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In this quarter’s newsletter: Energizing merger and acquisition (M&A) activity, key factors driving trends, plus access to insights to get you off and running in the new year.
An uptick in M&A activity with an interesting twist
As we write this quarter’s newsletter in mid-December 2023, we do not have the final tally of M&A deal volume for the calendar year, but we can say there has been an uptick in activity during the fourth quarter. While we don’t expect to achieve the record-breaking deal volumes of 2021 and 2022, the result of a pandemic-induced frenzy of M&A activity, 2023 was not a sleepy year from a historical perspective.
Last quarter, we discussed how muted private equity platform deals were due to the higher interest rate environment, bid-ask deltas between buyers and sellers, geopolitical unrest and other macroeconomic headwinds. However, smaller add-on transactions remain prevalent as private equity firms continue to bolster portfolio company growth through acquisitions in a slower-growth environment.
We are tracking a growing trend in the resurgence of the corporate or “strategic” acquirer, aka a nonfinancial sponsor, likely due to several reasons. Corporate acquirers are less affected by a rising interest rate environment, as they often fund an acquisition with their existing balance sheet. Corporate acquirers tend to have different rationales for purchases, such as adding new products or services, expanding geographically, increasing production to reduce the overall cost of goods sold, etc. A synergy benefit to a corporate acquisition is typically inherent in the overall deal thesis.
A surge in corporate energy-sector deals
One area in which our corporate M&A practice is experiencing significant growth is in corporate energy, according to Ryan Bosworth, RSM partner and transaction advisory services corporate channel leader. Our growing list of clients comprises public and private entities with annual revenues ranging from $500 million to over $20 billion. Bosworth notes that corporate acquirers often focus on middle market M&A to drive strategic transformation and accelerate growth.
Adding insight is Scott Barcroft, RSM partner and transaction advisory services value creation leader, who says a key component of most corporate deals is the ability to create and realize synergies and operational efficiencies. Larger corporate buyers typically have robust infrastructures that allow for significant rationalization of back offices, enhanced purchasing power and operational know-how, all of which can positively impact deal economics. Corporate buyers, particularly public entities, are much more likely to invest significant time and effort to realize synergies to their maximum potential. RSM’s recent discussions with corporate chief financial officers (CFOs) indicate more robust deal activity as we head into 2024, especially among well-capitalized entities needing to drive shareholder value.
A confluence of factors has driven the surge in corporate energy-sector deal activity. With a growing emphasis on sustainable practices and renewable energy sources, traditional energy companies strategically leverage M&A opportunities to position themselves in the evolving market. Notably, major players are eyeing partnerships and acquisitions in the renewable energy and carbon recapture sectors to capitalize on the global shift toward cleaner energy solutions.
The technological frontier is another key driver of corporate energy M&A trends. Innovations in energy storage, smart grids and digital solutions are prompting companies to engage in strategic acquisitions or investments to stay ahead of the curve. As the industry embraces digital transformation, M&A deals are about securing physical, cash-flowing assets and acquiring technological capabilities that enhance operational efficiency and reliability.
M&A outlook: What’s in store for 2024
RSM’s M&A practice has observed this rapid push to invest in renewables from both existing and new clients and also increased deal activity in conventional energy sectors, such as oil and gas exploration, oil field services and fossil-fueled power generation. Looking ahead, we expect the corporate energy M&A landscape to remain dynamic, with a continued focus on sustainability, regulatory shifts and technological advancements shaping the trajectory of transactions and future investment.
Here's how we see big corporate activity in the energy arena taking shape:
One factor that could slow corporate M&A activity is the changing regulatory environment. We expect the upcoming election cycle and continued unrest in global commodity markets to alter regulations further and influence the overall economic landscape.
In this quarter’s newsletter: Smaller deals making a big impact, the merits of back-office automation, plus access to insights to keep you well prepared to succeed.
Smaller deals making a big impact
Three quarters into the year and we are seeing more of the same. Well, sort of. While it has been a difficult period for middle market mergers and acquisitions (M&A) deal-making, we are tracking some interesting developments unfolding in the marketplace.
Deal activity in the first half of 2023 mostly mirrored the second half of 2022, primarily due to macroeconomic headwinds, the Federal Reserve’s interest rate environment, and inflation wreaking havoc on middle market businesses and investors.
A growing discrepancy between buyers and sellers over enterprise value expectations has, in many instances, elongated deal processes or broken them altogether. Industry sources report that multiples (enterprise value/EBITDA) are down from prior years for the first time in a long time. This valuation reset could be good for the overall marketplace, but it will likely take a while to normalize fully.
For private equity buyouts, platform acquisitions remain at the lowest levels during the past decade; however, higher add-on transactions have partially offset this lull. Smaller deals are easier to complete and have become prevalent in the industry as part of a “roll-up” strategy, whereby multiple companies are acquired to form a much larger entity, thus consolidating the market.
RSM transaction advisory services hit a peak in July for the year, which could be a reason to get excited about the fourth quarter and heading into 2024. Meanwhile, our sell-side due diligence deal volume as a percentage of the total was higher than normal during the second and third quarters, which may indicate a busy post-Labor Day fall season.
