Pent-Up M&A Demand Headed for Release

Sudden economic uncertainty hampered M&A last year as would-be dealmakers chose instead to wait on the sidelines. This year, many of those deals could come to market in a flurry of activity as buyers and sellers turn to M&A to drive growth in a challenging market. But buyers and sellers may be faced with a new problem, sources say: if too many deals come to market at once, rebound M&A activity could actually slow down.

Rising interest rates and expensive debt saw dealmakers pump the breaks on the hectic pace of transacting seen in 2021 and early 2022. This year, with buyers and sellers gaining more clarity on the economic climate, many are once again eager to transact. Data released by Citizens Bank in a recent survey of 400 leaders at U.S. middle-market companies and private equity firms found both buyers and sellers view M&A as a driver of growth: 35% of sellers said they planned to seek a sale this year because of strategic growth opportunities, while 62% of buyers said they plan to buy for the same reason.

“Our deal pipelines are full, and I think everyone’s are full,” says Theodore Swimmer, head of Capital Markets and Advisory at Citizens Financial Group. “Business conditions worsened in the fourth quarter of last year, so a lot of those deals carried over to this year and they are coming alongside others that have been waiting longer to come to market.”

Business conditions worsened in the fourth quarter of last year, so a lot of those deals carried over to this year and they are coming alongside others that have been waiting longer to come to market.

Theodore Swimmer

Citizens Financial Group

Investment bankers Middle Market Growth spoke to for this story said nearly every sector of the economy has a pipeline of deals waiting to come to market. Yet they also warn that the release of one backlog could cause another, with demand overwhelming the availability of resources and causing yet another M&A slowdown.

Where Demand Lives

There are a handful of sectors seeing the most M&A interest as investors look for opportunities likely to withstand current macroeconomic conditions.

Commercial services companies—including facilities support, HVAC, cleaning and environmental services—are leading the pack right now in terms of deal interest. “We’ve seen interest in elevator maintenance companies, for example,” says Brendan Burke, managing director at investment bank Capstone Partners. “Those are companies that have a locked-in customer base because by law, you have to have your elevators inspected and maintained.” Those companies are also ripe for roll-ups because sponsors can create a platform that consolidates across geographies, Burke adds.

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Other non-cyclical sectors including tech-enabled business services, healthcare and food services are seeing interest from buyers. “These companies tend to have good cash flow and demand is consistent,” Burke says the food services space. “Even if the S&P is down thirty percent, people still need lunch.”

Brian Murphy, president and managing director at Meridian Capital, agrees, while he’s also seeing renewed interest in agriculture as well as aerospace and defense. “Investors have made a flight to quality,” he says. “They’re looking for industries that have strong cash flow, are more mature and tend to do well even if there are adverse business conditions.”

Murphy adds that M&A activity this year will also be driven by an older generation of business owners eager for an exit. “Many of these industries are also led by baby boomers. There are more sellers who want to retire. Boomers are also a source of demand for industries like healthcare. Those are secular trends that will bring companies to market.”

One Bottleneck to Another?

With full pipelines and a number of investors willing to make bets on resiliency, M&A activity looks likely to pick up in 2023. Most estimates say the second half of the year will likely be the busiest for deals, barring another significant economic shock. Capstone’s Burke says if the pace of interest rate hikes slows or stops, the market “could rip.”

Motivated sellers that have been waiting for months are likely to be supported by investment bankers equally eager to make up for lost time. Private equity investors are also feeling pressure to deploy capital if they have funds that are nearing the end of their investment period.

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Meridian’s Murphy thinks the debt re-pricings that spooked investors and sponsors last year probably won’t carry over into 2023. He notes that financing that relies on a lot of leverage is still tricky to do in this environment, but many PE sponsors have been able to do tuck-in or bolt-on deals without having to seek out new financing arrangements. “Diligence is taking longer, and parties are sensitive to working within their existing credit facilities,” he says. “Highly levered deals are still going to be challenged, but for deals where that is not the case, people are more comfortable with where the market is right now.”

Sponsors are also looking at a wider variety of deal types and options. “We’re seeing more interest in minority stakes over a full sale, or investors may make an investment of a certain size to keep it within their existing credit facility,” says Larry DeAngelo, managing director and head of the business services group at Houlihan Lokey. These shifts are a response to tighter liquidity today and a softening of business conditions seen in the third and fourth quarters of last year, DeAngelo adds.

If everyone is coming to market at once it can actually slow M&A down.

Brendan Burke

Capstone Partners

As dealmakers find avenues to keep M&A activity up, however, the pressure could shift to timing concerns. With diligence taking longer, and sponsors weighing various options, dealmakers may hit a few speedbumps if the volume of new deals coming to market suddenly spikes.

Capstone’s Burke says that’s always a danger when there are a lot of buyers and sellers waiting on the sidelines. “If everyone is coming to market at once it can actually slow M&A down,” he says. “We might have a deal that is perfect for a specific deal team, and they’ll pass on it because they’re maxed out. Diligence requires a lot of resources and anytime markets get crowded we see more firms pass on opportunities because they don’t have anyone to look at them. That’s what you want to avoid—especially after a slower year.”