History shows that downturns, market lulls, and times of disruption always produce newer, stronger competitors that used the mayhem to make market gains. The M&A downturn of 2023 will likely be no exception, but it is not too late to act.
We expect to see more deals get done in 2024—if for no other reason than there are a lot of assets that should trade. We call it the “big backlog.” For example, while we often talk a lot about private equity (PE) dry powder, we also now have a backlog of PE portfolio companies that need to come to market. Many of these will be bought by strategics; others will be rolled into other financial sponsor portfolios. Likewise, our executive interviews suggest that corporates held on to assets that now should be divested and or spun out. These, too, we expect to come to market.
For the most part, corporate balance sheets remain strong, with lots of cash on hand, and the cycle of interest rate hikes seems, as of this writing, to have run its course. Any certainty around cost of capital will be a boon to dealmaking, and even more so will be a reduction in interest rates.
The M&A market has always had a bit of boom/bust nature to it. Experienced practitioners tell us that when the rebound in deals comes, it will most likely be fast—probably more scale deals first, as industry consolidation plays continue (see “M&A in Energy and Natural Resources: The Circular Economy Is Not Linear”), and then a return to scope-oriented capability investing to drive growth.
Of course, there are still some things that will hold deal volumes and values back. Regulatory scrutiny’s greatest impact may be in stopping deals before they ever get started. At the same time, geopolitical tensions may well keep the lid on certain cross-regional deals. And, of course, having been hit by several recent “black swan” events (pandemics and war, to name two), we remain humble in our predictions regarding future events.
That said, we expect 2024 to be a busy year. Let’s look at the M&A agenda that will give dealmakers the edge in the year ahead.
Proactive and prepared
Why was deal activity in 2023 so anemic? The simple answer is that with valuations so low, sellers did not want to sell.
Indeed, a big complaint by prospective buyers that did fewer deals in 2023 was that there were few attractive assets, according to our executive survey. Yet, successful buyers had no complaint. That’s because they created their own deal flow through proactive sourcing and screening. And these are the same companies that will be ready to capitalize when the big backlog of deals breaks in the months ahead.
Our conversations with executives point to two backlogs—corporate entities that have assets that do not fit with their long-term strategic priorities and PE portfolio companies that are aging in their funds and need to be sold. Neither group has been overly inclined to sell assets over this past year, but for very different reasons.
Corporates don’t sell for a bunch of reasons, the top three being bandwidth, cash flow, and inertia. Selling businesses is a time sink like no other. Stressed-out management teams over the past few years have not had the luxury of cleaning up their portfolio. When they do want to sell an asset, there often are two complications: The nonstrategic assets still contribute cash flow, and their divestment will leave stranded costs behind. And in the absence of activist investors, it is just easier to leave things in place, especially when deal valuations are down and stock prices are up.
But our experience shows that hanging on to assets too long leads to value destruction and misallocation of capital and management attention. Disappointing prospective valuations can dissuade companies from making the call to sell. Then, a weaker version of the business ends up on the market a few years later. Yet rarely does a better market multiple compensate for a less attractive asset.
Meanwhile, PE funds must sell, but they have huge discretion as to when to do it. The drop in deal multiples led to a wait-and-see atmosphere in 2023 (see “Looking Back at M&A in 2023: Who Wins in a Down Year?”). But if we now live in a world of lower multiples and more disciplined buyers, how much more value is there in waiting?
Who will blink first? Certainly, a cash crunch will bring some sellers to the table. Divestitures of more solid businesses by companies reshaping portfolios (or PE funds compelled to exit) will be a bigger factor in breaking the logjam. No matter. Buyers and sellers who aren’t waiting for others to make the first move will have the upper hand.
Value creation fundamentals
Benjamin Graham, the father of value investing, spoke of the “margin of safety.” It was a warning to all investors that has as much currency in 2024 as it did in 1934. Higher interest rates have introduced a whole new generation of M&A analysts to the concept of cost of capital and the value of $1 of earnings in the future. This has led some acquirers to make a short-term shift to scale deals where the cash flows are nearer and more certain. For others, it has shut off the M&A tap for the time being. But we know that the market ultimately rewards growth.
With the slimmer margin for error, a new deal discipline is coming to the fore. Being more selective was the top adjustment that M&A practitioners made in the face of rising interest rates, according to our recent survey. While we generally applaud more discipline among dealmakers when setting a deal strategy, staying on the sidelines means missing out. This is the time to lean heavily into a more proactive due diligence to build proprietary insights and tee up merger integration (see “Tougher Times: Putting the Diligence Back in Due Diligence”).
We expect competition for assets to intensify in the year ahead. As interest rates stabilize and even possibly decline, PE firms and M&A-cautious corporates will reenter the market. True, some competitive advantage will accrue to strategics that underwrite deals, with revenue and cost synergies not available to financial investors (that also have to contend with higher financing costs these days). But conviction and speed will be paramount. Successful buyers will use diligence to uncover a differentiated view on revenue and cost synergies and win the deal. And then, they will accelerate value realization in integration by using pre-close planning to rapidly mobilize and execute quick wins.
Sharpening the M&A capability for the next 20 years
We believe that the processes, skills, and tools that successful M&A practitioners have used over the past few years will be insufficient to stay ahead of the game going forward.
Two huge implications of our chapter “Generative AI in M&A: Where Hope Meets Hype” are that the data collection and synthesis elements of dealmaking are going to become greatly compressed and commoditized. Similarly, cultural integration and management have entered a new era in insight and importance. And as deal teams increasingly look to developing markets and emerging technologies, old rearview-mirror diligence techniques are going to prove themselves inadequate for assessing and valuing new opportunities.
Meanwhile, amid more regulatory scrutiny, companies must elevate their deal strategy and integration approach. As we explore in our chapter “Regulation and M&A: How Scrutiny Raises the Bar for Acquirers,” the prospect of a longer and more uncertain pre-close period raises the bar on early scenario testing for risks and a nuanced pre-close integration roadmap.
The most frequent acquirers, as always, will have a leg up on making this transition. In fact, the occasional acquirer may be shocked to see how much the world has changed—and wonder why they cannot win deals that they have a right to win.
Read on to learn more about the future of M&A across industries and newsworthy geographies.