Pucker Up: The "Lipstick Effect"​ and other predictions for M&A markets in 2023

The M&A market in 2021 saw record-breaking deal flow as markets priced the combined impact of plentiful low cost funds and line of sight to restored supply chains. However, in 2022, the market experienced a 37% drop in M&A activity, driven by a perfect storm of the Russian invasion of Ukraine, rising commodity and energy prices, inflation, and rising interest rates. As 2023 begins to unfold, there are somewhat contentious predictions of a global recession, but amidst the uncertainty, there are also opportunities for consolidation and disciplined M&A players. In this note, we set out our key predictions for M&A in 2023.

Prediction 1: Rise in distressed M&A

Due to the difficulties of raising capital, economic uncertainty and rising interest rates, companies that overstretched their cash positions and didn’t achieve commensurate revenue growth will need to rethink their strategy.

In some cases, simply trimming operating costs will do the trick. In other cases, that won’t be enough, and they will need to shore up cash balances by selling non-core assets. This latter category will present opportunities for businesses with excess cash to buy assets at a lower cost and extract synergies. We expect this to result in a significant increase in distressed M&A activity in 2023.

Prediction 2: The "lipstick effect" will drive a higher volume of smaller deals

In the third quarter of 2022, for the first time in more than three years, no deal worth more than $10 billion closed.[1]

The "lipstick effect" is the tendency of consumers to buy less expensive luxury goods during an economic crisis. We think it is a perfect description for what we expect to see in M&A markets this year.

What does this mean for M&A players? If you’re a seller: you’ll want to sell smaller, non-core assets to prop up your cash reserves. If you’re a buyer, you are more likely interested in smaller, bolt-on acquisitions payable in cash (rather than scrip or relatively expensive debt) and priced-to-sell as a means of building out your economic moat at a discount.

Prediction 3: Execution risk play on the minds of sellers and into the hands of buyers

No doubt execution risk is going to play on the minds of buyers and sellers alike in 2023. At a time when cash reserves are tight, exploratory due diligence is an expensive exercise for a tyre-kicker. As a result, we think that only serious buyers will actively participate in sale processes, possibly dampening competitive tension. On the plus side for buyers, many sellers will be forced sellers or have little choice, which should dampen execution risk from the buy-side risk.

For sellers, seeking to limit walk away rights through “material adverse change” conditions precedent will be particularly important, as it was during the COVID-19 M&A flurry. That said, if you’re a distressed seller, your ability to win this debate will be limited, particularly if your sale process has not attracted as many participants as it may have during 2022.

Ultimately, we think that serious and disciplined buyers who have adapted to market conditions will be the net winner here.

Prediction 4: Carbon reduction and ESG will be hotspots

Data from Ansarada’s Deal Indicators Report shows that new energy M&A deals commencing in the second quarter of 2022 dropped by 14% quarter on quarter globally (and 4% year on year).[2] Yet, during the second half of 2021, deals relating to energy transition accounted for 55.6% of all deals taking place in the sector.

This continued into 2022, and Tiger & Bear advised on a number of deals involving ESG, carbon reduction and solar tech players. We are also seeing a trend of businesses, including industrial players, coming together to find mutual solutions to reduce energy usage and, as a consequence, carbon emissions.

On the physical asset side, we expect large emitters to aggressively target deals aimed at reducing carbon production from their operations to meet net-zero targets (we have already seen big miners divesting coal assets despite high commodity prices and energy generators grappling with whether they should, and how they can, expedite the transition to net zero within their own generation portfolios).

Software too is also proving to be a key driver of the transition to clean energy and the path to net zero. But for many carbon reduction software businesses, cash is tight as the adoption curve simply hasn’t been what investors expected, meaning revenue growth has been soft. We think that there will be plenty of opportunities for tech players to pick up bolt-on carbon reduction and ESG tech businesses at a discount this year as investors grow patient and seek to de-risk their investment.

Prediction 5: Fintech consolidation will continue to intensify

We expect the increase in M&A activity in the fintech sector we observed in 2022 (more than 700 deals, and eight transactions worth more than a billion dollars)[3] in 2023, with higher interest rates and cautious venture capital activity leading multiple fintechs to seek an accelerated exit or balance sheet repair through mergers or acquisitions with larger peers.

To wrap up, we expect 2023 is expected to be a year of consolidation, with distressed M&A, smaller deals, increased execution risk, carbon reduction, and fintech consolidation being key trends to watch. While the global economy faces uncertainty, there will also be opportunities for companies to bolster their balance sheets, reduce carbon emissions, and continued growth in fintech M&A.

If you see an opportunity for consolidation and want help evaluating it, or you are contemplating divesting a non-core asset or business unit, get in touch with us to discuss how we can bring our unique multidisciplinary advisory skills (including corporate advisory and legal advisory) to help you analyse and, if the opportunity is right, execute on your M&A strategy while mitigating execution risk.

[1]    https://www.wtwco.com/en-AU/Insights/2022/10/q3-2022-global-m-and-a-performance-enjoys-bounce-back-in-third-quarter.

[2]    Available upon request at: https://www.ansarada.com/fy23-deal-indicators-report

[3]    https://fintechnews.sg/68969/funding/fintech-consolidation-set-to-intensify-this-year/