2024 mergers and acquisitions update

Garreth Hanley:
This is INTHEBLACK, a leadership strategy and business podcast brought to you by CPA Australia.

Gavan Ord:
Hello, welcome to INTHEBLACK. I'm Gavan Ord from CPA Australia, and today we're diving into the world of mergers and acquisitions or M&A. Our guest today is Stephen Craig CPA. Stephen is a partner at Pitcher Partners in Melbourne. He specialises in M&A and due diligence where he helps a range of clients including private business owners, private equity multinationals, and he helps them to successfully navigate their way through a transaction. He has experience working on both the buy and sell side of deals and across a broad range of industries within the Australian mid-market. Welcome to INTHEBLACK, Stephen.

Stephen Craig CPA:
Thank you, Gavan. Thank you for having me.

Gavan Ord:
So our first question today is the Pitcher Partners 2024 Dealmakers Report published in February and the mid-year update published in late July includes an M&A confidence score of 77% for Australian deals in 2024. Even though overall M&A volume dropped by 17% in 2023, can you explain what the confidence score is? And now that we're halfway through 2024, is the activity living up to the enthusiasm you saw at the beginning of the year?

Stephen Craig CPA:
Sure. So for a bit of background around the confidence score, it is a pretty broad question targeted at a group of respondents to our survey. The questions are asked in November, so November '23 for this current year's report. It's a simple one to 10 asking them about their expectations for 2024, ease of doing deals, ease of sourcing deals, and expectations for the year to come. We've asked that question now for four years, and we're starting to find that it is actually a really good indicator of sentiment. Its one limitation is it's at a point in time, so obviously if things change, the score doesn't have the ability to move with it. But for context over the years, the highest we've achieved is 81, and that was a really good lead indicator into 2021, which was a boom year for M&A. In 2023, fast-forward, that number dropped down to 75, not a huge drop, but the overall declining movement was again a good indicator for the challenges that the market faced in 2023.

At that point in time, the market was dealing with multiple rate rises, inflation was certainly throughout the headlines. And at that point in time too, there was no real end in sight for those rate rises. The forecast was for more to come, inflation still wasn't under control. Fast-forward again to November last year when we took that result of 77%, so a slight increase there, we viewed that really as cautious optimism of the market.

At that point in time, it felt like rate rises had finished, there was commentary around potential rate cuts in early ‘24 overseas and potentially mid ‘24 locally, but I think the main read there was respondents were feeling more certain about what the future held. So we saw that 77% as an increase off the prior year. The general responses around that 77% was, there was still pain to be felt in their market but there was optimism that as conditions improved, we were going to see a real return to or increase in M&A activity.

What's, I guess, eventuated over the course of the last six months is challenges haven't dissipated. Interest rates, that expectation around interest rate drops, that continues to get pushed out into the future. There's even commentary now around a potential rate rise. Cost of living pressures, that's a headline in the papers all the time and it's being felt by a lot of people out there. And inflation, so increased costs for inputs of businesses are still high and have increased over time and potentially some of those increases are still being borne out by some participants in the market. So the challenges I guess, haven't dissipated as much. I think that optimism is still there, but it's still waiting on conditions to improve and the conditions have not yet improved. So would that score be the same? It's probably around about the same, but we're still looking for those green shoots, so to speak.

Gavan Ord:
Yeah, and I'd agree with that. Late last year was sort of thinking it was the end of the interest rate increased cycle and looking forward to maybe interest rate decreases or cuts from mid-year. That just obviously hasn't eventuated. So obviously interest rates has been a big factor, affecting deal-making. Are there any other factors that affected deal-making over the last six months?

Stephen Craig CPA:
Deal-making is very much around sentiment and confidence. So some of the things that have really tested that, I guess we've mentioned inflation, it's hung around for longer than expected, the cost of living pressures, that certainly impacts particularly retailers. Their customers are looking to tighten their purse strings. A lot of companies with inflation, the inputs have gone up, whether it be wage growth or the cost of raw materials. So those uncertainties are being borne out with how do deal-makers understand, deals are often struck on earnings, and so how do deal-makers understand the earnings of a target if you've got these competing pressures, which the confidence isn't there as to we know which way they're going to go.

