2023: An outlook on developing M&A trends

After an explosive year of M&A in 2021 in the wake of the COVID-19 pandemic, dealmaking returned to more normal levels during 2022. While it is true that this reflected a natural correction following a year of inflated activity and pent-up demand, 2022 saw a far harsher dealmaking environment, with stockmarkets retreating, a general economic downturn and Russia’s protracted war in Ukraine.

As we enter 2023, these headwinds, and others besides, are expected to continue pushing M&A activity downwards, with many forecasting that declining deal volumes and valuations are unlikely to turn about in the near-term.

However, that’s not to say that we’re in for a quiet year. Despite the headwinds, there is also a considerable degree of optimism among dealmakers polled in recent surveys, while certain factors could help to spur relatively strong levels of dealmaking (not least the widespread financial distress that many businesses are already facing in a worsening economic climate) while several key sectors are expected to see major M&A activity.

2022’s downward trend
Dealmaking naturally took a huge hit as the COVID-19 pandemic raged throughout the majority of 2020. As a result, 2021 saw a surge in M&A as a result of pent-up demand, bountiful cash reserves for some corporations, high levels of business distress on the other hand and vast amounts of dry powder built up by private equity firms.

2021’s dealmaking frenzy was always likely to see a correction and so it proved. While deal values increased 1 per cent last year, volumes fell by 8 per cent (still above pre-pandemic levels) and this is a trend that many are forecasting to continue – and perhaps accelerate – during 2023.

Despite some market watchers expressing optimism about the prospects for dealmaking in 2023, a report from S&P forecast that there was not likely to be a sharp turnaround in M&A activity in the near-term, due to a range of adverse factors, including rising interest rates, economic uncertainty and declining appetite among corporate and private equity buyers.

Looking at the EU M&A market, a poll from CMS found that 73 per cent expect an increase in deal volumes during 2023, but also highlighted numerous potential hurdles that buyers face. 16 per cent expect valuation gaps to be the biggest issue that dealmakers will face and that deal value will suffer as a result.

If deal volumes are set to increase, then CMS’s report seems to point towards distressed M&A being the leading factor. 26 per cent of respondents to CMS’s poll expect distressed acquisitions to be the biggest driver of sell-side activity, while 23 per cent expect undervalued deals to be the main driver of buyer activity.

The economic downturn sweeping many major economies is likely to be one of the biggest headwinds that M&A faces in 2023, as buyers contend with higher interest rates, which will push the cost of financing up, while weakened currencies could simultaneously impact purchasing power and push valuations down, disincentivising business owners from exploring sale options.

Tighter financing conditions
One of the key factors forecast to depress M&A activity during 2023 is a widespread tightening of financing conditions amid soaring inflation. Key central banks, including the Bank of England, European Central Bank (ECB) and the US Federal Reserve, have raised interest rates this year in an attempt to keep a handle on inflation, with future increases widely expected.

As a result, financing is becoming more expensive and less readily available to buyers, severely harming their prospects for funding M&A deals as banks and investors become more selective about how they deploy their capital.

In CMS’s 2023 outlook, 87 per cent of respondents polled said that they believe financial conditions will become more difficult, with 45 per cent of that number saying that financing conditions will become much harder. Perhaps most significantly, however, no respondents whatsoever said that they expected financing conditions to become easier, while just 13 per cent believed that there will be no change.

The rising cost of debt is not the only contributor to tight financing, with a range of separate factors exacerbating the situation. As economies around the world deteriorate and consumer sentiment drops, 18 per cent of businesses polled by CMS felt that revenue and profit underperformance would be the main headwind harming the ability of buyers to access M&A financing over the coming year.

Geopolitical turmoil was also seen as one of the leading challenges for securing M&A financing. Of course, the core issue here is Russia’s ongoing war in Ukraine, which has wrought a vast degree of uncertainty upon markets. It has led to more complex and serious due diligence considerations and massively disrupted supply chains throughout Europe. Outside of the EU, deteriorating relations between the US and China are further complicating cross-border M&A and tightening lending conditions.

