What can we expect from the M&A market in the future?

Despite record levels of mergers and acquisitions (M&A) activity in 2021, 2022 (particularly H2) saw a slowdown in activity. Supply chain disruption, inflation, rising interest rates and softening consumer confidence have hindered investment decisions—but there are reasons for optimism. The eurozone narrowly avoided a recession and there is an emerging consensus that inflation is stabilising with interest rates expected to peak in 2023. Many businesses have strong balance sheets and some entities have used the peak multiples to rationalise their portfolios and build healthy balance sheets for future investments by selling non-core assets. While valuations remain high, there may soon be a reset that could provide opportunities for buyers to acquire assets at better values. As we look ahead, digital transformation and ESG will continue to drive M&A activity as companies work to transform their businesses and remain relevant.

How has economic volatility affected business valuations?

Estimating a company’s future cash flows is a critical component of any valuation. Economic uncertainties such as volatility in commodity prices, foreign exchange rates and other market fluctuations can make this task more difficult. However, taking a longer-term view and using judgements and assumptions based on historical data and other benchmarks can help you see through the shorter-term noise. Many companies have come to the market on the back of peak profitability driven by pent-up demand and strong margins. The challenge today lies in assessing the sustainable level of margins as we advance. Despite these challenges, a company with growth potential, a large target market and strong margins will likely attract a higher valuation. Buyers will also consider the strength and depth of the target company’s management team, as a company with a talented and diverse team is more likely to succeed post-acquisition, while companies with a clear ESG strategy are increasingly attractive.

Amid the current uncertainty, what do you typically advise your clients to focus on?

Business leaders must be ready to move quickly when suitable targets arise. This means knowing what talent and technology they need to meet their objectives and being able to move rapidly when the time comes. It is also important for businesses putting themselves up for sale to be in a position to demonstrate the full potential value of their business to potential buyers. This means identifying not only growth areas, but also potential areas of underperformance and having clear plans to address these. This reduces uncertainty and helps the business maximise its value in the market. Ultimately, building resilience against the unknown requires preparedness, agility and creative thinking. But capitalising on opportunities requires more than being agile and having your funding lined up. Having a well-thought-out strategy that aligns with your ESG and transformation goals is crucial. Profitable growth is critical and you must ensure that any acquisition fits your overall strategy. Otherwise, it could be detrimental to your business in the long run.

What challenges do companies typically face after completing an acquisition?

Integrating two businesses can be complex, especially if they have different cultures or operating models. There may be challenges in aligning processes and systems, consolidating teams and integrating company cultures. In addition, there may be challenges in retaining key employees and ensuring that the newly acquired business continues to perform well post-acquisition. The new owners must be prepared to deal with unexpected issues, such as legal or regulatory challenges or changes in market conditions. In truth, completing an acquisition is just the beginning of a new series of challenges for companies. Companies therefore need to have a clear integration plan that aligns with the deal rationale and be prepared to adapt if they are to enjoy long-term success.

As an advisor, what mistakes or myths do you encounter as you work with businesses on their M&A transactions?

One common challenge we see time and time again is that sellers underestimate the demands that will be placed on the management team during the due diligence process. Typically, a limited number of people in the company will have knowledge of the deal and they will be juggling their day job as well as requests from multiple bidders across the different due diligence workstreams, from financial to tax and legal. Engaging your advisors to prepare a vendor due diligence report can be really helpful as it:

1. reduces the number of parties requesting information;
2. helps you to position the full potential of the business; and
3. can help identify potential risks early in the process.

This ultimately leads to a smoother process while limiting disruption to the underlying business.

Finally, what’s the most valuable M&A advice you share with your clients?

Develop the agility to move quickly and craft a well-thought-out strategy for where you want to go. Be creative in arranging funding and structuring transactions, especially in the current high-interest-rate market, and model the risks with scenario plans and build them into your valuation models. Remember that while economic troubles may be receding, they have not disappeared. But that shouldn’t stop you demonstrating the full potential of your business by strategically articulating your value proposition.

Learn more about PwC’s Deals Advisory practice.