The past few years have seen some of the highest M&A deal volumes ever in the consumer retail market. So what should we look for in 2023? This question was posed to several industry experts on a panel at a the 2023 ICR Conference.
Interest Rates and Inflation
Rising interest rates and persistent inflation are certainly big factors in the consumer M&A outlook for the upcoming year. Daniel Penn, managing director at MidOcean Partners, a private equity firm based in New York, shared some anecdotal statistics from a recent analysis, concluding that there has been about a two and a quarter term de-leveraging that direct lending sources now have to look at.
“This has an immediate impact on a company’s ability to borrow,” he said, “which ultimately has to flow through valuation. There’s not going to be a lot of traditional control buyouts in the consumer retail space in the next year. Instead, I think you’re going to see a lot of what we would call alternative transactions, like structured investments to de-lever. This will be a year where the macro has a direct impact on the cashflow abilities of companies and the types of transactions buyers and sellers are willing to enter into.”
Meanwhile, the debt capital markets have been choppy the past couple of years, to say the least. “This is probably why the syndicated financing markets are basically still closed and the direct lending market has pulled back,” said Penn. “They are more selective and are going through an enhanced interest coverage analysis. If lenders were previously willing to lend $150 million to $250 million into a transaction, they may be willing to lend half of this now because they’re being more conservative.”
Going Private
Daniel Brass, an M&A partner with Davis Polk in New York, sees opportunities this year for buyers to take companies private. “I think there are some companies out there that went public over the past couple of years that may be finding themselves in the current climate not necessarily suited to being public companies,” he said. “So there will be opportunities to take them private.”
On the strategic M&A side, Brass is now seeing more earnouts, especially in bilateral negotiations. “I think the majority of my deals last year involved an earnout,” he said.
Due Diligence and the M&A Timeline
The panelists noted a desire for more due diligence among investors to potentially elongate the M&A timeline. “Due diligence is being extended, especially as it relates to projections and inflation,” said Kati Penney, a partner who leads the corporate transactions practice at CrossCountry Consulting. “I’ve seen an expansion in regard to the types of questions that are coming about through due diligence, as well as them certainly drilling deeper.”
From the seller’s viewpoint, Penney says that companies are getting themselves in position potentially for a dual path and thinking both about the public markets and a sale. “If we reflect back to 2021, I think there was basically one path for companies and that was going public, whether traditional or through a SPAC,” she said. “We certainly saw a change in that in 2022 and expect that in 2023 as well.”
ESG: A Part of Life Now
ESG has gained a lot of traction among corporations over the past few years. “I think the ESG component of corporate America is here to stay,” said Penn. “All of our limited partners have ESG diligence, and we have an ESG officer so it has become part of the asset management business at large. Sellers would be wise to put forth these considerations because it’s now a due diligence checklist item just like accounting, management and information technology.”
Brass concurred: “ESG is a part of life now and a core part of due diligence,” he said. “Regardless of whether or not it’s appearing in sims, I think people are well-advised to put it in and address the questions.”
Consumers expect the brands they do business with to be focused on social responsibility, said Penney. “Investors also have a heightened focus on ESG and commitment to it,” she said. “I don’t see it going away anytime soon.”
This Time Next Year…
So what will the consumer retail M&A market look like a year from now? Penney said she hopes there will be more certainty, or at least less uncertainty. “I’m hoping that by then some of the geopolitical risks as well as things in regard to inflation will be a little bit more normalized.”
“I think what you’re going to start hearing about after this year is the maturity wall that starts to occur in 2024 and beyond,” said Penn. “Good companies that have performed well when they come back to the market will likely still be in a position that are over-levered from that current market condition.”
“We’ll look back on a year when we had lower volumes of M&A,” said Brass. “I think there is a preparation for IPO, but I don’t think the markets are receptive. But hopefully toward to the end of this year, we’ll see a little bit more receptivity, or people being able to more credibly plan for IPOs so that dynamic will shift a little bit.”
For more on the what to expect for the consumer retail market, get the ICR Consumer Retail & Digital Team’s outlook on 2023.
