Business executives and M&A professionals in a recent survey offered cautious optimism for the market next year, despite rising interest rates and elevated expectations for a U.S. recession.
Nearly two-thirds of business executives and M&A professionals told law firm Dykema Gossett PLLC that they expect the market to strengthen in 2023, driven in part by buyers with reserve funds that they need to invest and a rise in distressed deals amid a weaker U.S. economy.
“For now, it appears dealmakers remain hopeful, if vigilant, in the midst of economic turbulence. With the effects of COVID-19 subsiding and hoped-for easing of supply chain constraints, players with cash reserves still have opportunities in the coming year — even if that means shifting toward tighter due diligence, smaller add-on acquisitions, and cross-border outbound deals,” Dykema’s annual M&A outlook concludes. “Macro and micro-economic conditions are not expected to substantially reduce M&A activity, but instead to reallocate dealmaking across a select range of industries and buyers.”
Buyers that lack readily accessible capital or financing also may shift to more promising sectors, Dykema reported. Buyers that are well-financed “will take advantage of more attractive valuations and may be drawn to roll-up strategies.”
“Whatever the case, these approaches are likely to sustain deal volume to some degree and, in turn, bolster dealmakers’ confidence in their ability to carry out transactions,” the law firm stated in its outlook for 2023.
‘Bullish outlook,’ recession fears
Dykema’s 18th annual M&A outlook is based on a survey of more than 200 senior business executives and dealmakers across the U.S. who offered their expectations on the market in the next 12 months.
Thomas Vaughn, a partner at Dykema’s Detroit office and co-leader of the firm’s Mergers & Acquisitions practice group, attributes the “bullish outlook” in part to high levels of capital that investment firms have amassed and need to deploy.
“Even with the steady march of rate hikes and price increases, dealmakers who have stockpiled dry powder will be able to capitalize on lowered valuations and engage in deals,” Vaughn said.
Still, the survey’s results were not all positive. Amid the optimistic 65 percent of respondents who expect stronger deal flow in 2023, more than 20 percent expect a weaker M&A market, a rate that’s more than triple of what Dykema found a year ago heading into 2022.
More than seven out of 10 expect an economic downturn in 2023, with 43 percent saying a recession is “very likely.” Another 28 percent said a recession next year is “somewhat likely.”
The latest U.S. economic outlook that Comerica Inc. issued on Oct. 20 estimated the chances of a recession by the end of 2023 at two in three. Comerica economists also projected negative 1.6 percent Real GDP growth for the fourth quarter and negative 3.9 percent in the first quarter of 2023, with growth returning to 2 percent in the second quarter.
Even if a recession occurs, it may not translate to a corresponding decline in deal flow. More than half of respondents to Dykema’s survey believe it will generate M&A opportunities as economic conditions bring more sellers to the market.
One-quarter say a recession will drive a “small increase” in deals next year, and 26 percent said it would result in a “significant increase” in M&A volume.
Three-quarters of survey respondents expect more deals next year involving distressed companies that are in need of a turnaround.
“If dealmakers are speculating that the recession will be corrective — rather than indicative of the precipitous downturn the U.S. experienced in the 2007-2008 fiscal crisis — it tracks, then, that well-positioned acquirers will see the potential for buying opportunities in a downturn,” according to the outlook.
‘Haves and have-nots’
Higher interest rates also are expected to affect deal flow in 2023.
Asked about their top obstacles to transactions, 47 percent of respondents cited rising interest rates. The Federal Reserve Open Market Committee this week implemented the latest increase in the federal funds rate, 0.75-percentage point hike, in an ongoing effort to ease inflation that’s been running at 40-year highs.
PNC Bank expects another 0.50-point increase when the FOMC meets in mid-December, followed by a 0.25-percent rise in early 2023, “which would definitely be a weight on economic activity.”
The “tough combination” of higher interest rates and high inflation “is expected to reshape both deal terms and how transactions come together, or fall apart,” according to the Dykema outlook. Nearly half of survey respondents expect the greater use of alternative payment types to finance deals, such as seller financing and earnouts. More than four in 10 expect reduced deal values and less access to capital.
“Once again, all of these factors are interrelated,” Dykema’s outlook states. “An earnout can be useful if the parties are having difficulty reaching an agreement on an upfront cash price, and when capital is scarce, these payment types can help push deals over the finish line.”
Jeff Gifford, leader of Dykema’s Corporate Finance practice group, said the results from this year’s poll indicates that M&A is “entering a market of haves and have-nots.”
“Buyers with a large amount of liquidity — and consequently, no need to borrow at high interest rates — expect to take advantage of affordable buying opportunities, while those who have relied on banks to finance their acquisitions see significant obstacles ahead,” Gifford said.
General economic conditions, inflation and the availability of quality acquisition targets were also cited among the top barriers to deals in 2023.