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Confidence amid uncertainty
Proactive dealmakers are finding value creation opportunities in a fluid business environment. Dealmakers are favoring smaller deals, with deal volume relatively strong compared to pre-COVID periods. While only about a third of deals have a reported value, disclosed deal value is hovering around pre-pandemic levels. Economic uncertainty and regulatory scrutiny have helped dampen big deals and a weak IPO market is helping to create opportunities for buyers with strong balance sheets.
Corporates continue to have an advantage due to their ability to use equity and cash, and inherent levers for synergies and capabilities. Corporate margins, while under pressure, are still above historical norms and equity market returns are positive year-to-date through June 8, 2023. Divestitures are also expected to increase as companies focus on their portfolio, capital and funding.
Companies with the financial flexibility to do deals can transform their organizations by moving closer to customers, leaving challenged sectors and speeding up digital transformation.
A combination of acquisitions and divestitures can add complementary capabilities that help make companies more innovative and resilient. Savvy leaders are allocating more planning time and resources to M&A integration, increasing the odds of success as companies “transact to transform” to gain an edge on more deliberate competitors.
We see four primary drivers influencing M&A activity:
- Capital allocation: With high interest rates, inflationary pressures and near-term economic uncertainty, companies will need to be more purposeful in how they allocate capital to deals.
- Opportunity amid uncertainty: Despite economic volatility, geopolitical turmoil and other pressures, smart dealmakers will be able to find opportunities to reshape their businesses in line with long-term strategic priorities.
- Necessity for business reinvention: Technological advances, demographic shifts (including smaller workforces) and geopolitical upheavals are evolving business models to meet shifting customer demands. Companies that strategically manage their portfolios are at an advantage in this dynamic business environment. Strategic, well-executed integration is the key to a transaction actually transforming a parent company.
- Resilience and innovation for growth and sustainability: As businesses tackle long-term challenges, from climate change to technological transformation, they will seek deals that boost resilience and sustain growth.
Transact to Transform: PwC’s 2023 M&A Integration Survey
Companies have begun to crack the code on how to make integration successful: leveraging experience, early and sustained investment in integration, and a commitment to creating and implementing new long-term operating models.
However, successful M&A organizations — defined as reporting significant success across strategic, operational and financial measures — are rare. Only 14% of survey respondents in our recent M&A integration survey indicated this elusive level of success.
Under the right circumstances, M&A offers a blend of opportunity and challenges. But it requires companies to concentrate on a disciplined, proven approach to integration and ultimately, transformation.
Capital allocation
Bank credit has tightened, bond yields are still high and markets are volatile. This presents opportunities for corporates with strong balance sheets. Private equity (PE) sponsors with large amounts of dry powder also have been getting deals done. Some PE sponsors have turned to more creative financing solutions, including higher equity contribution, seller's notes, paid in-kind financing and the private credit markets.
The IPO market has remained quiet for over a year. Some high growth, venture-backed companies may seek to issue debt as an alternative. Private capital is another option for high growth companies. Some high growth firms, however, may simply decide to tamp down their burn rate and wait for more favorable options. While the IPO market remains mostly closed, there is a large backlog of companies in the pipeline and investors still hold large amounts of dry powder. There will likely be an increasing volume of activity in the new issue market, subject to stability in the interest rate and economic environments, and an acceptance by listing companies of the new, lower valuation environment.
As start-ups look for exits, there may be opportunities for acquisitions at reasonable prices. Strategic acquisitions can help companies increase supply chain resilience, reduce geopolitical risks through diversification or “transact to transform” their businesses with new technological capabilities and market opportunities — such as entering new territories.
Improved executive confidence and a stronger debt market would increase the likelihood of an M&A upturn later this year. Business confidence, as measured by The Organization for Economic Co-operation and Development, is a good current and leading indicator but recent confidence levels have been weak. Debt markets tend to be very strong leading indicators; high-yield lending is also a good current measure. These indicators have improved but aren’t as supportive as in 2021 or early 2022.
Even in this market, there are opportunities to drive strong returns through a combination of acquisitions and divestitures that allow corporate leaders to reshape their portfolios. A divestiture can eliminate management distractions from strategic imperatives. It can also be an important source of capital for acquisitions or transformative business initiatives — a key consideration with current financing costs.
Opportunity amid uncertainty
Economic uncertainty — including the potential for a recession, tight labor markets and inflation — plus continued geopolitical turbulence and high interest rates are pressuring margins for some companies. But the flip side is opportunities for companies to make high-impact acquisitions and divestitures.
Transformative acquisitions in technology, for example, can drive innovation, accelerate speed-to-market and boost flexibility. Smart acquirers are also continuing to re-align their supply chains to prevent the kinds of production problems that hampered large segments of the economy in the last few years.
As yields for lower rated debt have risen, corporates face a greater downgrade penalty than in recent years. That, combined with pressure on margins from pricing power versus demand, may prompt some companies to explore divestitures.
US regulators are stepping up their scrutiny of acquisitions and preparing to launch a new regulatory review process for US outbound investment. Since 2020 there’s been a 50% increase in deals reviewed by the Committee on Foreign Investment in the United States (CFIUS), which screens acquisitions of U.S. firms for national security risks. The new outbound investment regime will create increased regulatory risks for firms investing in certain industries and jurisdictions. Companies need to consider their regulatory exposure in multiple jurisdictions and try to limit vulnerabilities that could be created by sanctions, investment restrictions or geopolitical tension. Technology, media and telecommunications may be subject to particular regulatory scrutiny.
