Mergers and acquisitions – players adjust to a more selective market

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Is the downturn in the mergers and acquisitions market now over? With $68 billion worth of deals announced or completed, the first half of the first half of 2023 is the lowest in the last 10 years (2013 and 2020, each marked by the recession and the healthcare crisis, excluded.)

The absence of large transactions is the first explanation. “Since 2009, there has not been without a transaction worth more than 10 billion in the French market,” says Patrick Perreault, co-head of mergers and acquisitions at Société Générale. Large companies with strong balance sheets are still reviewing proposed takeover projects, but few deals actually materialise. Nevertheless, dialogue continues and significant strategic deals continue to be announced in resilient or growing sectors.” Indeed, three major deals were announced in the second quarter, although the largest was not worth €5 billion: Teleperformance’s takeover bid for Luxembourg-based Majorel in April, CMA-CGM ‘s acquisition of Bolloré’s African logistics business in May and Kering’s acquisition of perfume company Creed in June

Even if three transactions are not be enough to reverse the downward trend, they could herald the end of the slide that also seems to be taking shape in the mid-market. “The cost of senior debt in the small-cap segment has risen from 1.5% to 5% to 6%, and the proportion of bonds redeemable at maturity is trending down. Many deals are much harder to do under these conditions.”

Valuations penalised by rising interest rates

The market’s decline was largely driven by the macroeconomic environment, led by a sharp rise in interest rates. Private equity funds, mid-caps and SMEs, all very active, are the first to suffer. SMEs, all very active in small caps, were the first victims of the rise in interest rates, exacerbated by the tightening of banking conditions. Within a year, the cost of acquisition loans has tripled or quadrupled and banks are becoming more choosy. “In 2017, one of my clients received a senior bond at Euribor + 1.8 points,” recalls Vincent Behr, managing partner at Invest Corporate Finance, an advisory firm for mergers and acquisitions in the SME sector. Today, the situation and the outlook are better, but the same bank is not able to push its margin below 2.10 points despite all its efforts.
The cost of senior bonds in the small-cap segment has risen from 1.5% to 5-6%, and the share of bonds redeemable at maturity is trending downwards. Many transactions are much more difficult to arrange under these conditions.”

The rise in interest rates had a mechanical effect on company share prices, which returned to their 2020 multiples (9.9 times EBITDA). However, according to the Argos Index, this average multiple masks a record divergence between the valuationsof the most desirable sectors such as healthcare and technology (multiples above 15) and those of the less desirable sectors. “Rising interest rates have a very abrasive effect on valuations,” says Guillaume Piette, managing partner at Financière de Courcelles, an M&A advisor specialising in small-cap companies. Where investors were targeting IRRs of 20%, they have now risen to 25%. Against this backdrop, only very resilient assets that are not cyclical and those with strong growth prospects can get financing.”

Stabilisation of smid-caps in the second quarter of 2023*

Smid-caps, or ‘small and middle caps’, are companies valued between 5 million and 1 billion. As the use of the term varies, the law firm White & Case distinguishes between “lower-middle deals” (from 5 to 100 million) and upper-middle deals (100 million to 1 billion euros). Next are large caps (from 5 or 10 billion), followed by mega-deals or mega-caps and finally jumbo deals (generally over 50 billion).
After plummeting by 57% in the last quarter of 2022 and by a further 30% in the first half of 2023 overall, acquisitions of European companies are now back on track. Acquisitions of European companies rebounded in the second quarter (+36% in value, +2% in number), according to the Argos Index, which tracks deals worth between €15 million and €500 million, excluding start-ups.

Debt funds as an alternative to banks

The rise in interest rates and the tightening of bank lending were partly offset by the rise of private loan funds (or “unitrancheurs”, see box) in the acquisition finance market”. Last year, they provided 18.2 billion in financing, of which two-thirds was for corporate acquisitions and buyouts, a 44% increase.
The partial displacement of banks and bond markets by private debt funds is not unique to France. Last October, Elon Musk’s $44 billion acquisition of Twitter was financed by funds. “They are currently more active than banks in the leveraged buyout market, notes Louis Godron, CEO of the Argos Wityu fund. But because they know less about the companies than their bankers, their due diligence is more thorough and their response times suffer.”

While loan funds are a partial response to declining bank lending, they are not able to counteract the wait-and-see attitude resulting from exogenous shocks to firms (including new technological breakthroughs and regulatory turmoil by authorities). For example, media and political debates about the phase-out date of internal combustion engines or gas boilers, or the use of private swimming pools, cloud the outlook for sectors as diverse as air conditioning, car repairs, electricity and tourism. “These uncertainties increase the development assessment gaps,” Vincent Behr notes. The heating and air conditioning companies all have multi-energy offerings, but the uncertainty around gas negatively impacts valuations and makes transactions difficult unless you separate renewables from fossil fuels, which is not practical.

