In the last quarter of 2022, it was already visible that the takeover market was tilting. It was clear that the impact of the war in Ukraine and the ensuing international crisis on the energy market were having an effect on economic developments. The first half of 2022 showed a prosperous growth in the number of transactions and an increase in transaction volume. The market tilted in the second half of 2022. The level of transactions in both size and volume was a lot lower1. In October last year, we therefore wrote about a possible tilt in the merger and acquisition market, see: Everything is rising, but for how long? Will the M&A market tilt?
Given current market developments, this now seems easily explainable and obvious, but in October 2022, most other indicators were still positive. In particular, the low unemployment rate and shortage of suitable labour were positive indicators which meant sentiment was still positive initially. At the time, the advantages seemed to far outweigh the disadvantages. Eventually, the market turned and, over time, several factors turned negative, causing the M&A market to deteriorate rapidly.
Globally, the M&A market also stopped growing. In the US alone, major investment banks announced much lower results due to the dramatic decline in M&A transactions.
Reasons for the M&A market downturn
There are a number of reasons why the market has stopped growing.
Higher interest rates, lower prices
High interest rates affect company valuations. High interest rates mean that company valuations are lower, as companies are discounted at a higher discount rate. Sellers often struggle to adjust their price expectations downwards. The business is seen as a ‘life’s work’ and business owners do not see the risks as much as the buyer. In contrast, the buyer faces higher financing costs and will factor this in when considering what price can be financed.
Rising costs and uncertain market
Most sectors do face rising costs such as energy, labour and interest costs. A few sectors are hit harder by the current circumstances, e.g. horticulture or construction. Within these sectors, the sharply rising energy price in particular plays a huge role. But uncertainty about nitrogen policy is also causing major investments to be postponed. Companies are also mostly struggling to fill open jobs at acceptable wages in the short term.
The above developments do not contribute to sentiment and will lead to uncertainty and reticence among buyers.
Results go down
Rising costs are putting pressure on companies’ results. It may also be more difficult to maintain or grow sales.
In December, CBS published a contraction of 0.2% for Dutch GDP. A slight decline, but depending on the figures from the fourth quarter, the Dutch economy could turn into a recession. This ultimately means that the starting points of companies that would want to sell are less favourable.
The data the bankruptcies within the Dutch SME sector even show a sharp increase in the number of bankruptcies. After the almost endless COVID-19 support, companies are now being hit for the first time2.
Blowing off transaction
The uncertainty in the market is also reflected in the fact that the number of deals being called off increased in 2022. One in five deals were called off in 2022, while about 26% are shelved. This is according to a new survey by M&A platform Datasite3. Putting the deal on hold or calling it off may be due to disappointing results or market dynamics that make the risks considered greater or too great.
Scale remains a key positive driver for the M&A market
Ultimately, there are also positive elements that actually drive the growth of the M&A market. The M&A market is ultimately driven by the drivers of active and strong companies. A key driver is economies-of-scale, or economies of scale.
What is the benefit of economies of scale?
In today’s era, markets and processes are becoming increasingly complex and challenging. The world before COVID-19 and the Ukraine war is completely different from the world of today. Another example is the rapidly growing regulatory environment and need for social reporting. Even smaller companies will have to comply with ESG regulations and stricter environmental legislation in the near future, and this is not infrequently a major challenge.
The advantage of an acquisition or merger is that a larger company is created. With this, all kinds of synergies can be realised. But costs can also be better spread. When the company is larger in size, it is also more resilient to complex problems. Especially recently, we have seen a sharp increase in complexity and this is increasingly a ‘driver’ for a merger or acquisition. In 2022, this was visible at supermarket chain Jan Linders, which announced that it would continue as a franchise organisation under the Albert Heijn Label to better cope with the increasing IT/automation challenges.
Examples of focus areas where complexity has only increased are:
- Labour market
- Supply chain
- Technological requirements
- Increased regulations around sustainability
In our view, these focus areas are the new drivers of the mergers and acquisitions market, which will resume growth in 2023 after a two- to three-quarter lull. Transactions may then be concluded at lower prices than in the past two years, but especially in the light of a somewhat longer history- still on terms attractive also for the seller. A new balance will thus lead to market recovery.
For more information about this article call Gonneke van der Lee (06 52466518) or Maarten Vijverberg (06 55853074)
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