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Successful dealmakers will find opportunities
While economic and geopolitical uncertainties have created headwinds, they’re also generating opportunities. A reset in valuations, the availability of capital and the increased competitiveness from corporates should provide openings for dealmakers in the year ahead. The strong US dollar will fuel outbound investment, tempered by the underlying weakness in foreign markets and compressed foreign earnings.
In 2022, M&A market activity continued to exceed historical norms while retreating from the new heights of the previous year. Once the final stats are tallied, 2022 will end up as one of the strongest years outside of 2021.
The need for speed in business transformation, which is accelerating thanks to technological advances and the evolving economy, will keep dealmaking front and center. Whether changing supply chains, adopting new go-to-market approaches or adding capabilities, the market is impatient. The fastest way to transform a business is through M&A, divestitures or other deals.
While doing deals, leaders must also keep a close eye on stakeholder trust — among customers, investors, regulators and business partners. PwC’s surveys of consumers and business executives on issues of trust reveal substantial gaps between what consumers say is important and what executives believe. Since trust — and distrust — can alter consumer behavior, protecting it must be a top priority to preserve value in dealmaking.
We’ve entered a period of changing economic and financial fundamentals. Interest rates, inflation and wages have all been rising. A number of macro factors, from trade wars to shooting wars, are driving economic uncertainty. This is not an unprecedented environment though. It’s a return to conditions we’ve navigated in the past.
Business leaders recognize the challenges. Some 90% of executives tell us in the November Pulse Survey they're concerned about macroeconomic conditions, and 81% expect a recession in the next few months.
Still, most business leaders also know they can’t cut their way to growth. And as we saw in the past five years, deals have been a key fuel to business resurgence and economic expansion. Executives say they are confident they’ll be able to hit near-term growth goals and execute on strategic transformational initiatives.
Over the next 12 to 18 months, 44% plan to hire talent with specific skill sets to drive growth. And a growing number of executives — 35% in PwC’s November Pulse Survey — say they’re planning an acquisition or divestiture over the same period. That’s up 10 percentage points from August 2021.
What will drive successful deals? Consider these factors:
- Capital discipline, including the power of portfolio renewal and the value in divestitures
- Navigating uncertainty
- Speed to unlocking value from transformational deals
- Increasing resilience and security
The power of portfolio renewal and the value in divestitures
The volume of acquisitions has been outpacing divestitures in recent years. Prior to 2017, S&P 500 companies divested two businesses for every seven they acquired, according to PwC analysis of Capital IQ data. From 2017 to 2021, they divested two businesses for every nine acquired, a better-than-10% decrease in divestiture frequency than the prior five-year average.
Strategic leaders recognize that divestitures can be an important source of value creation. A disciplined, strategic approach to divestitures can drive overall returns, even in a challenging environment.
We looked at divestitures over the past decade and found that the median company saw a 3.8% increase in its stock price above its peers around the announcement date, according to PwC analysis of Capital IQ data. The top quartile received a 10.4% stock price boost, and companies that had a positive impact at announcement sustained a 3.1% excess return above their industry peers.
A divestiture can eliminate management distractions from strategic imperatives. It can also be an important source of capital for acquisitions or transformative business initiatives — a key consideration with current financing costs and the capital discipline to deliver required returns.
Strategic portfolio reviews can help make divestiture decisions more objective and clear away emotional barriers and inertial factors. The discipline of persistently reviewing portfolios can improve outcomes and reduce the stigma often associated with them.
Timely divestiture decisions can improve performance in the current business environment. Evidence suggests that proactivity can increase the odds for delivering a positive return by five times. That means setting aside emotions, making objective assessments and then acting quickly.
PwC’s portfolio review and divestitures study demonstrates that moving faster and decisively on divestitures can create more value for shareholders.
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Capital discipline
Though capital discipline has never gone out of style, we expect it will be a prime factor in 2023 deals.
While rising interest rates may make debt service more costly, rates are still far from historical highs. Lower valuations will create opportunities for acquirers. Companies with healthy balance sheets and a strong strategic vision can use deals as a path to business transformation and increased shareholder value.
Likewise, divestitures can provide an opportunity to improve overall returns — especially when the cost of capital is higher. Companies should consider shedding nonstrategic units and focusing capital on transformation and strategic growth.
