No Match Found
The short-term outlook is for macroeconomic headwinds and financial volatility – conditions that will hardly have stakeholders turning cartwheels. But these conditions will also create once-in-a-decade opportunities for investors thanks to a closing of the valuations gap, a more considered bidding field, and a subdued initial public offering (IPO) market.
We’ve identified four areas of opportunity: transformative M&A, environmental, social and governance (ESG) considerations, workforce strategy and technology. There are plenty of prospects for corporate and private equity (PE) investors who are prepared to get creative in how they drive value.
Because in 2023, it’s not a stretch to say that dealmaking will require flexibility and some imagination.
Uncertainty and volatility will bring challenges and create opportunities in M&A in 2023.
In 2022, Australian M&A activity slowed from record-setting highs in 2021. However, activity continued to exceed historical norms and 2022 still ended as one of the strongest years ever. Rising economic and geopolitical uncertainty didn’t deter the market and almost two-thirds (58%) of Australian CEOs told PwC’s CEO Survey that delaying deals is not something their company is considering in the face of economic challenges in the next 12 months.
Yes, investors will face tougher conditions in 2023. But those who take advantage of the slowing economy and use it as a chance to make strategic acquisitions at a reasonable price will see the highest returns.
Overall, the rewards will be there for those who make M&A a core part of their strategy.
There are reasons for optimism in M&A in 2023. Inflation is predicted to peak. So are interest rates. Meanwhile, near-term tailwinds spell opportunities for savvy investors. (Tailwinds such as cash-rich corporates, plenty of dry powder among private capital, infrastructure and sovereign wealth funds, and lower valuations for potential targets.) Today’s M&A landscape is not for the fainthearted. But the right strategy will see investors succeed in the long term.
It’s widely expected that interest rates will plateau around mid-2023 but this is unlikely to bring much operational relief for businesses. Australia’s labour market will remain tight this year, and prices will remain elevated even as the rate of change for inflation tapers off.
Turning to trade, uncertainty hangs over the Chinese economy. The end of China’s zero-COVID policy has not meant the end of Australia’s trade woes, and Australia remains highly exposed to Chinese importers.
And yet commodity prices are strong, and are forecast to stay that way throughout 2023, stabilising the Australian dollar, and providing good news for budget repair in Western Australia, Queensland and, to a lesser extent, New South Wales. The federal budget is also set to benefit, and we may see a balanced budget – or possibly a small surplus – on Budget Night 2023.
It’s good news, too, for Australia’s COVID recovery – economically, at least. Economic growth will almost certainly slow in 2023, but certain sectors such as international education and tourism are set to do well this year, while labour constraints in childcare, healthcare, construction and more will ease as international visa holders return. Meanwhile, the Great Resignation appears to be morphing into the Great Recommitment, supporting labour productivity. And tech layoffs from some of the majors will improve supply of tech talent in the broader economy. Offshore markets, meanwhile, won’t fare so well. Ongoing geopolitical turmoil, combined with volatile market conditions and more rate rises, mean the US and UK are both potentially staring down the barrel of a recession this year. Australia may dodge a recession. But misery loves company and the bad news from offshore may dampen business sentiment here. On the upside, global investors may view Australia as a safe pair of hands. Similarly, COVID has caused a refocus on supply chain resilience and we’re seeing greater numbers of investors seeking to rebuild our manufacturing sector in Australia. In general, how will businesses respond? Rate rises will lead to some deleveraging of small-to-medium businesses, and we may see more businesses experience financial distress even as conditions ease.
In 2022, 1,699 deals were announced locally (down from 2,118 in 2021), while publicly disclosed deal values reached US$78bn (down from US$195bn in 2021).
As the M&A market has invariably cooled, winning approval to conduct M&A transactions, especially those that are transformational, will be harder today than it was six months ago. Given greater investor scrutiny, dealmakers will need to find ways to convince boards, investment committees and other stakeholders about new investment opportunities.
Australian deal volumes and values 2018-2022: M&A activity down from 2021 highs but above historical norms
To drive successful deals in 2023, consider these five key trends:
Make “defensible” your word of the year for 2023 as investors increasingly seek sectors that are rock-solid bets. (Think: life-sustaining sectors such as healthcare, education, defence, energy transition and infrastructure.) As well as refocusing on services like accounting and HR software. Moreover, they’re looking for defensible assets in those defensible sectors. That is, assets with high barriers to entry such as intellectual property patents, strong market pricing power and/or the ability to pass on costs.
