A Return to Reality
There is no question that M&A and the general economic landscape looked a lot different in 2022 than it did in the white hot 2021 environment. Inflation, rising interest rates, geopolitical conflicts, and continued supply chain constraints took their toll on the public markets and ultimately impacted deal valuations and closings in the private sector.
In January, we surveyed private equity groups investing across various industries and deal sizes within the middle market. Our goal was to gain insights on deal activity over the past year and to probe investors’ expectations for 2023.
One of the most glaring trends we uncovered was that while deal flow remained consistent or higher than 2021 for over half of the firms polled, most respondents agreed that deal quality fell rather significantly year over year, as illustrated by the charts below.
While one might assume that significantly higher interest rates would price many buyers out of the market, the lack of quality deals in 2022 seemed to ramp up competition for high quality assets. In fact, nearly 80% of respondents reported that auction process competition was higher or the same in 2022 than in 2021, which was a year of record valuations and closed deals.
It should come as no surprise that the record-paced Federal Funds Rate hikes affected private equity leverage reads in a notable way, especially in the second half of the year. The following charts illustrate the downward shift in leverage that most financial sponsors experienced when soliciting financing for transactions. Two-thirds of respondents reported a 0.25 to 2x EBITDA leverage drop in the fourth quarter alone, with three-quarters seeing a drop of the same range when compared Q4 leverage reads year over year.
The survey also dove into investor predictions for 2023 and their expectations regarding valuations in specific sectors. Respondents anticipate that the consumer sector, which already saw a fairly precipitous drop-off in valuations in 2022, will continue to dip in 2023. Nearly half of the firms surveyed believe that valuations for consumer deals will decrease moderately in the coming year, while another quarter anticipate a significant decline.
Industrial and manufacturing deals also received a lukewarm assessment from buyers. Nearly half (43%) of respondents expect a moderate decline in valuations while 39% predict sector valuations in the coming year will be consistent with 2022.
Business services elicited the most optimism, with 52% of respondents believing that valuations will either remain consistent or increase moderately. (It should be noted that 43% of firms project a moderate fall-off in business service valuations.)
A complete summary of 2023 industry valuation predictions can be found below.
Overall, M&A deal flow remained stable in 2022 relative to historical standards, although macroeconomic and geopolitical conditions shifted the market landscape fairly significantly.
Investors’ 2023 predictions appear mixed. The future will likely depend largely on the Fed’s rate strategy. Although a continued high inflationary environment would likely put additional downward pressure on valuations, private market M&A fundamentals remain strong. Demographic effects of retiring Baby Boomers and the $1.2 trillion in private equity dry powder awaiting deployment point to continued interest from buyers and sellers in 2023.
Bobby Motch | Head of Sponsor Coverage | Class VI Securities, LLC
As head of Sponsor Coverage, Bobby is responsible for managing financial and strategic sponsor engagement, developing sponsor-related content, and managing Class VI’s Buyer CoPilot program. Prior to his role as Head of Sponsor Coverage, Bobby was responsible for executing and closing transactions and supporting Class VI clients through financial analysis, modeling, market outreach, industry research, and valuations.
The views expressed represent the opinion of Class VI Partners. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Class VI Partners believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and the Class VI Partners view as of the time of these statements.
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