Some other issues around confidence, global conflict, obviously there's been a few issues around the world, Russia and Ukraine, in the Middle East, that always leads to uncertainty, even to the point around elections as well. So US this year, UK has just been, and Australia I think is ready for one next year. So even elections can just create a little bit of uncertainty, which then leads to people being more cautious, which then can make them consider M&A a bit more deeply rather than being a bit more impulsive.

Gavan Ord:
So what trends are you seeing in the small-cap market, the mid-market, the large-cap market in terms of deals this year? And before you answer that question, maybe just explain for our listeners how you define mid, small and large.

Stephen Craig CPA:
Sure. So I'll start in the middle. That's where my focus is. So the middle market, deal values or enterprise values between 10 million and 250 million. Obviously then large cap sits above 250 million and small cap below the 10 million. If I was to talk generally about those groupings, the mid-market is typically quite a stable area of the market. You've got probably the majority of the volume of businesses transacting in that segment. Your typical business in that segment is a medium to large private enterprise. And so transactions for them are often based around life issues, around succession planning, and that's not always an area where people are prepared to wait to try and time the market. So you've got this greater volume of businesses who aren't as prepared to often wait to try and time the market. So you've got this natural churn rolling through that section of the market.

From a buyer's perspective too, mid-market is attractive for other mid-market businesses, but also some of the large corporates. And for the large corporates, the mid-market is seen as, I guess is perceived as less risky, smaller capital required, easier to integrate, more manageable in terms of scale. So there's potential there that even in risk averse times, you've still got the larger corporates also interested in the mid-market.

The large cap, the movements there, there's more volatility, you've got more exposure to the sort of the mega deals, the bulge bracket deals. You take for example 2021, which was a boom year. You had Afterpay, you had Sydney Airports. They combined for about 60 billion, which out of 1200 odd transactions that year, those two alone captured about 22% of the year's value. So you've got far more susceptibility there for volatility based on a handful of big deals.

In saying that, I've positioned the mid-market as stable and the larger cap as more volatile. We're actually seeing a little bit of the opposite in the last six months. There's been a bit more caution in the market. The mid-market has seen a bit of a drop-off in terms of value and volume, whereas the overall market driven by the larger caps has probably been far more stable, actually an increase in deal value and a smaller drop off in terms of volume. We're reading into that as a couple of bulge bracket deals, which are probably propping up the values. And I think all these cost pressures that we've talked about, they're potentially impacting the mid-market more greatly than some of the larger businesses.

Gavan Ord:
So you'd see more caution in the mid-market over the last six months?

Stephen Craig CPA:
Yeah, certainly. We've had a few engagements where we've seen potential buyers just pause their process. They're a logical buyer for the target business. They've even said so. They've said they're very interested, but their first concern is about their own backyard. And so their response been, we're very interested, but we've got some things to deal with first in our own business, our own cost pressures, revenue streams, et cetera, before we want to go and commit to acquisition and growth strategies through acquisition. So there's still deals being done, but we are seeing that caution come through.

Gavan Ord:
So how does Australia compare to other countries in the region and globally? Do you have any insights into the factors influencing deals in those other markets?

Stephen Craig CPA:
Yeah, look, I think Australia is perceived very well internationally from an M&A perspective. In terms of movements, I think our increases or movements in terms of deal value and volume have been pretty in line with global trends. But Australia is seen, I think, as a pretty safe market to enter into from overseas buyers. You've got a relatively stable government, you've got clear legal framework, and it's a great strategic positioning for anyone looking to enter into the Asia-Pac region as well. So we're certainly seen favourably. It does attract a lot of international buyers, and I think overall though, our results, particularly in this last half of the year, probably mirrored the global markets.

Gavan Ord:
And that's basically what I've seen as well. It's a global caution in the M&A activity, as you said, there's also these big deals which can influence the outcomes, but in the mid-market, I'm seeing this drop off globally as well. And talking to members overseas, they're seeing less M&A activity.

Stephen Craig CPA:
And certainly the challenges that we've talked about, inflation costs, et cetera, these are not isolated to Australia. So these are global trends that everyone's dealing with and I think everyone's dealing with in the same way.

Gavan Ord:
Totally agree. In terms of M&A activity so far this year, who's been active? Is it local or offshore buyers or both? And what are the factors influencing capital inflows and outflows?

