M&A Market Outlook: Signs of Optimism

Speaker 1:

Welcome to Markets Plus Minutes, where we cover the latest market, economic and business trends. Today, our host is, Warren Estey, Head, Investment Banking for BMO Capital Markets. As the end of 2023 nears, Warren is going to discuss the current M&A environment and what to expect as we head into the new year.

Speaker 2:

The views expressed here, are those of the participants and not those of BMO Capital Markets, its affiliates or subsidiaries.

Warren Estey:

I would say that it is a very complex environment, I think you've got a lot of cross currents whether that's fed policy, fears of a recession, GDP growth issues, geopolitics, all of that has really impacted confidence, right? Confidence that you can actually come to an agreement on a price for a transaction, confidence that you can actually get that transaction financed, confidence that you can ultimately get the transaction done. So it has made it a very challenging couple quarters, there's no doubt about that.

But as I sit here in the second half of '23, I would just note that broad market volatility is down 30, 35%. Equity markets are actually performing rather well and even the financing markets are coming back to life and some would say becoming more efficient. And so what that means is that value is more banded, and that gives people on both sides of the table more confidence to actually sit at the table. And it means that bid offer spreads are actually tighter than they have been over the last couple quarters, and all of that, to me, means that I think we should feel more confident in the second half than in the first half of '23.

Warren Estey:

corporates are in a superior tactical position going back and looking at multiples paid over the last six or seven years, corporates have been extraordinarily disciplined and it's a deviation of less than one multiple in terms of what they are willing to pay. And it's the private equity clients who, given what the interest rate environment has been historically, that multiple can vary up to three terms so we are in a position now where there is a normalizing of expectations of value of capital structures. And what we are finding from when we speak to strategics is that they clearly understand that they are in a tactically superior position, they are going to use that position to their complete advantage, they will drive processes, and I think they are a very compelling ultimate buyer to a large swath of management teams right now.

Warren Estey:

And I would just add, I think that in buoyant markets, the buy side gives corporates more leeway. And in challenging markets, the buy side adds more pressure to corporates, to make sure that every part fits and every part creates value. And there aren't any parts that drag ROE down. And if those are identified, there's a lot of people on the buy side spending a lot of time thinking about how I would deconstruct company X or company Y. And so I think in these types of challenging markets, you see more activist campaigns, you see more private equity firms making soft approaches to mid-cap corporates, to large-cap corporates where one or two pieces may or may not fit.

Warren Estey:

I think what this market is requiring people to do is be extraordinarily creative and think of things in the medium to longer term. And I think that that is also showing up in deal structure where you are seeing more equitization in transactions, you are seeing earnouts. Earnouts may be a way that someone can actually ascribe greater value either on the sell side or the buy side.

Warren Estey:

from a positive perspective, we are seeing transactions that could not get done last year where people just kind of put down the pencil. We are seeing those transactions actually be revived at the behest of both the initial inquirer and the potential seller

Warren Estey:

I feel a lot better about that and seeing that. I would say that even banker chatter is becoming more positive rather than bankers talking about can a deal get done? Bankers are talking about how a deal gets done. And again, it goes back to that creativity point. So I think there's a lot of different ways to create value, there's a lot of different ways to create certainty in transactions, and those types of things are happening with more regularity in today's M&A market than they were over the last year.

Warren Estey:

The IPO market is a great barometer. Valuations are now coming back to levels where people can at least begin talking about that, but I think until you have an IPO market that fairly, in the seller's mind, justifies a process, I think you're going to see fewer sponsor sell sides, simply because you want some form of competitive tension there. the sponsor clients that I speak to regularly, they're doing a lot of running the companies that they've recently bought over the last two to three years. So I think it remains pretty complex for them.

Warren Estey:

I would say that capitalism finds a way. And M&A activity is a key part of capitalism. And so when I see, two private equity sponsors going after a public company in a very public bidding war, when I see things are being revived from failed processes last year, that gives me a lot of confidence in the forward.

But I think it's going to be deal-by-deal.  You need the deal-by-deal confidence. Each deal needs to go well, whether it's a financing or whether it's an M&A deal to build the broad market confidence, broad market defined as buyers, sellers, financiers, banks that are financing it, et cetera. And so deal-by-deal, you'll hopefully see that confidence built, and then my view is that you'll have a [inaudible 00:39:52] market that's characterized by confidence and momentum.

Speaker 1:

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