As 2022 progressed, we’ve seen a tepid level of IPOs, turbulence in LBO debt markets and new regulatory scrutiny on SPACs. These conditions could create rich veins of opportunity for corporates with cash and strong credit ratings to execute deals at favorable prices.
IPOs dwindled significantly in 2022 compared to earlier years — there were 723 IPOs in the first three quarters of 2021 but just 97 in the same period in 2022. More than 60% of the IPOs announced this year were subsequently withdrawn. However, the pool of potential IPOs is significant and contains good opportunities. More than 650 potential unicorns may be looking for an exit, creating significant opportunities for investors and for corporates that could acquire VC-backed companies.
Likewise, many SPACs are looking to close deals in 2023, but regulatory and financial uncertainty may lead to redemptions over deployment. There’s also the potential for orphan deals that corporates might be well positioned to complete at attractive prices.
Private equity has been active in recent years with acquisitions and is expected to remain active in looking at exits and recapitalizations. There’s been increased interest among PE funds in acquiring insurers as a way to increase returns and assets under management, and we expect that to continue.
History suggests companies that make acquisitions during downturns tend to see higher shareholder returns in the following quarters.
The median acquirer during the 2001 recession outperformed its peers by 2.43% over the next six months and 7.01% over the next year. Those deals were characterized by strong buyers executing smaller deals at lower valuations. Firms that made acquisitions early in the recession tended to see higher overall returns in stock value. Similar conditions exist now.
Growth alone is not a sufficient corporate strategic objective in a rapidly changing environment. The right combination of making acquisitions and divestitures to reinvest can drive return on capital even in an environment with higher capital cost and inflation.
Navigating uncertainty
Several converging factors are generating macro-level uncertainty and will require leaders to be alert and strategic throughout the coming year.
Economic uncertainty. Inflation and the rising cost of capital continue to alter deal calculus and influence the financial markets. The possibility of a recession is also shaping expectations.
Global politics. The Russia-Ukraine war and its impact on energy costs and food prices continue to make Europe and the rest of the world nervous. US-China relations, along with China's zero COVID policy, are reducing opportunities in China for US companies and contributing to a reassessment of supply chains. And elections around the world pose the possibility of disruptions.
US politics. The midterm elections produced a divided Congress, with Democrats hanging on to control in the Senate by a tight margin and Republicans eking out a narrow majority in the House. More than half of executives surveyed by PwC say this outcome will be positive for the overall business environment and their companies. But business leaders are also concerned that with Congress divided, the Biden administration may push policy changes via executive orders and regulation. The Federal Trade Commission, for example, has blocked some large deals this year, including a $2 billion-plus deal in the publishing industry. While most deals are still getting through, the regulatory environment will remain a key consideration for dealmakers. Tax regulation, cyber policy and regulation, and the SEC’s role in ESG reporting are top areas of concern for executives.
US dollar strength and cross-border deal flow. While inflation and other macroeconomic forces are roiling markets and economies around the country, the US remains better positioned than other industrialized countries, with relatively lower inflation and low unemployment. We expect this to translate into sustained strength for the dollar compared to other major currencies. This could create significant opportunities for corporates with a clear global strategy and strong balance sheets. Conversely, however, the strong dollar will create more challenges for non-US firms that wish to enter the market or bulk up with US acquisitions. One note of caution given concerns over a possible recession in 2023: The US dollar and outbound M&A have a positive correlation that tends to break down during recessions.
Due to economic uncertainty, C-suite leaders will be called upon to be smart about protecting the downside in their businesses, including watching spending and looking for opportunities to trim costs. One large health insurer, for example, invested $8 billion to acquire a company to help it streamline payment and operations. Companies with strong balance sheets are likely to find that uncertainty can serve up some attractive deals. Other companies will be able to take advantage of the current environment to build on their core strategy through transformative deals. A $14 billion deal announced in the fourth quarter of 2022 frees up capital for the seller to focus on a growing demand for manufacturing automation technology.
Speed to unlock value from transformational deals
Even in the midst of uncertainty, the markets are impatient. The most successful deals will be those that allow companies to quickly transform strategic aspects of their business, pushing the business forward quickly. These strategic shifts include opportunities such as moving closer to customers, leaving troubled sectors and speeding up digital transformation.
One pharmaceutical and medical devices firm announced a $16.6 billion acquisition that will enable it to enter a fast-growing segment of the medical device business. The deal is designed to help the acquirer continue to transform into a faster-growth company.