A further knock-on effect of this could be reducing dealmaking appetite among private equity firms, one of the key drivers of M&A activity. Private equity buyers often rely on leverage, with higher financing costs damaging their ability to access the credit to leverage major acquisitions, despite the huge amounts of unspent capital that many continue to sit on in the wake of the COVID-19 pandemic.

Despite this, private equity firms are still forecast to deploy their capital where possible, resulting in 40 per cent of CMS respondents saying that private equity will be the most readily available source of acquisition financing.

Private equity buyers are particularly likely to continue deploying funding into the UK’s most fragmented industries. A huge range of sectors within the UK remain highly fragmented, ranging from wealth management, to nursery education, to care, and to industrial products. These all offer a wealth of opportunities for private equity buyers to invest in consolidators targeting buy-and-build acquisition strategies. Such opportunities will become even more apparent over the coming months, as smaller operators across these sectors face growing pressure to sell in an increasingly hostile operating environment.

Optimism remains
However, in spite of the major challenges that M&A will face as we head into the new year, polls have illustrated a significant degree of optimism among dealmakers about their future prospects for making acquisitions. Many companies with cash will continue to be very active in M&A because we are entering recession territory. Seasoned M&A managers know that recessions often produce the opportunities of the decade.

In CMS’s end of year poll, just 12 per cent of respondents said that they were not currently planning on making acquisitions. By comparison, that figure stood at 33 per cent in the previous year’s report (even in the wake of booming dealmaking during 2021), while in the year before that (following a year in which M&A was decimated by the COVID-19 pandemic) a massive 65 per cent of respondents said they were not planning acquisitions.

In terms of the prospects for dealmaking within Europe, a large majority of dealmakers in the CMS study are also optimistic, with sentiment for the forthcoming year again higher than in the previous year’s survey. At the end of 2021, 53 per cent of dealmakers said they expected dealmaking in Europe to increase over the coming year, a figure that rose to 73 per cent in the 2022 edition. The survey also shows that more dealmakers expect a significant increase in European M&A compared to last year’s edition, while no respondents expect a significant decrease in activity.

Despite tougher dealmaking conditions as we enter 2023, private equity buyers are still seen as being keen to deploy the reserves of capital they have accumulated over the past three years (a June 2022 estimate by Preqin put the amount of capital held by private equity buyers at around £1.56 trillion).

Despite the overall downturn in M&A activity during 2022, dealmaking has remained relatively strong in the UK, which in total accounted for 25.2 per cent of the overall European deal volume and 20.2 per cent of European deal value, respectively, last year.

This has seen the UK become the leading destination within Europe for international dealmaking, ahead of Germany and the Netherlands, and the third biggest globally, behind the USA and Singapore. This was initially driven by the UK’s strong economic response to COVID-19 and rapid vaccination programme, which gave it a key edge over European rivals, which struggled to match its pandemic recovery.

This is a trend that has a strong chance of continuing, with the UK likely to remain one of Europe’s main hubs for inbound investment, despite the overall slowdown in M&A activity. However, at the outset of 2023, it seems that the UK’s status as a dealmaking hub is likely to be driven by significantly different factors than its strong COVID-19 response.

Distressed M&A could define 2023
Economic turmoil is currently engulfing the UK, as companies run into financial distress amid rapidly escalating inflation, soaring energy bills and declining consumer confidence during the ongoing cost-of-living crisis. With many companies still sitting on enormous debt piles in the wake of COVID-19, these factors have seen insolvencies soar over recent months and this is a situation that is likely to deteriorate further during 2023.

This is taking a huge toll on sectors such as construction, manufacturing and hospitality, to name just a few of those badly affected. According to an October 2022 report, 35 per cent of hospitality firms expressed concern that they could collapse by the end of the year and the picture is unlikely to have significantly improved since then as government policy moves closer to austerity, likely dampening consumer sentiment further.