Stephen Craig CPA:
Look, both, I'm going to sit on the fence here, both have been active, both local and international. International buyers coming into the market, they typically make up about a third of activity within the local market. And in the last six months, again that's held true, I think about 38, 39%, so just over. Certainly there was lows through the Covid period. Travel restrictions certainly didn't completely stop it, but certainly hindered. International buyers are certainly back from that point in time and the last six months indicates that we're back to business as usual. We're seeing inbound interest on transactions from the likes of Japan and the UK, the US, broader Europe as well. So there's probably no sort of one area that we see more or less attention from. It's horses for courses depending on the industries that we're working within and we're seeing interest from across the globe.

Gavan Ord:
Is there any sector or industry where M&A activity is stronger than others?

Stephen Craig CPA:
Not specifically. There's a lot of... You read the papers, you see a lot in healthcare, in tech. There's certainly industries that get a lot more attention, but the mid-market, again, where we play, is a very diverse sector and we see a broad range of transactions across a range of sectors. We've seen, well, private capital is one that's had a lot of interest recently. HMC's acquisition of Payton, Regal's acquisition of Merricks, there's a lot of media attention around that. We've seen activity in building services, professional services, ESG, anything related to ESG or sustainability certainly attracting a lot of attention as well. Plenty of buyers who are keen to either enter that space or expand their exposure to those spaces.

Gavan Ord:
AI, is still flavour of the month or has that sort of past a bit?

Stephen Craig CPA:
I think some of the recent headlines have been that there's a bit of caution around will the earnings generated, will they match the hype? But certainly AI, digitization, they're areas of significant interest. Digitisation, especially with, again, I go back to the cost pressures, I don't want to keep harping on the negative, but digitisation can certainly help either reach out to customers more efficiently or to a new channel of customers, or it can help with cost savings too. So there's a lot of interest in those sectors.

Gavan Ord:
Looking into your crystal ball, what do you see as on the horizon for M&A activity for the 2024/25 financial year?

Stephen Craig CPA:
Very good question. I think the last six months have probably been described as a bit of a holding pattern. There's negative pressures. The positive side to it is there's still a lot of dry powder sitting out there through corporate balance sheets, private equity, superfunds have got funds to deploy.

So there is still a lot of active buyers out there and there's a lot of people searching. We get a lot of requests from people looking for acquisitions, what have you got? So, there is a positive element there that is waiting to act, but they're somewhat being restrained by the caution at the moment. So I guess the question mark around the next 12 months is, where do the economic conditions take us? Six months ago we thought rates were going to drop. Right now, I don't think there's any lead indicators as to which way it's going to head.

And so that's probably the biggest challenge. Are things going to get tougher? Is there a potential rate increase out there? Or are these rate cuts going to eventuate? And it's not all about interest rates. I know that's sort of been something I've been talking about a bit, but overall business sentiment, are we going to see cost pressures start to reduce? Are we going to see cost of living start to come under control and where's that going to take us? So there's a little bit of a... We're sort of sitting on the, well, I'm certainly sitting on the fence here as to which way it's going to head. I think caution is going to remain certainly in the near future. I think everyone's looking for those indicators as to is it upwards or downwards? I think there's uncertainty at the moment.

Gavan Ord:
You mentioned the side about cautious optimism. Would that be sort of your longer term view in this space?

Stephen Craig CPA:
Yeah, certainly. I think most people expect there to be an uplift in the not too distant future. I don't want to put a timeframe on what that is. As I said, there is buyers out there actively waiting, they're interested. There's still deals being done. Again, don't want to harp too much on the downside. There is still deals being done. Good businesses will typically still find a buyer and add a valuation that is expected. So not at a discount, certainly not at a fire sale. So there are deals being done, and I think there's a question mark as just to do we see an uplift in that in the near term?

Gavan Ord:
Well, thank you, Stephen. Thank you so much for sharing your insights on the M&A activity with us today. It's been great talking to you. And in the show notes, we'll include a copy of Pitcher's latest half-yearly report.

Stephen Craig CPA:
Thanks for having me.

Gavan Ord:
And thank you for listening to INTHEBLACK. Don't forget to check the show notes for resources from CPA Australia and the full report on deal making from Pitcher Partners.

Garreth Hanley:
If you've enjoyed this episode, help others discover INTHEBLACK by leaving us a review and sharing this episode with colleagues, clients, or anyone else interested in leadership, strategy and business. To find out more about our other podcasts, check out the show notes for this episode and we hope you can join us again next time for another episode of INTHEBLACK.