Another sector to watch is fintech. Valuations of fintech firms have fallen below the valuations of commercial banks, creating opportunities for banks to potentially acquire fintechs and accelerate digital transformation efforts.
Investing in purpose, ESG and culture are central to unlocking value from transformational deals. Despite economic uncertainties and pressure on costs, 44% of executives are hiring in specific areas to drive growth.
Unlocking value from transformational deals begins with solid, strategic decision-making around whether to do a deal and what deal is the right deal.
Here are some key considerations:
- Ensure corporate strategy is relevant. Given economic uncertainty, it may make sense to consider strategy sooner.
- Consider organic potential. If your strategy has shifted or should shift, companies should assess whether they have the assets and capabilities to change direction organically. This includes an assessment of talent, intangible assets and time. If organic change is likely to be slow, a deal could dramatically speed up the process.
- Conduct a portfolio analysis. Make this a regular part of the business planning process, as it is particularly important when considering a company’s ability to execute on its strategy. A portfolio review may reveal opportunities for divestitures that could free up capital and management attention, as well as point toward potential acquisitions. For instance, one large software company this year announced a $20 billion acquisition to meet the needs of a key market segment.
- Evaluate deal-execution capabilities. C-suite leaders need to have a plan not only to carry out the deal but to ensure that it delivers on a transformation promise. Value creation goes well beyond integration. Deals in the coming year will have clear value creation plans to harness the value and drive the required capital returns. This includes detailed integration planning and a strategy for retaining key talent in a newly acquired business unit.
Increasing resilience and security
As businesses survey the deals landscape, a major factor in their decisions will be managing and mitigating a variety of risks. Geopolitical uncertainty, the potential for supply chain disruption, cybersecurity concerns, exposure to cryptocurrency fluctuations and other factors will be part of due diligence. But resilience isn’t just about protection. It’s about positioning to win in a turbulent market where the business's ability to adapt or withstand changing dynamics is its competitive advantage.
One area where leaders must pay attention is trust. Some 71% of consumers say they are unlikely to buy from a company if it loses their trust. This means trust is as important to financial sustainability as more traditional business metrics, which in turn places issues such as cybersecurity and reliability in the spotlight.
On the acquisition side, companies will be looking at risk factors to help them determine appropriate valuations, highlight integration challenges and assess new strategic risks that an acquisition could produce.
Some businesses will also seek out deals to help them mitigate risks by providing new capabilities or reducing existing risk. The shift to onshoring and near-shoring to reduce supply chain risk is one example of how resilience and security concerns can drive deals.
Here’s another example: There’s growing investor pressure in the oil and gas industry for companies to invest in more environmentally friendly businesses. In several deals in the spring and summer of 2022, global oil companies poured billions into solar- and wind-powered producers as well as sustainable fuel companies. Investors and other stakeholders will likely continue to pressure oil and gas companies to boost their “green” investments and chip away at their carbon footprint.
On the divestiture side, business leaders should be thinking about ways to reduce risks for potential buyers. Implementing a robust ESG reporting system, for instance, can provide transparency that gives potential buyers confidence in a deal — and it might boost valuations in the process.
Even if a divestiture is not imminent, companies can help reduce future risks of a move through internal reorganizations. Such reorganizations can make it easier to divest a business unit in the future, reduce operational risks and create an asset that can stand on its own. Internal reorganizations can create assets that have potentially greater value after a divestiture, generating additional TSR and reducing business risk. The ability to operate independently while still under the parent company’s umbrella also may improve the chances of regulatory approval.
Bottom line
Companies that have strategic discipline and conviction will be able to find and execute good deals that create shareholder value.
High performing companies conduct regular portfolio reviews to assess which business units are strategic and which are no longer a fit for the core strategy. This creates opportunities to divest and redeploy capital into transformative opportunities that create value through new technology, talent and ESG capabilities. It also allows management to shift focus in the direction dictated by corporate strategy.
This may create an opportunity for strategic buyers to acquire earlier-stage companies. Acquirers with capital will likely have opportunities to do deals from a position of strength while factoring the rising cost of capital into dealmaking.
Markets will not be patient. C-suite leaders should seek out transformative deals that can help their company leapfrog forward and quickly generate value for shareholders. Despite some headwinds, we believe there will be opportunities for savvy dealmakers in 2023 and beyond.
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