Opportunity knocks as IPOs fall

Organizations engaging in mergers and acquisitions (M&A) will need to take a more deliberate, strategic approach to growth and capital allocation. A precipitous drop in IPOs in 2022 is among several factors changing how both buyers and sellers are engaging the M&A market in 2023, experts tell CFO Brew.

The weakening of the IPO market in 2022 means there are potentially more companies available for direct acquisitions. According to PwC’s US Deals 2023 Outlook report “more than 650 potential unicorns may be looking for an exit, creating significant opportunities…for corporates that could acquire VC-backed companies” in 2023.

However, macroeconomic uncertainty, rising interest rates, labor costs, and cost-cutting pressure (aka the usuals) make it more incumbent on acquiring companies to focus on value creation and capital discipline, according to John Potter, PwC partner and US deals, clients, and markets leader.

“Factoring in a higher cost of capital, and thus, the elements that are going to drive value returns on that capital are much more at the forefront of the decision making today,” Potter told CFO Brew. “It’s putting attention on it that hasn’t been there for 20 years.”

Off a cliff. In late December, EY’s Global IPO Trends report found that IPOs fell 78% in 2022 after a record-breaking year in 2021, with 90 offerings last year compared to 416 in 2022. The collapse of SPACs contributed to the fall in IPOs, with SPAC IPOs in the US decreasing 86% in 2022, according to EY. But overall economic sentiment and volatility had a major impact on IPOs last year.

“A record year for IPOs in 2021 gave way to increasing volatility from rising geopolitical tensions, inflation, and aggressive interest-rate hikes,” Paul Go, EY global IPO leader, said in the report. “Weakened stock markets, valuations, and post-IPO performance have further deterred IPO investor sentiment.”

A broad drop in valuations, especially in tech, makes lower-priced companies more attractive to acquirers. It also makes IPOs less attractive for companies looking to go public—they simply weren’t going to raise as much money in an IPO as they would have even a year ago. That leaves companies looking for alternatives, Potter told CFO Brew.

“While the IPO market may not be as active right now, the correlation I see between that in the alternative ways for liquidity or change of control would be an acquisition,” he said. “It creates that intersection where one of the key things I see in the M&A market today is aligning buyer and seller views around value.”

Opportunity knocks. The other factor changing the M&A equation for companies looking to strategically acquire is rising interest rates. For companies with strong balance sheets and ready cash, the higher cost of debt works in their favor, as private equity, which is typically debt-financed, is finding it more expensive to get deals done, Susan Dettmar, US leader of M&A consultative services at Deloitte, told CFO Brew.

“The silver lining is that…companies that want to get into M&A that are not private equity—they’re not getting priced out of the market the way they were last year,” she said. “Businesses that are looking to acquire…are suddenly finding themselves able to align to their strategic goals through acquisition because they can afford it.”

However, minding the fundamentals of value creation and capital discipline in the face of these changing conditions should still be top priorities for companies looking to acquire, Potter added.

“People are making sure they understand those dynamics and the way those variables will play out in the future,” he said. “So they can have the confidence to invest the capital in things that are going to be critical to growth.”

There are broad expectations that the economy will improve and M&A will pick up in the latter half of 2023, and there are already signs that the IPO market will recover this year. While interest rates are high and private equity has taken time to adjust, PE is still sitting on a mountain of dry powder that can be put to work in the M&A markets.

“IPO markets will open up certainly as volatility retreats, clarity of inflation and interest rates come through,” Potter said. “We’re setting ourselves up for what is going to be an increasingly competitive market when it comes to acquisitions.”—DA

Correction 02/22/2023: This story has been changed since publication to update the spelling of Susan Dettmar's name.