Buyers turn to alternative financing amid market challenges
After a fairly lengthy period of respite, merger and acquisition activity is set to rebound in the second half of this year, according to a new Grant Thornton survey.
M&A professionals are predicting an uptick in deals while mitigating interest rate hikes with alternative financing as private equity firms are planning to hold assets longer in hopes that valuations will rise over a longer time horizon, the survey shows.
There is optimism among 150 US-based M&A professionals including investment bankers, M&A attorneys, PE investors and CFOs that deal volume has already hit bottom and is set to rise. After the unparalleled burst of transactions in 2021 and early 2022 fueled by pent-up pandemic frustrations, M&A activity slowed substantially as inflation and interest rates soared beginning the last half of last year.
“Six months ago, buyers were waiting to see what would happen. I think we’re finally hitting normal again.”
Steady interest rates and modest improvements in economic conditions appear to be sparking a turnaround in transaction expectations. Grant Thornton’s survey showed that 99% of respondents expect deal volume to increase over the next six months, with 11% forecasting a significant increase.
Eric Burgess, Partner, Transaction Advisory Services for Grant Thornton, said people are getting more comfortable with buying in the current climate.
“It’s just getting back to a little more normalcy,” he said. “You have inflation plateauing, and I think for the most part six months ago many buyers were waiting to see what was going to happen. I think we’re finally hitting normal again.”
That sense of normalcy comes with some caveats, however. Burgess said PE leaders have increased the number of deals they’re closing, but the transactions are smaller and include many portfolio company add-ons that PE firms are bundling in hopes of driving higher valuations in the future.
Larger deals are less common, but thanks to strong fundraising with limited purchases over the past 15 months, buyers have opportunities to initiate smaller transactions at bargain prices.
“Valuations are down, and corporates are sitting on a lot of cash,” said Elliot Findlay, National Managing Principal, Transaction Advisory Services for Grant Thornton. “They’ve got the cash on the balance sheet, and ultimately they are ready to deploy to buy companies at a low or depressed values.”
According to the survey, the top industries for transaction activity over the next six months will be:
- Technology, media, entertainment and communications, which have been hit hard by recent economic stagnation that caused a decline in advertising revenue.
- Banking, as regional banks are recovering from the shock waves associated with the collapses of Silicon Valley Bank, Signature Bank and First Republic Bank earlier this year.
- Healthcare, which has a strong supply of customers and potential for technology transformation that is attractive to PE buyers.
Note that the industries forecasted to have the slowest rate of M&A activity are not-for-profit/higher education; hospitality and restaurants; and transportation, logistics, warehousing and distribution.
The top industries for M&A activity in the next six months are technology, media, entertainment and communications; banking; healthcare; services; and real estate/construction, according to data from Grant Thornton’s latest M&A survey that’s represented in this bar chart.
New strategies as interest rates rise
After the Federal Reserve's interest rate hike in July, the benchmark rate had risen a total of 525 basis points over 17 months, making financing for deals a more complex proposition.
Indeed, three in 10 M&A professionals said they had executed fewer deals as a result of the increase in interest rates. In response, buyers found new financing strategies.
Nearly two-thirds (66%) have been exploring alternative financing plans to fund transactions. Private funds that invest in minority equity stakes are supplying capital for some deals, and net asset value financing appears to be growing in popularity.
Meanwhile, 45% of respondents are increasing the equity component in financing to avoid high-interest lending for these acquisitions.
“I’ve seen situations where full equity checks are being written for the first time in over a decade,” Burgess said. “But I think buyers are writing these equity checks in the hopes of refinancing in a year. And there are also a lot more mezzanine lenders as well as secondary debt being utilized.”
Meanwhile, PE firms are pursuing new tactics related to their current portfolios. They’re seeking alternative financing arrangements and holding on to assets longer in hopes of a bigger payday down the road when the valuation environment is more attractive.
Private equity firms are dealing with lending restraints by searching for alternative financing and holding assets longer, according to data from Grant Thornton’s latest M&A survey that’s represented in this bar chart.
What’s next? Overdue exits
The question is when the valuation environment might get more attractive. With almost six in 10 PE firms holding onto assets longer because of the constraints in the current lending environment, the sector is likely to experience a glut of overdue exits. Firms are holding in the hopes of seeing valuations increase in the coming months because they are looking to maximize returns on their investments.
“Growth drives valuations. And I just don’t know anyone that’s coming out with really aggressive growth forecasts right now.”
In addition to the over-supply of companies looking to exit, the forecast of these companies’ performance does not reflect the levels of growth that usually attract new investors. “Growth drives valuations,” Findlay said. “And I just don’t know anyone that’s coming out with really aggressive growth forecasts right now across a whole variety of industries.”
So despite the stock market inching higher, steadier inflation and unbridled optimism over the pace of deals, there still may be tough times ahead in terms of valuation until that aggressive growth returns.
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