First a COVID bump, and more recently a COVID slump, have played havoc with valuations. Investors want assurance, and so the question on everyone’s lips is: Are earnings sustainable into the future?
For instance, buyers are wary of pricing assets on an uptick as there’s no saying how long earnings will surge. Similarly, they’re asking: Are those assets on a downwards trajectory really performing poorly? Have their fundamentals changed, or is it an EBITDA blip?
Overall, what we’re seeing is a reluctance to deploy capital due to a lack of alignment on value. Where capital is being deployed, it’s in those sectors where earnings are most consistent, and where input prices can be passed on. Investors want to bypass the bumps and slumps and invest in businesses that will win across several cycles.
Value alignment is everything.
To preserve value in an uncertain market, flexibility and agility are a must. Whether you’re buying or selling, reassess your approach to transactions. Think outside the box. Meet in the middle on transactions. Create bespoke deal structures.
We’re seeing a whole host of flexible deal arrangements right now. For instance, there are several deals coming to market where funds will need to partner with the vendor on a go-forward basis because sellers want to retain some ownership or create more opportunities to deploy debt instruments rather than pure equity. Similarly, earn-outs are being put in place, which drive collaboration within family-owned businesses to avoid direct buyouts and, therefore, reduce risks for buyers.
PE funds, in particular, have a reputation for innovation, and we’ve seen funds use a combination of financing structures in recent months including term loans, seller notes, all-equity funding, consortium deals and minority investments.
Less formal processes (read: opportunities) are available for those who are willing to adapt and move quickly.
As we emerge from the worst of the COVID-19 pandemic, expect to see plenty of companies reassessing their portfolios and reconsidering their investments in non-core or lower-growth areas. Companies should exercise capital discipline and undertake strategic reviews.
Demergers will continue to prove popular as a way to unlock a multiple re-rating. On the flipside, mergers will offer economies of scale and support margin resilience (or better yet, margin accretion) in an inflationary environment.
Corporate carve outs will be high on the agenda in 2023 because the window of opportunity is wide open for corporates right now. Lower valuations are bringing cashed-up corporates out of the woodwork, and we’re seeing plenty of due diligence – a sure sign of increased M&A activity among corporates.
And while capital recycling is nothing new (that is, boosting your portfolio by selling or part-selling non-core assets to raise more capital), what is new in 2023 is its prevalence. Telcos are doing it and have sold off towers and are now moving to fibre assets. And we can expect it to be a theme across other sectors, too, as borrowing becomes even more expensive and more difficult to secure.
So then, will governments across the country consider recycling capital due to the high levels of debt across state and federal governments? Now is a great time for governments to partner with the private sector and create value for communities.
Expect even greater activity in the public-to-private space next year as investors capitalise on the value available in the public market – especially, the value alignment that exists there. The shift towards take-private transactions is part of a longer-term trend as investors seek to avoid the volatility of the public market, and because there are myriad forms of private ownership options.
There’s also the chance to snap up some high-quality assets due to distress in the market. Distress funds or turnarounds are driving opportunities, especially in retail and the construction space and this will continue throughout 2023.
Dive into the major trends and insights
To further unlock value in 2023, dealmakers need to rethink their portfolios and get creative, keeping value at the core of their strategy.
True, markets are uncertain, but they’re also impatient. The most successful deals in 2023 will be those that allow companies to rapidly transform strategic aspects of their business, pushing the business forward fast.
Unlocking value from transformational deals begins with solid, strategic decision-making around whether to do a deal, and which deal is the right one.
In 2023, the following issues may determine whether your business is fit for transformational M&A activity:
Ensure your corporate strategy is relevant. Given current macroeconomic challenges, you should regularly review and optimise your business portfolios to align with up-to-date strategies. Also, consider if your existing capabilities are fit to drive continued growth.
Consider organic potential. If your strategy has shifted (or should shift), then assess whether you have the assets and capabilities to change direction organically. (This includes an assessment of talent, intangible assets, and time.) If organic change is likely to be slow, a deal could dramatically speed up the process.