Given the underlying economic conditions, corporate leaders should keep in mind that deals done before or in the early stages of a challenging environment can provide advantages to dealmakers and improved ROI. The most successful acquirers will be those that start planning early for acquisitions and integration. Experience with prior acquisitions, finding the right targets for acquisition, and early planning and resources devoted to integration are critical to success.
Necessity for business reinvention
Technological advances, changes in the global economic and political environment, and shifting demographics are pushing corporate leaders to transform their companies faster than ever. Those that fail in these transformations risk losing control of their own fates in the coming years. Our global CEO survey found that 40% of chief executives believe their businesses will no longer be economically viable in 10 years if they continue on their current course.
Corporate leaders need to ask themselves several questions as they navigate the next decade. That includes considering how long their current business model will remain viable, how their resilience and workforce strategies fit together and how much time and money they’re investing in the future.
Selling businesses that no longer fit a company’s strategic priorities can be an important part of the reinvention process. Divestitures provide capital for acquisitions that align better with long-term strategies and also free up resources. Our recent study, The power of portfolio renewal and the value in divestitures, found that companies typically experience an immediate improvement in stock price (about 3.8% above their industry median) when they announce a divestiture. One in four companies were able to achieve double-digit growth in their stock price.
On the acquisition side, transformation provides opportunities to acquire valuable technology, reshape and strengthen supply chains, grow market share and enter new markets. The most successful M&A organizations are continually assessing their overall portfolio of businesses and testing it against their long-term corporate strategy.
Leading companies capture a performance premium by making mutually reinforcing investments in their business, operating and technology models, which in turn drive performance factors such as innovation, speed-to-market and flexibility. All the while, they are lowering friction, or what economists call “transaction costs” — the time and resources needed to do business inside the organization and as companies engage and interact with external parties. Those mutually reinforcing investments enable these companies to transform and grow faster, outperforming their industry peers by 44%.
Resilience and innovation for growth and sustainability
Corporate leaders are using deals to strategically transform their companies to adapt and thrive in a rapidly changing marketplace. Our global CEO survey found five broad megatrends driving these deals: climate change, technological disruption, demographic shifts, a fracturing world and social instability.
PwC’s recent M&A integration survey illustrated how regulatory policies and the global pandemic shaped the size and type of transactions — they were bigger, bolder and riskier. For the first time in our survey’s history, more than 25% of executives indicated that the purchase price of their largest acquisition exceeded $5 billion. Transformational deals also increased significantly to nearly half of all deals.
Companies have been more conservative in 2023 due to economic uncertainty. Average disclosed deal sizes are lower and likely will rise through the next economic expansion. The reduction in M&A-related lending has contributed to the current bias toward smaller deals. While the volume of leveraged loans originated to finance M&A transactions did increase in April and May relative to the first quarter, the value of deal-related financing remains subdued. Deal sizes often rise later in the cycle as valuations rise, financing improves and acquirer confidence grows.
Regardless, we expect the trend for transactions aimed at resilience and innovation to continue long term:
- We continue to see companies reshaping their overall strategy in response to environmental, social and governance (ESG) pressures, divesting businesses that aren’t a good fit and acquiring companies in industries that are more environmentally friendly. Increasingly, companies are finding in ESG practices opportunities to not only reduce risk but also to create value.
- With low unemployment and high wages squeezing margins, many companies will look to automation, robots and artificial intelligence to boost their productivity and efficiency. For example, generative AI can automate and enhance aspects of almost all business operations, ranging from customer service to software development and data analytics. Acquisitions to enable those efficiencies will be an area of focus this year and beyond.
- Private equity firms are focused on areas where new investments, consolidation or an attractive business model hold the promise of strong returns. For example, manufacturing and distribution operations can be made more efficient and profitable by investing in automation technology. In the healthcare market, specialist clinicians are highly fragmented, creating opportunities for consolidation. And the subscription model that cloud-based software-as-a-service (SaaS) companies offer is attractive for its cash flow.
- Social changes — including demographic shifts, political instability and, on the geopolitical scale, a multi-polar world — are creating new challenges for companies. Consumer preferences are changing in response to these forces and many consumer-facing companies are finding that younger buyers, especially, expect meaningful action and often want values that mirror their own.
These interconnected forces are fueling change across the business world. They are not necessarily new forces, but their strength and interconnectivity in the US and around the world are growing.
The bottom line
Strategic leaders are finding M&A opportunities that can make critical changes to their business. They’re divesting business units that do not fit and redeploying capital and management bandwidth to new opportunities in line with shifting customer preferences, technology opportunities and demographic changes.
Savvy acquirers start to think very early — during or before deal screening — about what a new operating model might look like. And they’re devoting more resources to integration, earlier and consistently, to maximize the return on those acquisitions.
Finally, corporate leaders are looking beyond today’s economic conditions to position their companies for the next expansion. They are screening opportunities to help them grow the markets and businesses they want to be in over the next decade to give them the best chances to achieve long-term value creation.
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