M&A deal activity has mirrored much of the larger economy and markets so far in 2023. There has been plenty of reason for optimism, but that optimism has certainly been cautious; deal activity remains lower in the wake of global uncertainties during the last three years.
A couple of mid-year reports on the M&A outlook lay out the story.
PwC’s mid-year M&A review notes that global M&A deal volumes declined by 4% between the second half of 2022 and the first half of 2023. Deal value was down by 12% and the energy sector was among the leaders in that category.
Potential sources of optimism for the remainder of the year and into the next include increased portfolio reviews by corporate and private equity. Specifically, PwC sees “a more capital-constrained environment leading to a greater focus on divestitures as companies look to deleverage balance sheets, free up capital to re-invest or, in the case of private equity, return capital to their investors.”
PwC also sees a push for mid-market and smaller deals as larger deals have been facing greater scrutiny with financing and regulatory concerns.
Restructuring could be a source of activity, given the high capital costs and economic pessimism. “Companies that were able to secure fixed-rate debt at historically low rates during the pandemic are benefitting from lower financing costs. But those facing a refinancing event or variable-rate debt are feeling the impact and need to take action,” according to the PwC report. It also indicates that $200 billion of institutional loans will mature in 2025. If rates remain high, these loans will face a significantly higher interest rate if debt needs to be rolled.
More specifically to O&G, accounting and consulting firm KPMG released a report on M&A activity in energy, natural recourses and chemicals, noting that volume is down, but value is up.
KPMG writes that lower activity is driven by a pessimistic outlook resulting from elevated price levels, high interest rates and a fear of recession.
The report notes that “O&G companies are reshaping their portfolios to address changes in energy policies, improve their resilience to price volatility and reduce carbon emissions.” For O&G, Q2 2023 saw 95 deals, which was a 10% decrease from Q1. But the deal value came in at $43.9 billion, up 104% quarter over quarter.
KPMG does call for quiet optimism, however. Though not looking for lower Fed rates it notes that even a pause in rate hikes may help, particularly with private equity deals.
KPMG also said the Inflation Reduction Act (IRA) is a major incentive for investment in sustainable energy and infrastructure. There are numerous deals on hold as guidance rules for the IRA are finalized. In addition, O&G companies continue to hold higher cash balances that may serve as dry powder for deals later in the year.
With all the talk of capital costs and interest rates, the Fed outlook remains an important piece of the M&A landscape.
Earlier in the year there was the thought among Fed watchers that a rate-hike pause, might be in the cards for the latter half of 2023. The September Fed meeting put a damper on those expectations. While the Fed paused, after a hike in July, it also signaled another 25-basis point raise in November or December. For 2024, the median expectation of Fed members surveyed project a rate of 5.1%, implying that rate cuts for next year will be no more than 50 basis points. Markets have been anticipating a more dovish look for 2024 and responded accordingly.
Owners and investors interested in selling or buying a business might get a bit bored following the Fed so close. But they must understand that even when deal financing is available, potential investors now have a choice they haven’t had in decades: a meaningful risk-free rate of return.
As has been the case for a while now, the M&A outlook is mixed. There are reasons for optimism, particularly in the O&G space, but fear and uncertainty continue to hover over the entire economic outlook.
