Strong Economy Could Set Stage for Slower M&A Pace in 2020
Fewer risks, solid organic growth and record amounts of available capital could stifle middle-market dealmaking in the year ahead.
Continued economic strength is causing more middle-market leaders to revise their growth strategies, which could spell fewer deals at higher valuations in the months and years ahead, according to a recent report.
For industry-watchers, 2019 seemed like the year economic growth would finally slow. After a record-setting expansion—now in its 11th year—a slowdown seemed inevitable to many, says Jim Childs, co-head of M&A advisory at Citizens Bank Capital Markets.
“We’ve been conditioned to believe a downturn will occur about every seven or eight years,” he says. “But it appears the economy has legs and that maybe there’s not a cliff coming anytime soon.”
Last year, almost half of middle-market executives anticipated an economic slowdown within two years. Today, most worries have eased.
According to the “2020 M&A Outlook” from Citizens Bank Capital Markets, middle-market leaders reported a dramatic decline in the risks that could impact their operations, such as slowing U.S. economic growth and deteriorating global economic conditions.
Similarly, 46% of survey respondents in the fourth-quarter Middle Market Indicator from insurance company Chubb and the National Center for the Middle Market predict risk for their company to increase over the coming year, a 2% decrease from the previous quarter.
“We’ve been conditioned to believe a downturn will occur about every seven or eight years, but it appears the economy has legs and that maybe there’s not a cliff coming anytime soon.”
Jim Childs
Co-head of M&A Advisory, Citizens Bank Capital Markets
The growing preference for prioritizing internal growth is also prompting buyers and sellers to embrace deal types outside of a majority buyout.
In 2019, nearly half of middle-market sellers expected to sell their entire business. Fast forward to today, and that share has fallen to 27%, with most sellers shifting their focus to carve-outs. The same percentage of buyers say they want to explore deal types that don’t involve acquiring an entire business, such as bolt-on acquisitions.
With an imminent recession seeming less likely, Childs says, there’s less urgency among middle-market executives to close deals. According to the Citizens report, just under half of midmarket leaders are considering selling in 2020—18% fewer than a year ago.
Companies are also using the current moment to revise their growth strategy. According to the report, 42% of middle-market executives now expect most of their companies’ growth to occur organically rather than through acquisitions, a 5% increase from the year before.
With urgency diminished and more internal resources available, middle-market businesses are in a better position to sell than they were a year ago and feel they will be able to fetch a better price down the road. “It’s more of a seller’s market in 2020 than it was in 2019,” Childs says.
With urgency diminished and more internal resources available, middle-market businesses feel they are in a better position to sell than they were a year ago and will be able to fetch a better price down the road.
Childs says this kind of activity would not have occurred 10 to 15 years ago. “It’s a different mentality,” he says. “It used to be you sold your company and away it went. Today, sellers are thinking of transactions not as necessarily selling their companies, but as personal financial diversification as well as getting a financial partner who could possibly help them grow the business.”
An emphasis concentrating on organic growth, an environment encouraging sellers to shop around for the best deal, and record amounts of available capital are contributing to high valuations that could remain elevated for the foreseeable future.
That could lead to a slower pace of M&A activity in 2020 than a year prior. Just over half of middle-market leaders are considering buying in 2020—16% fewer than a year ago, according to the Citizens report—and fewer executives are receiving deal solicitations.
“We expect it to be a little bit more of a selective market,” Childs says, adding that selectivity could mean higher-quality deals.
But threats to the economy remain, including international trade disputes, the fallout from coronavirus and the 2020 U.S. presidential election. “There’s a lot of issues that could crop up and any surprises could cause public and private valuations to pull back,” he says.
Barring an escalation of those risks, it’s safe to assume that current trends will hold, Childs says. “These are possibly the best of times, and it appears people expect them to last a bit longer.”
Benjamin Glick is ACG Global’s marketing and communications associate.
