The M&A Environment: Where Is It Headed?

"The macro environment continues to be complex. The cross-currents of Fed policy, economic growth, inflation and geopolitics, combined with an opaque regulatory environment, make navigating today's M&A market challenging. The opportunity set is growing, and the capital markets are becoming more efficient. Taken together, we think clients will be rewarded for their perseverance, as my colleague Amit Melwani elaborates on in the following piece."

-- Warren Estey, Head, U.S Mergers & Acquisitions --

From a distance, the North American M&A market appears to be stuck in neutral as inflationary pressures, rising interest rates, and an uncertain global economic outlook cool the dealmaking environment. But looks can be deceiving.

Despite headwinds, there is reason to believe that the M&A market is moving in a positive direction. That was the key takeaway at the State of the M&A Market session presented by Amit Melwani, Managing Director in the BMO Capital Markets Mergers & Acquisitions Group with a special focus on Food, Consumer & Retail, at our 18th annual Farm to Market Conference in New York. He said there is evidence the markets have started to stabilize in the past quarter. “Ultimately, what we’re seeing is a better feeling about the M&A markets,” he said.

Melwani identified five drivers for M&A in food, consumer and retail: portfolio optimization, topline growth and enhanced margin, vertical integration, increased activist campaigns, and distressed companies seeking liquidity.

Plenty of Dry Power

“When you look at the annual average of deal volume, we’re right in line with the 10-year average on a year-to-date basis,” Melwani added. But he added this number could be understated, given the momentum he’s seeing in the M&A space. “There are real opportunities here for M&A to increase.”

Other than in 2021 and 2022, when M&A activity reached record highs, capital is being deployed at its highest clip since at least 2016, and there is still more cash available to put in play. Overall, corporate balance sheets have around US$1.7 trillion of available capital ready to be deployed for strategic deals.

The private equity (PE) market could also be a tailwind for this space, with PE raising a staggering $2 trillion over the past decade. Much of those funds are still looking for a home. As of 2022, private equity firms were sitting on about US$800 billion of cumulative dry power, said Melwani.

Putting Money to Work

Private equity is taking a more cautious approach. “They’re making smaller bets on what’s out there, but they’re still doing a similar number of transactions to what we’ve seen in recent years,” said Melwani. “People are trying to find creative ways to put the money to work.”

At a later session during the conference, Michael Cippoletti, Managing Director & Head, Food, Consumer & Retail, BMO Capital Markets, expanded on this point, saying private equity has typically been slow to act if there is no sponsor driving the timing, he said. The reopening of the bond market, however, is signaling that private equity firms are poised to become more active in the M&A market.

That’s not to say mega deals – those valued over $1 billion – are off the table; it’s just that they’re happening more slowly, said Melwani.

Strategic Deals Earning a Premium

Over the past few years, sponsors – the organizations that facilitate deals within the financial services industry – have been willing to pay higher multiples, but that’s flipped recently with strategics or company-led buyers looking to advance their own objectives, being able to pay more. “They’re finding ways to pay the higher multiples to facilitate growth,” Melwani said, using convenience stores as an example of why paying more can work.

“If there are a lot of synergies identified in the deal, it lowers the purchase multiple paid quite substantially,” he said. For instance, if you look at synergies in recent convenience store transactions as an example, strategic buyers are expecting synergies from cost savings to be in the range of 50-100% of the target’s earnings before interest, depreciation and amortization (EBITDA).

Overall, there is a bias towards purchasing high-quality companies, with dealmakers also looking for opportunities that add scale. In the right conditions, companies are getting the higher multiples they seek, while others are backing away from deals when they can’t get the value they need, provided they have the liquidity to wait for a better offer. 

Changing Approach to Deal Structure

With rising interest rates making it more expensive to access leverage, companies are getting more creative when structuring a deal so they don’t have to put up as much money upfront.

Earnouts are one example. That’s where the seller of a business can get additional compensation in the future if it achieves certain financial goals. These types of deals are up 20%, signaling a greater focus on topline growth and profitability right now over the growth-at-all-costs approach we’ve seen in recent years, said Melwani.

There has also been a greater shift toward more equity financing, with almost a quarter of deals involving 100% stock consideration. Historically, it’s been between 5% and 15%, he said.  

A Surge of Activist Investors

As valuations in the public markets have fallen significantly from all-time highs in 2021, there has been a big increase in activist activity. “Activism is on pace to blow every year out of the water in terms of the activity in the U.S.,” said Melwani. 

Activist investors have increasingly been pushing companies to sell to strategic buyers to unlock shareholder value, particularly those that may have gone public in the last two years at extremely high IPO prices that have now fallen considerably. “Activist investors are out there right now trying to push their agendas.”

Cautiously Optimistic Outlook

There’s no question more M&A is on its way, said Melwani. Many companies are laying the groundwork to launch a sale process as soon as they feel corporate and equity markets have returned. 

“This is encouraging for us in M&A, as we look at it and see that there’s opportunity out there and deals are being done and people are working towards getting things across the finish line,” he said. “While a market that is not as robust as we have seen in the past couple of years, I wouldn’t call it an unhealthy market in the sector. We’re cautiously optimistic that things are going to be moving in the positive direction throughout the rest of the year.”