Conduct a portfolio analysis. This should be a regular part of your business planning process, but it’s particularly important when considering your company’s ability to execute on its strategy. A portfolio review may reveal opportunities for divestitures, freeing up capital and management attention, as well as point toward potential acquisitions.
Evaluate deal-execution capabilities. C-suite leaders need to have a plan to a) carry out a deal and b) ensure it delivers on a transformation promise. Value creation goes well beyond integration, but successful integration can help drive transformation.
What’s on the cards for transformational deals? In 2023, successful deals will have clear value creation plans to harness value and drive the required capital returns. This includes comprehensive integration planning covering people, ESG and technology.
ESG themes are core to long-term value creation, hence ESG considerations will continue to drive deal activity in 2023. Evidence shows that when investors embed ESG considerations into their strategies they achieve superior valuations.
Value is at risk if ESG is not properly managed and integrated into company strategy and operations, and we have seen divestments and spin-offs of assets that fail to meet investor expectations across E, S and G areas.
Moreover, the current environment means the ESG stakes are higher than ever before. ESG is no longer seen as a box-ticking exercise – it’s a business imperative and lenders and investors are looking for genuine commitments and action. They’re also looking for transparency, so reporting is key (even if your news is less than rosy).
Stakeholders are more informed about ESG and how it can impact value. Faced with spiralling inflation and interest rates rises, stakeholders are sensitive to the cost structure of target companies, and ESG now forms part of due diligence almost without exception. Good ESG governance is a must. Buyers want to be confident that risks are being identified and managed. (Can you, for instance, demonstrate your management of physical climate risk? Or, of modern slavery risk in your supply chain? What about good workplace hygiene such as policies that support diversity and inclusion? And how will you allay concerns around cybersecurity and data privacy?)
In terms of targets, we’re seeing plenty of interest in assets with circular economy opportunities and decarbonisation potential. And buyers are savvy. Potential acquirers know the difference between simply purchasing carbon offsets versus taking real steps towards decarbonisation, so organisations must make every effort to move towards net zero. Also, to use technology to improve visibility of supply chains, and to invest in better ESG reporting platforms.
Organisations can’t afford to lose quality staff during the M&A process. In fact, 82% of companies who say significant value was destroyed in their latest acquisition lost more than 10% of employees following the transaction. To ensure the value creation objectives of a deal are preserved and unlocked, organisations must focus on the following four no-regret steps:
Culture: It’s hard to overstate the importance of culture in M&A transactions. In fact, 81% of surveyed executives wish they’d better understood the culture of a target organisation earlier in the transaction process. Too often, cultural issues only start to emerge during or after the signing process. How, then, do you get on the front foot to mitigate the risks associated with culture in M&A? It isn’t always easy to get a clear picture of an organisation’s culture. Robust due diligence incorporates interviews, focus groups, cultural reviews, surveys and more so that a wide range of voices are heard (and not just the executive team), to get a representative sample of the whole organisation.
Staff retention: With the unemployment rate currently at its lowest level since 1974, and it being an employee-led market, now is not the time to shift your focus away from talent retention. Seasoned dealmakers and business leaders appreciate the significance of employee attrition and turnover, and in the current employment landscape, this will continue to be a key risk factor to manage. It all comes down to identifying key people and keeping them engaged. (Note, this is not just those people in managerial or business-critical roles; it includes key talent in all layers of the business.)
Employer value proposition (EVP): Given the challenges associated with attracting and retaining talent, it’s never been more critical to have a robust employee value proposition in place. Our research shows that 69% of employees say that fulfillment and meaning are important factors when considering a change in work, and while financial incentives are important, it's not the whole picture. To keep employees engaged, organisations need to leverage a strong and differentiated EVP - think: development opportunities, emphasis on work/life balance, flexible hours, hybrid working, and a focus on health and wellbeing.
As the economy softens, and dealmakers work harder to get more value out of each deal, investing in technology will pay dividends in 2023. From capitalising on current systems and vendors, while managing the risk of potential cyber attacks, to data and analytics/reporting, through to transforming dealmaking to future-proof your (post-deal) organisation, technology, and the effective use of data will prove more fundamental than ever to organisational value this year.
