sub-sea fibre. The demands of Generative AI are a key driver of growth.

Some of the largest corporates (particularly with edge computing requirements) are thinking of coming out of consortiums and building the relevant infrastructure themselves.

In Europe, regulators have said they are open to consolidation of the terrestrial fibre networks. In 2024 we see a lot more consolidation as a result of this as participants look to establish more pan-European networks.

The sub-sector is more immune to geopolitics than others as demand is such a driving force. We are not expecting the US elections to have a material impact.

• Media

A bright spot in the sub-sector is video gaming which we anticipate will remain active. This sector is experiencing the most significant growth within the broader media and entertainment space. There is demand for platforms to be integrated and we anticipate that investment in new titles will continue to be ready to benefit when there is an uptick in consumer spending.

Gaming looks set to continue to grow and be attractive for corporates and funds. Virtual reality hardware prices are dropping and making them more affordable to the consumer. Developers will be looking to leverage off this and landing a big title will make any modest sized players an attractive acquisition target.