Valuation and Deal Outlook
2023: Like "déjà vu all over again?"
(Estimated reading time: 3 minutes)
Dealmakers expect a revival in 2023, even though market conditions aren’t yet considered ideal. Likewise, the VRC team echoes these expectations for the year ahead yet anticipates that when we look back in 2024, we may see that 2023 will fall into a similar, familiar pattern as 2022, as macro headwinds still hang over the market. 2022 faded in discord, with Q4 global deal volumes dipping to $827.2 billion – the lowest final quarter since 2019’s Q4 low of $863.3 billion. In time we’ll see if the year’s coming M&A activity will give further credence to the late, great Yogi Berra’s famous phrase, “it’s like déjà vu all over again.”
We sense that businesses are seemingly more certain about rising to a continued challenging atmosphere, including some cautious optimism that the Fed’s interest rate hike path appears to be taming inflation. On the other hand, uncertainty about interest rates, inflation, and recession fears continue to give everyone quite a bit of heartburn.
Turning our focus to the markets, we believe it wise not to get too caught up in longing for the Dow’s January 4, 2022, high water mark of 36,799. We remind ourselves and our clients that the DJIA has remained at ~90% of that peak ranging from 33,000 to 34,000, which we think shows both the resiliency and reasonability of the market.
Multiples is another area where that reasonableness shows. Q4 earnings and revenues reported thus far have shown some fair to positive surprises; FactSet shows that 67% and 64% (respectively) of the S&P 500 report actual EPS and revenues above estimates, and so far, we’ve seen no major corrections on multiples. That said, as we review sector-specific multiples, software and technology are much lower than where they were during the pandemic; it is with alarm that we react to recent news of major layoffs from Amazon, Microsoft, and Google, but this disheartening news is reflective of the stock drops and possibly revised outlooks in the tech space.
What’s the Deal with Deals?
M&A is very much on the agenda for corporate strategics in 2023; while it likely won’t be the year of the mega-deal, companies will be approaching the space with thoughtful due diligence as the turbulence felt from the pandemic may continue to linger. Overall, dealmaking will also depend on further stabilization of inflation and a hopeful avoidance of—or a short-lived—recessionary period.
Optimistically speaking, April through June could see execs finding more confidence to make acquisitions, possibly at a bargain, especially considering that valuations are down from 2021’s frothy levels. Market makers also expect to see normalized merger activity, considering that businesses will continue to gain scale and improve supply chain headaches.
2022 saw private equity buyers focusing efforts on adjusting their current portfolios as opposed to making as many new platform acquisitions as in 2021. With still substantial dry powder coffers and deal activity remaining at reasonable levels, we expect to see them reshaping portfolios with opportunistic investments and add-ons, ensuring their portfolio companies are well positioned for growth and can weather any potential downturns as valuations reset. Even in a recessionary environment, PE acquirers will find strong balance sheets or capital to deploy with even more fertile ground for dealmaking.
Expected Trends VRC is Monitoring in 2023
The only certainty is uncertainty hanging over the market and economy; as such, we expect dealmakers to incorporate creativity into their agreements to mitigate risk while not keeping M&A on the sidelines as they continue shaping transformative deals, long-term success, and positioning to thrive in a rapidly changing, competitive market space.
- Earnouts and contingent consideration provisions will see continued popularity, particularly in private transactions, to bridge buyer and seller expectations and any gaps in valuation.
- In 2022, continuation funds were seemingly the talk of the town. While some talk has quieted due to market volatility and valuation uncertainty, we expect to see activity in this space in 2023. The timing of such moves and the critical need for a fairness opinion will be key for these transactions.
- Beginning in December 2022, the new SEC rules around Pay-Versus-Performance have come online, and companies are now required to comply in 2023. Clients have started seeing that the valuation requirements could be complex and are seeking the required sophisticated modeling of an independent firm like ours.
- With the death of the FASB’s goodwill amortization workstream, we are hearing from many companies that haven’t tested goodwill for the last two or three years. In 2023 and beyond, we anticipate more organizations will need to return to regular impairment testing cycles.
Continuing changes to international tax regimes will continue shaping M&A this year. The OECD’s efforts to harmonize global tax rates for large companies with international operations—the base erosion and profit shifting (BEPS) initiative—is clipping along, and multinationals are reacting through restructuring to optimize tax exposure and potentially shedding certain assets that don’t fit in. Much of this global tax activity is also centered around repatriating intellectual property while moving all non-U.S. IP into a single holding company as entities ensure compliance with the OECD’s rules.
For a more in-depth conversation on these or other topics related to the deal or regulatory environment, we welcome you to contact article author PJ Patel or a member of your VRC Team.