Q1 Dealmaker’s Digest: Unravelling Trends in M&A Activity

At the beginning of 2023, the outlook for deal-making was uncertain and had been since the middle of 2022. M&A activity will likely remain muted until macroeconomic factors start to improve, which many believe will happen in mid-2023. The decline from the highs of 2021 due to economic and geopolitical headwinds was hard to stomach, but investors are feeling cautiously optimistic about the future. The first quarter of 2023 has now ended, and, much to everyone’s dismay, a new crisis has reared its head caused by the collapse of several influential banks.

This article explores key trends in the current deal-making landscape and mulls over what the rest of this year may hold.

The Impact of the Banking Crisis

One of the most significant events of Q1 2023 was the banking crisis. The collapse of Silicon Valley Bank (SVB) in early March significantly impacted private equity. The bank provided debt financing to private equity firms, and its collapse left a void in the market. This void was compounded by the fact that many private equity firms were already struggling to raise capital as investors grew more cautious amid the economic headwinds that shook 2022.

To make matters worse, the rushed acquisition of Credit Suisse within the last couple of weeks has shaken confidence in banks further. This banking crisis has resulted in conservative debt lending practices, and the larger private equity firms are searching for novel capital deployment strategies. For example, instead of financing leveraged buyouts, firms focus on deals requiring less leverage, such as assets that can be acquired through majority equity transactions.

The Rise of Value Investing

Firms must create value from their existing portfolios to counter current volatility. When interest rates were low, it was far easier for businesses to pursue a growth strategy. That ship has now sailed. In many cases, the current climate of low valuations makes sell-offs unpalatable. Instead, firms are focusing on operational improvements, cost optimisation and strategic realignment to enhance portfolio companies’ profitability and long-term potential. 

“Sector Champion” Buy-and-Builds

Some private equity funds are concentrating on smaller buy-and-builds to create “sector champions”. The current economic climate does hold some benefits for firms pursuing a buy-and-build strategy. If they have the capital to do so, firms can purchase businesses at a discount. Moreover, there is currently less competition for acquisitions as many investors are still exercising caution or cannot access sufficient funds. However, problems may arise if buyers underestimate the complex nature of due diligence and integration that come with these deals. Only time will tell if buy-and-build strategies enacted during this turbulent time bear sufficient fruit. 

Shifting Sector Focus

The current economic environment has also instigated a shift in sector focus. Industries such as technology, healthcare and energy have attracted significant interest in recent months due to their resilience and growth potential. Niche sectors, such as clean energy, healthtech and eCommerce logistics, are particularly attractive to investors, as they tend to be less crowded, giving firms a better chance to find investment opportunities likely to generate strong returns with the added benefit of diversifying their portfolios. 

Sustainable Investing Gathers Steam

Despite ongoing challenges, ESG issues remain a key focus for investors and companies. Governments and regulatory bodies have been implementing new regulations to encourage sustainable investing. For example, mandatory ESG disclosures and carbon reporting requirements have increased transparency around sustainable investments, allowing investors to better assess the credentials of their investments. 

In 2022, ESG-focused fundraising showed itself to be resistant to the deal-making headwinds which affected other asset classes. Today, ESG matters for more than deals—it is now a vital part of due diligence, and many firms are explicitly focusing on ESG considerations in value creation plans.

Outlook for 2023

The first quarter of 2023 has ended, and despite some hair-raising moments (namely the banking crisis), the general feeling among investors remains cautiously optimistic. While a turbulent economy and a fragile geopolitical situation create problems, it also creates opportunities for those willing to adapt and innovate. Investors and companies must navigate the evolving landscape carefully, leveraging new strategies to stay ahead in a volatile market.