In construction, meanwhile, rising costs for energy and raw materials, unpaid bills, staffing shortages, supply chain issues and inflation, among others, have created a “perfect storm” for businesses in the sector, according to Red Flag Alert, which recently warned that there could be more than 6,000 insolvencies across the entire sector during 2023.

Against this backdrop, there are likely to be rife opportunities for cash-rich buyers to acquire distressed companies at low valuations and either wait for economic stability to return or look to invest in order to enable struggling businesses to achieve growth here and now. For example, a wave of insolvencies could lead to a smaller pool of construction companies competing for contracts, potentially opening up significant opportunities for solvent businesses within the sector.

Low valuations and financial distress are no doubt creating the scope for significant amounts of distressed M&A this year, but there is one other factor that will have a profound effect on inbound M&A within the UK during 2023: the UK’s weak currency.

The UK pound took a battering during 2022, at one point falling to an all-time low of $1.03 against the US dollar. While the end of Liz Truss disastrous tenure as Prime Minister gave sterling a lift, the currency still puts UK-based buyers at a disadvantage to overseas parties, particularly US firms buoyed by a strong dollar, who have already begun pouncing on distressed businesses and assets amid the ongoing economic upheaval.

Distressed M&A is not simply a trend that will be confined to the UK, however, with recessionary fears, rising prices, supply chain disruption and inflation factors that will be impacting businesses throughout the world, particularly in Europe, the region most affected by Russia’s ongoing war in Ukraine. In CMS’s latest survey, 20 per cent of European dealmakers said that they would be motivated to target acquisitions over the coming year due to the opportunities presented by high levels of business distress.

Oliver C. Wolfgramm, a Partner at CMS Germany, explains: “We will see more distressed deals as we face simultaneous economic problems, including lingering losses due to the pandemic, continuing supply chain problems, high inflation and recession fears, but also multiple severe geopolitical crises and uncertainties – such as the war in Ukraine and rising tensions between China and Western democracies.”

Key sectors will boost activity
This is not to say that M&A in 2023 will be wholly defined by distressed acquisitions, as there are several growing sectors which are set to see a wealth of activity over the coming year. Here are a few industries that could see strong dealmaking activity during 2023.

Tech
Perhaps predictably, the main sector that is forecast to drive M&A activity during 2023 is technology, with tech-driven disruption in particular predicted to motivate dealmaking activity across a huge array of industries as businesses seek to unlock cost and operational efficiencies and engage more customers. In a nutshell, technology-related acquisitions, in any number of industries, can help companies to drive growth, even in the most adverse of economic conditions.

The applications of technology within business are virtually limitless nowadays, but some key sectors forecast to see considerable tech-related M&A during 2023 include healthcare, logistics, recruitment, hospitality and financial services.

Tech was not immune from the downturn in M&A last year, seeing declining deal volumes and valuations. However, as we go into 2023, there have been forecasts that weakened valuations could boost activity as appetite for tech deals increases. According to a study by EY, 72 per cent of tech CEOs say they are planning M&A activity, compared to 59 per cent of CEOs across all industries.

Assessing the prospects of tech M&A in 2023, EY’s Global TMT Strategy and Transactions Leader Olivier Wolf commented: “The deal market has slowed due to macro headwinds and financial volatility, but this has improved opportunities for corporate buyers with strong balance sheets. In turn, competition for targets should heat up again next year, as hundreds of billions of private equity dollars come to the market. Transformative acquisitions could launch tech companies into new markets or adjacent verticals like HealthTech, and accretive acquisitions have the potential to strengthen portfolios with leading-edge technologies like artificial intelligence.”

Increasing regulation will be another factor to spur investment in tech, which can vastly improve reporting in key areas such as sustainability, financial management and, indeed, within M&A itself.

In CMS’s survey, tech was, again, expected to be the leading driver of future M&A activity, with 68 per cent of dealmakers polled ranking technology, media and telecommunications (TMT) as either the highest or second highest growth area over the coming year.

