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With inflation surging and the economy raising question marks, it is no wonder the rate of mergers and acquisitions of midsize companies has slowed the record-breaking pace of 2021.
In the second quarter of 2022, 23% fewer deals were announced than a year earlier, according to data from S&P Global analyzed in Firmex’s Q3 2022 Deal Flow Bulletin. Yet under the surface, there is a lot of evidence that the desire to merge is as strong as ever, and that the decline in announcements has largely been a pause as buyers and sellers adjust to the current conditions.
Indeed, in the first half of this year, more companies entered into serious merger negotiations than they did in 2021, according to Firmex data used to prepare the Deal Flow Bulletin. It’s just that a smaller share of those talks has turned into announced deals, at least so far.
Firmex has a window into the pace of dealmaking because our virtual data rooms are used by buyers and sellers to exchange confidential information during due diligence. We don’t know what’s being negotiated, but we can count the number of deal rooms opened. Over time, this measure has been a reliable indicator of future M&A activity.
This picture is confirmed in Firmex’s quarterly survey of investment bankers and merger advisors that serve middle-market companies. Three-quarters of survey respondents say the volume of deals they handle is staying steady or increasing – but 55% say it’s taking longer for these deals to close.
What’s slowing things down? In a word, “uncertainty.”
That was by far the most common answer when advisors were asked what was influencing deal volume.
“Our view of the future keeps shifting,” one banker wrote. “We are still struggling to understand what normal earnings are after the pandemic, with all the volatility in the supply chain, energy costs, wages, and interest rates.”
Deeper probing about whether a series of factors was encouraging or inhibiting dealmaking found that the biggest downer was rising interest rates, with 55% of respondents citing it as an inhibition. The second most inhibiting factor was supply chain issues at 46%.
Surprisingly, some factors that were seen by many as depressing deal flow were described by others as spurring it. The prospect of a future recession was cited as encouraging deals by 23% of advisors, even as 43% said recession fears are inhibiting transactions. Similarly, nearly as many respondents said that continuing labor shortages are prompting mergers (23%) as preventing them (29%).
Overall, the picture is that advisors on the front lines see the post-pandemic rush of deals abating to a brisk but steady pace. Firmex’s December survey found that more than two-thirds of advisors said they expected it to be busier in 2022 than in the record-setting 2021 – now the most common view is that volume is staying even. Still, more respondents predict an increase in volume than see a decrease (32% vs. 21%).
M&A advisors know the forces that have driven dealmaking over the last few years are as strong as ever: a large number of private equity funds have money to invest, and a generation of entrepreneurs is looking to sell their companies and retire. Firmex’s April survey found 49% of advisors seeing more buyers entering the market and 52% saying the number of sellers is increasing.
As prices start to cool off record highs, buyers’ and sellers’ valuation expectations are becoming more closely aligned, and the clouds on the economic horizon may well be encouraging business owners to sell now while they can instead of holding out for a higher price. When asked about the valuations of deals in the market, a plurality of respondents (48%) said “above average,” while the common sentiment (45%) was “very high” six months ago. And a majority now expect prices to decline in the coming months – a change from December, when most advisors said valuations would remain constant or increase.
Falling prices may continue to encourage even more mergers. When asked about factors that create difficulty in closing deals, the biggest sticking point was “seller valuation expectations” with 42% of respondents saying it presents a “high difficulty.” Comparatively, only 34% of respondents said “Inflation or economic uncertainty” was a deal killer.
“The market will remain buoyant, but for different reasons than in the past three years,” one banker told us. “Before, deals were driven by excess cash in the market. The next three years will be driven by the fear and uncertainty of the markets.”
To be sure, the changing economy is shifting the industries that appeal most to acquirers – activity in real estate, consumer, and retail companies is declining, while there is more activity in renewable energy and healthcare.
With this perspective, it’s hardly surprising that, when asked to characterize their overall feeling about the M&A market in the coming months, 48% of respondents said they were positive and 18% said they were feeling negative.
The people closest to the negotiations between mid-sized businesses and the firms interested in buying them say that the forces pressing them to close deals are ultimately stronger than the ups and downs of the economic cycle.
“In spite of inflation, stock market, and recession discussion,” one banker wrote, “the market liquidity will continue to drive deal volume in a positive way.”
Mark Wright is the General Manager of Firmex.