As a start, technology and the potential impact on value must be a critical focus throughout every stage of the deal lifecycle. The importance of tech in deals has been further accelerated with the increase in the number and sophistication of cyber attacks. Globally, Australia was hit harder by cyberattacks than many other countries in 2022 and, as a result, we found 60% of Australian organisations are increasing their cyber budget in 2023 in an effort to proactively manage this risk and build digital trust.
This means involving true, business-minded technologists during the early stages of the deal. And then having analytics experts working side-by-side with dealmakers throughout the entire deal process, entrenching collaboration and connectivity between commercial, analytics and technology workstreams, capitalising on your tech experts during due diligence.
Ask yourselves: How are we using tech to get greater insight during the deals process? How are we using data? How are we managing our cyber risks during the business change? How is it driving value? During dealmaking, it’s vital to have the right (tech) people in the tent.
The second part of the equation is around future-proofing your organisation, and that means making the most of your technology post-deal. Whether through training or skills capture, ensure your people understand the current technology available, and the ways in which it can transform the business. For instance, rather than necessarily investing in new tech, can you optimise your current tech environment to better service your business? It’s about getting bang for your (tech spend) buck.
Notably, we’re seeing an interest in businesses that are less mature around technology and data. Instead, dealmakers are looking for opportunities to maximise return by investing in data rich businesses that can be brought up the maturity curve whilst managing their costs (such as right-sizing existing in-house technologies, negotiating with current vendors, or simply making better use of data. And there are plenty of data-rich businesses in Australia which haven’t yet made the most of their data.) It’s about doing more with less and focusing on the gaps to implement more agile and efficient solutions, rather than opting for a wholesale replacement.
Private Equity perspective
PE (along with infrastructure and sovereign wealth funds) has effectively created an engine for M&A and has developed into a consistent source of deal-making capital, whatever the weather. In fact, PE has put record amounts of capital to work in recent years, increasing its share of M&A from around one-third of total deal value five years ago to almost half in 2022.
And even though capital raising is proving difficult right now, there’s still A$26bn circulating in the Australian market, driving activity among PE funds (as well as among broader financial investors). Those that are cashed up are taking full advantage of improved buying conditions right now.
Of course, improved buying conditions mean we’re seeing PE funds being increasingly active. There's demand for assets that have resilient business models, strong pricing power, and a clear competitive advantage. We’re also seeing increased operational interventions. That is, many funds are engaging operational partners to assist with driving value creation at a portfolio company level. Investors are looking for businesses that are going to win across several cycles, and not simply in the short-term. As a result, many PE funds are embracing a more defensive mindset than 12 months ago and holding assets for longer.
We are in a rare moment of opportunity, and for companies with the right strategy, business case and courage, CEOs can create deals that will shape their business and contribute to their longer-term success. While the window of opportunity is open – it’s hard to predict how long acquirers will have in order to make the bold moves that could change the game in their sector.
Looking ahead, expect the focus to be on asset selection, as well as investing in companies that are future-proof. We also anticipate heightened due diligence as businesses ensure they’re getting a good read on the true earnings of potential assets. Additionally, acquirers are actively assessing value creation opportunities during due diligence, as an additional layer of safeguard in an uncertain environment.
Renewables and energy transition will continue to spark activity in 2023. The question remains: How can the government best unlock the energy sector? Opportunity abounds.
ESG is a significant long-term consideration. When assessing assets, investors should take a 10-year perspective to avoid getting stuck with assets that could fall foul of ESG expectations in the future. As an investor, ask yourself: What’s the ESG shelf-life of these assets? How do we drive value creation? As a seller, consider: How do we demonstrate our ESG credentials to potential investors?
About the data
We have based our commentary on data provided by industry-recognised sources. Specifically, values and volumes referenced in this publication are based on officially announced transactions, excluding rumoured and withdrawn transactions, as provided by Refinitiv as of 31 December 2022 and as accessed on 2 January 2023. This has been supplemented by additional information from Dealogic, Preqin, S&P Capital IQ and our independent research and analysis. This publication includes data derived from data provided under license by Dealogic. Dealogic retains and reserves all rights in such licensed data. Certain adjustments have been made to the source information to align with PwC’s industry mapping.