Professor Scott Moeller, Founder and Director of the M&A Research Centre, Bayes Business School, outlined the key motivation behind tech-related M&A in the CMS report, writing: Many firms realise that to stay competitive requires a technology-savvy organisation and that organically growing their technological expertise may not only be too slow but impossible. Thus they choose the faster route, which is to acquire the companies that have that knowledge.”

Wealth management
While distressed and opportunistic inbound M&A could be the most prominent deal types in the UK during 2023, there are also numerous highly fragmented industries that are undergoing sustained periods of consolidation.

Sectors ranging from elderly and veterinary care to second-hand car retail and early years education are extremely fragmented and experiencing widespread dealmaking, often driven by private equity-backed UK-based consolidators.

However, one industry stands out among all of these for the sheer scale of the M&A activity it has been experiencing over recent years, as well as the forecasts over how long the consolidation frenzy will last: wealth management.

Despite years of strong dealmaking, the UK’s wealth management sector remains extremely fragmented. In early 2022, Jason Hollands, Managing Director of Tilney, Smith & Williamson, was quoted as saying that the UK wealth management industry is comprised of over 5,000 firms, the majority of which are small, local businesses.

Amidst this fragmentation, there are an array of other factors that are pushing a wave of dealmaking in the wealth management industry, including increasing regulation, an ageing population of owners, rising sale multiples and private equity investment.

This has driven the industry to a point where, in a 2022 survey by Gunner & Co, 60 per cent of financial advice firm owners polled said they were planning an exit within three years, while, also in 2022, LEK Consulting forecast that the factors driving dealmaking were sufficient to support at least another ten years of consolidation.

Against this backdrop, several key consolidators have emerged, perhaps most notably Fairstone Financial Management (which has made over 50 acquisitions, including seven in 2022) and Perspective Financial Group (which has also passed the 50 acquisition milestone and last year completed 12 takeovers).

Logistics
Supply chain disruption has been a key economic factor over recent years, with the situation being successively exacerbated by Brexit, COVID-19 and the war in Ukraine. This, along with a shortage of qualified drivers, the rising costs of fuel and labour and the overall impact of inflation have combined to significantly depress confidence within the sector.

According to the 2022 Logistics Confidence Index from Barclays and BDO, confidence in the industry has fallen 12 points from 2021 to 50.4. The same report showed that just 45 per cent of firms predict their margins will improve over the coming year (compared to 62 per cent a year earlier), while 30 per cent are anticipating a drop in profitability over the coming year, up from 19 per cent a year earlier.

However, despite this dismal backdrop, M&A sentiment within the industry has rarely been higher, with almost 45 per cent of owners polled saying they were planning on making acquisitions over the coming year, the highest figure in the 10-year history of the Logistics Confidence Index.


M&A plans within the logistics sector are being driven by many factors, including a need to expand geographically, diversify service offerings, achieving economies of scale and, crucially, improving tech uptake in order to help overcome the challenges posed by supply chain disruption.

Despite the turmoil that the logistics sector is experiencing and the resulting drop in confidence among business owners, the sector perhaps illustrates something that could emerge as a key M&A trend during 2023: the use of acquisitions to respond to challenges and secure growth.

Conclusion
2022 saw dealmaking return to more normal levels after the post-COVID-19 boom and, as recession takes hold around the globe at the outset of 2023, this has prompted forecasts that dealmaking will continue to decline over the coming 12 months.

Amid a raft of significant headwinds, there is good reason to believe that dealmaking is highly unlikely to return to the heights of 2021 this year and it is not out of the question that deal volumes and values could decline further from their 2022 levels.

However, there remain signs of the resilience of M&A activity in spite of this, with considerable optimism among dealmakers and business owners in several key sectors making clear plans to target acquisitions during 2023.

Of course, as the global economic picture continues to be gloomy, there are two fundamental truths that point to dealmaking continuing to be strong in 2023: that recessions open up a wealth of distressed opportunities for potential buyers and that, during economic downturns, M&A is one of the few reliable routes for solvent businesses to target growth.

One final point to remember, and it is a fact borne out over time and corroborated by many research studies: The best deals are done in recessions.

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