The merits of back-office automation
Economic pressures and a potential recession have pushed many private equity portfolio companies into preservation mode. Chief financial officers (CFOs) are shifting their focus from high-stakes digital transformation to low-code automation of the back office.
For much less investment and little coding knowledge, you can streamline many back-office processes that involve tedious, repetitive, manual tasks across complex systems and applications to drive scalability. Let me share an example of how process automation helped one of our clients overcome its growing pains following a series of mergers and acquisitions.
RSM client benefits from process integration
After growing from eight properties to over 1,500, a global hospitality company’s business processes became highly disjointed among legacy groups, resulting in duplicative work and inconsistent service quality. Moreover, many of these processes were highly manual and time-consuming, leaving little opportunity for the staff to focus on strategic initiatives.
After a private equity firm acquired a majority stake in the company, the push to integrate processes across the organization accelerated. Leadership zeroed in on robotic process automation (RPA) as a first step in gaining efficiencies and engaged RSM to assist with selection and implementation.
RSM led an independent review of the company’s people, processes and technology to identify integration opportunities within existing applications. We leveraged “fit-for-purpose” technologies combined with RPA to optimize business processes and data flows.
By expanding platform usage to eliminate repetitive manual tasks, the company significantly improved its process efficiency, including a 65% reduction in manual account reconciliations. Productivity also increased, and by saving more than 350 full-time equivalent (FTE) hours per month, the company’s workforce was able to redirect their efforts toward core business functions and drive value.
Business-led technology enablement has become imperative for middle market companies to succeed in these challenging times. As a leading provider of systems and solutions, RSM has the experience, industry knowledge and resources to help you drive value from the back office.
In this quarter’s newsletter: Staying focused on optimization and rationalization and why your existing portfolio matters more now than ever.
Our view of the current middle market M&A landscape
The outlook remains uncertain for private equity mergers and acquisitions, with deal count faltering by another 9.3% from the fourth quarter of 2022, according to PitchBook’s latest U.S. PE Breakdown.
There’s also a new dynamic happening between buyers and sellers regarding the bid-ask spread for transactions. The average multiple for middle market PE deals is shrinking, so price negotiations are taking longer.
We are still seeing deals get done but not as much upmarket activity or billion-dollar-plus transactions. There’s a heavier concentration in the lower market, with fewer platform acquisitions and more add-ons to existing portfolio companies, primarily because they are easier to finance and execute than larger buyouts.
Another trend we’ve noticed is the uptick in sales preparation by PE firms amid speculation that the M&A market may turn as early as the second half of 2023 or the first quarter of 2024. Firms are planning ahead to ensure they will be transaction-ready for when the time does come.
The existing portfolio matters more now than ever
Many of our PE clients are concentrating their efforts on existing portfolio company operations, focusing on optimization and cost preservation to build exit value and using cash flow modeling to understand the impact of rising interest rates. Firms with high-performing portfolio companies are also assessing their exit strategies to consider all available options.
RSM now forecasts a 75% chance of a recession over the next 12 months due to tighter lending standards following the recent turmoil in the banking sector. Meanwhile, portfolio companies already have to deal with stubborn inflation, global uncertainty, supply chain issues and a talent shortage, all contributing to an increase in cost structures.
In response to these challenges, private equity firms and their portfolio company management teams are looking inward with an eye on cost optimization and operational improvement. By analyzing their selling, general and administrative expenses and improving operational efficiencies, private equity-backed portfolio companies (portcos) can reduce 10%-25% of their selling, general and administrative (SG &A) expenditures, increase operational efficiencies and increase EBITDA.
Now that deal flow has slowed, firms are also evaluating their portfolio operating models and investing in people, process and technology while time permits. As always, the goal should be to do more with less. If automation can be enhanced by just 20%, it essentially eliminates the need for strategic outsourcing by eliminating labor costs. Leveraging technology and artificial intelligence to optimize operations is one of the most effective measures to reduce costs and enhance value.
Utilizing a managed services model is another significant opportunity for companies to conduct day-to-day business operations at a reduced cost structure and within an environment geared toward continuous improvement.
How RSM can help with optimization and rationalization
Here’s an example of how a rapid cost takeout benefited one of our clients. A PE-owned tire and automotive repair provider engaged our advisors to conduct a procurement cost savings analysis following an acquisition. They aimed to identify and achieve significant cost savings to enhance the business’s value through increased profitability.
Through a SKU-level analysis of the client and target’s existing procurement mix (e.g., tires, oil and parts) and in-place vendor and distributor agreements (e.g., volume-based incentives, applicable discounts and features), RSM identified and proposed optimal terms, pricing and mix, resulting in actionable annual cost savings of approximately $4 million or the equivalent of a $40 million increase in total enterprise value assuming a five-year exit timeline.
RSM continues to remain busy serving private equity firms and their portfolio companies, and we are hyper-focused on responding to the ever-changing marketplace dynamics caused by macroeconomic and other factors.