A drop in business valuations is presenting strategic M&A opportunities

Now might be the time to make strategic M&A acquisitions on the cheap, as the economic challenges and uncertainty of the last 12 months have driven down business valuations across a broad range of sectors in both the private and public markets, experts tell CFO Brew.

That drop in valuations makes acquisition targets more affordable and may produce a better return on investment in the long run, according to one M&A expert.

“Some people would suggest companies that are able to do M&A in a downturn end up better off because they buy things at good valuations,” Susan Dettmar, US leader of M&A consultative services at Deloitte, told CFO Brew. “So they don’t have to work so hard to generate the synergy that pays for the premium.”

Recent PwC research backs this up. PwC found that companies that made acquisitions in the 2001 recession—which also saw a significant fall in valuations—produced 7.01% shareholder returns after 12 months, while companies that did not engage in M&A returned an average of 2.43%.

“These challenging conditions create opportunities for buyers to achieve better returns and even outsize growth,” PwC wrote in its Global M&A Industry Trends: 2023 Outlook.

And they all fall down. Medium- to long-term economic uncertainty is still dampening valuations, John Potter, partner and US deals, clients, and markets leader at PwC, told CFO Brew.

“I do think public equity markets have reflected a current view of valuation based on near-medium term outlooks,” he said. “The private markets are probably a little slower to adjust their expectations regarding valuation.”

It’s not hard to see why. Globally last year, inflation, supply-chain tangles, higher interest rates, the war in Ukraine, and labor shortages drove down company valuations because of “future cash flows being discounted at higher rates and becoming less valuable,” according to Pitchbook’s 2022 Annual Global M&A Report. Additionally, higher interest rates have made it harder for private equity to finance deals, further dragging down valuations.

This drop in valuation led to significantly fewer IPOs, a drop in private equity deals, and a slowdown of M&A activity in the last half of 2022 and into the first quarter of 2023.

But those conditions are ripe for good, profitable deals. Buyers are finding bargains, with “median deal multiples declining to 8.8x EBITDA from a 14-year high of 11.1x,” in 2022, according to Pitchbook.

“Opportunistic buyers can get a really good deal value,” Maria Bunch, principal in Deloitte’s M&A advisory practice, told CFO Brew. “They probably have less competition to get that deal.”

Companies that take advantage of the price drops see much better results. Boston Consulting Group research on 38 years of M&A data found that deals done in weak economic conditions produced 9.6% better shareholder returns than deals made in strong economic circumstances.

Brave new world. Companies have had to make a lot of adjustments as valuations have fallen, Dettmar told CFO Brew, but they are starting to settle in.

“Until recently, we were in a seller’s market, and now we’re in a buyer’s market,” she said. “I think now that expectations are a little more modulated, the buy side and the sell side are coming together a little bit better again.”

That shift also means that M&A buyers and sellers are finding themselves in different positions as valuations have fallen.

“From a deal-making perspective, there’s really a valuation conundrum,” Potter said during a January webinar. “Buyers have to come to terms with a reduction in their own valuation, potential dilution, the inability to tap into the debt markets, and then sellers have to come to terms with their new valuations that are no longer this bright, shiny thing.”—DA