While Waiting for a Revival, Let’s Stay at the “TOPP” (Transformative, Optimistic, Patient & Persistent)

A year ago, I wrote an article on the importance of savoring the excitement of the ever-changing M&A tide. Indeed, booming markets are not always the only factor driving deal activity because sometimes the best opportunities arise in challenging times – this is especially true of M&A.

Since the second half of 2022, global deal activity slowed down significantly. Global announced transactions in first half of 2023 dropped 37% compared to first half of 2022, according to Refinitiv. However, the beauty of M&A is that it can transform in order to meet the strategic needs of the market and stakeholders in any environment. There is a case to be made for cautious optimism in the current economy and for deal makers to keep busy at the “TOPP” while waiting for the market revival.

“T”: Transformation

The market has fundamentally changed, and the winners are always those who proactively transform with the market tide.

In the on-going valuation reset, well capitalized companies and financial sponsors who remained resilient during the past three turbulent years, are now geared up to “transact to transform” in order to stay ahead of future competition and proactively reposition their portfolios. The growing importance and urgency of longer-term structural shifts, such as the digital transformation and upgrade, the revolutionary impact of AI and the necessity of “green” economy recovery, are creating pent-up demand. Although we may not yet see many mega size transactions, small to mid-size transformative deals are on the rise.

To excel in the current deal environment, transformative deals must be proactively cultivated with a clear M&A strategy roadmap. A regularly updated and expanded target pipeline that may create transformational value, with consistently revisited deal structures and carefully prepared due diligence for various scenarios, will equip acquirers with the confidence and capability to move fast and boldly when the opportunity arises. This is vital because the opportunity cost for companies who are passive without a pragmatic M&A roadmap throughout the downturn can be huge.

“O”: Signs of Optimism

Although M&A activity decreased significantly since the second half of 2022, we are still not too much lower than the annual pre pandemic deal value levels, setting aside the exceptional year in 2021.

M&A is still the essential tool for strategic and transformative deals to refine the future landscape, and we are seeing the first signs of optimism and small indications of stabilization on the not-too-distant horizon: US inflation is gradually subsiding, interest rate escalation may have peaked and the European energy crisis appears to have been averted. Importantly, while some recession fears persist, market discourse has been dominated by the broader growth themes of digitalization, decarbonization and AI.

After all, a market downtown is exactly the time to enter and stay ahead of the competition.

There is no lack of opportunity and capital in the current environment – deal conversations, both soft sounding and serious negotiations, are continuing. With current low valuations and record levels of accumulated dry powder, investors are working hard building conviction to seize the unique opportunity to enter the market. There is much pent-up demand from cash rich corporates and well capitalized Private Equity (PE) firms - thoughtfully planned transactions with strong strategic rationale and potential for significant transformative value creation, will get done.

The drive to be the first mover is appealing and pushing deal makers to get ready.

“P”: Patience and Persistence

Nonetheless, in order to succeed in the current market, deal makers need to be both more patient and persistent.

Pre-deal preparation and the M&A deal execution process is taking much longer and getting much more complicated than in normal market conditions.

In order to bridge the valuation gap and justify the business case, deal makers are spending significant time to identify, quantify and justify value creation – either traditional revenue and cost synergies from operational enhancements and market expansion, or transformational value from digital upgrade, sustainability planning and strategic repositioning. Deals are now involving more complicated structures, innovative financing solutions, much deeper and more robust due diligence,  longer and wider condition precedents, representatives and warrants to mitigate the risks and uncertain outcomes.

The behavior of companies and PEs throughout cycles have also changed. Well capitalized companies learnt to pursue a more programmatic approach to M&A for better performance, and are proactively searching for acquisition targets with justified value creation, as well as actively recycling  capital via divestments. PE firms now also invest more consistently through the ups and downs of the cycle, instead of waiting for markets to bottom.

Deal makers need to persistently work with buyers and sellers during uncertain and challenging market environments in order to take advantage of opportunities to reshape the business. These persistent efforts will help market stakeholders to gain confidence and react faster when opportunities arise. M&A deals planned with a clear strategy, strong process, careful due diligence, thoughtful structure and post-deal plan will be best positioned for success.

Looking ahead

The current macro environment will continue to impact M&A deal making. Although there is still uncertainty and fear of a recession in the market, market leaders are working hard to seize the downturn to Transform, with consistent and disciplined efforts to reset, reflect and reposition, in order to execute and deliver a long term strategy for sustainability and competitiveness.

We are entering an era of great change full of opportunities. The market is searching for signs of Optimism to regain confidence and deploy record-level dry powder. Patience and Persistence are especially needed from deal makers to succeed in this environment before the next revival.

In the fast-changing M&A tides, stay at the “TOPP” through tough times to come out of the cycle stronger!