In 2023 we expect technology & services M&A to move into choppy waters with pockets of opportunity, more add-on transactions and a pendulum swing to more of a buyer’s market. We like the Goldman Sachs outlook for how this cycle is different and where the US narrowly avoids a recession.1 Consider the two sides of the M&A table:
- Sellers have benefited from strong end markets, heavy emphasis on technology innovation and rising valuations. We’ve seen this movie before, when the cycle turns, there is often a period of incredulity regarding what businesses are now “worth”. In time, the private markets will find their clearing price, often with a fresh mix of creative structuring including a mix of stock, earnouts and seller financing.
- Buyers seem to be in one of two camps:
- The wait-and-see buyers: looking for signs that key factors of inflation, supply chain, interest rates and geo-political forces will stabilize enough for better clarity on M&A model inputs – including valuations; and
- The bold buyers: stepping into the uncertainty with a determination and strategic vision to get things done.
Our Prediction for 2023 Technology and Services M&A: The Year of the Add-On
We are optimistic – based upon our client work with both buyers and sellers - we are seeing good activity levels, which is perhaps a little surprising. Notably, the mix has shifted from platforms to add-ons and from control to a greater interest in minority positions.
The bolder buyers sense the opportunity:
- The antidote to organic growth: To make up for lost ground from anemic end-market growth, we are seeing PE-backed portfolio companies turn to add-ons for natural roll-up benefits. An Axial survey asked, “How would you characterize the appetite for add-ons across your portfolio companies”, 80% said “Increasing”.2
- Valuation pressure: The market complacently enjoyed a steady and resilient rise in valuations over the past decade…until now. Earlier this year, what started as a pullback of higher-risk assets at the steep end of valuation, has now bled into the broader market as interest rates rise and the growth rationale ebbs. However, this is a story with two sides.
- The public equity multiples are trading at 30-50% below their 5-year average (some SaaS revenue multiples are down more); and
- The private company valuations have been more resilient. At least partly driven by buyers' appetite for smaller-sized, lower-risk investments.
- Structure to bridge the gap left by higher interest rates and rising risk factors: As rates and risks rise, the purchase agreement corollary are earnouts, minority positions, stock substitution and seller financing. There are exceptions of course, for example, in cyclical markets where earnings may have troughed early, we see more durable multiples and less structure required to close the deal.
On the buyside, we expect rising levels of activity for the bold buyers:
- Programmatic M&A initiatives: Launching an initiative to build out a funnel of acquisition targets requires vision, creativity and patience.
- Envisioning more creative combinations: The pressure of end-market weakness combined with post-COVID disruptions is leading both sides of the M&A table to more creatively consider what could be.
- Sellers facing trough earnings and declining multiples: A tough combination, however, in our experience, a little patience and structure can go a long way to crafting a great outcome.
M&A in 2023 Started Several Months Ago
The forces of M&A were already undergoing transition into year-end. We see the more aggressive buyers spooling up corporate development efforts in search of replacing lost organic growth at lower multiples. We see sellers anxious about their end markets and reconsidering their options and timelines to exit. As one industry player noted, “persistence and creativity” are likely to be the themes of M&A in 2023.
Sources:
1 Goldman Sachs, Global Economics Analyst, Macro Outlook 2023: This Cycle Is Different
2 Axial, The Lower Middle Market Add-on Report
DISCLAIMER This presentation is intended for information and discussion purposes only and does not constitute legal or professional investment advice. Statements of fact and opinions expressed are those of the participants individually and, unless expressly stated to the contrary, are not the opinion or position of Harbor View Advisors, LLC (“HVA”). The information in this presentation was compiled from sources believed to be reliable for informational purposes only. HVA does not endorse or approve, and assumes no responsibility for, the content, accuracy or completeness of the information presented.