The technological breakthroughs brought about by artificial intelligence also lead to a wait-and-see attitude. “No investor will invest in companies whose business model could be threatened by generative artificial intelligence (e.g. ChatGPT),” says Guillaume Piette. Digital services (ESN, formerly SSII) or call centres, whose attractivenessis affected by the pandemic and rising energy prices, are now penalised by the uncertainties regarding their adaptability, which is of course assessed on a case-by-case basis.
This climate of uncertainty, coupled with highly visible failures, even when they concern foreign banks (three bankruptcies in the United States), or when companies are finally rescued (Crédit Suisse, Orpea, Pierre & Vacances, Casino, etc.), pushes strategic development objectives into the background. “Since 2020, companies have had to urgently adapt to the sudden changes in their environment,” Guillaume Piette points out. Most have succeeded in doing so, and all are agile, but they tend to be reluctant to mobilise their teams and resources to seize acquisition opportunities. They are only receptive to “perfect matches”, which by definition are rare.

A first half of strategic acquisitions, 80% cross-border

According to LSEG Refinitv, the total number of transactions announced, in progress or completed this half-year is likely to be $68 billion, including those planned in the context of restructurings (Orpea and Casino), the completion of which is still hypothetical, and delistings. The table below summarises the ten largest transactions, 80% of which involve a foreign counterparty.
It should be noted that the valuation of mergers and acquisitions varies from one source to another due to the time lag between the announcement of the signing of a contract and its execution after obtaining regulatory approvals (in particular from competition authorities) and the time required to complete the transaction.
Kering’s acquisition of perfume maker Creed, which was announced at the end of June and whose price has not yet been disclosed, is likely to be among the top five.

Less open sales processes

Because potential buyers are rarer and their financing options less certain, sellers are more reluctant to engage in competitive sales processes that are necessarily visible. “Informal sale processes with a few potential buyers informal sale processes with a few potential buyers who were already very close to the target company and its managers are back in fashion,” says Alexandre Courbon, Managing Director and Head of Mergers & Acquisitions France at HSBC.

The prospect of having to hold several bilateral discussions at the same time, sometimes several months apart, causes sellers prepare more thoroughly for the activities they plan to divest. Vendor’s Due Diligence ( VDD) and all the legal and operational details that can save time between the signing of a contract and its closing between the signing of a contract and its closing (the “closing”) are almost systematic. “In uncertain market conditions and with objectives already well identified, sellers want to keep some leeway”,” notes Alexandre Courbon. They prefer not to engage in broad processes structured around a phase I (brief information, info memo, non-binding letter of intent) followed by a phase II (data room, firm offer) that could be in case of failure”.

“The future can no longer be extrapolated from the past. Successive crises have changed business models. We help our clients create business plans with scenarios for transformation and resilience.”

Sectors excluded from CSR

No matter how hard we try to prepare for a sale, it is difficult for some companies to sell out because investors have to be above reproach when it comes to CSR.
Today, an operator of retirement homes or a processor of meat products is likely to be rejected outright by investors,” says Vincent Behr. Even if the company has a solid track record and promising prospects, the risk of illiquidity on exit will deter investors.

The importance of CSR is directly reflected in the contracts. “Institutional and financial buyers are increasingly demanding in terms of compliance,” explains Anne Fréchette-Kerbrat, M&A partner at Fidal. They demand clear and precise contractual guarantees and reject anything that might resemble a limitation of liability. Clauses such as ‘the seller has no knowledge of violations of laws or regulations’, which used to be common, are often no longer negotiable. If a seller is unable to provide a strict guarantee, for example that their company will not trade with an embargoed country and will not pay bribes, most buyers will turn away.”
Investor concentration on “virtuous” sectors will not reverse. In the first half of the year, investment funds that are members of France Invest invested €2 billion in companies committed to environmental change, rising to €3.4 billion by 2022. More and more funds are seeking to be classified as “Article 9” (most committed to the ecological transition) or “Article 9” (most committed to the ecological transition) or “climate funds”.

For example, the Argos Climate Action fund reserves its investments for companies capable of reducing their greenhouse gas emissions by at least 7.5% per year.

The growing success of debt funds

The tightening of prudential restrictions on banks has encouraged the development of non-bank lenders.
In France, debt fundraising has increased almost tenfold in 10 years and will reach €12.4 billion in 2022. They are growing almost as fast internationally, where they have attracted €224 billion, about one-tenth of all private equity transactions.

Tikehau, Eurazeo, EMZ and Andera (Actomezz) are among the leading managers of private bond funds in France.
They invest in particular in unitranche loans, i.e. hybrids of senior and subordinated debt.

Increasingly sophisticated due diligence

Assessing the transformative capacity of energy and environmental companies and their resilience to exogenous shocks (inflation, scarcity, constraints, etc.) requires due diligence that is more comprehensive and complex than searching for exceptional items and anomalies. “The future can no longer be extrapolated from the past. Successive crises have changed business models,” notes Eric Demuyt, Managing Director of Eight Advisory, a firm specialising in due diligence. Advisory, a company specialising in financial due diligence. We help clients build business plans with transformation and resilience scenarios, whether to absorb and pass on utility cost increases. We help clients build business plans with transformation and resilience scenarios, whether to absorb and pass on utility cost increases, to overcome disruption, or to begin the energy and environmental transition.
These new areas of investigation are making due diligence longer. Despite the decline in mergers and acquisitions, our services remain stable,” says Eric Demuyt. It is difficult to distinguish what is due to changes in our market share and what is due to our clients’ demand for more in-depth analysis. Analysis, but it is certain that it is more elaborate today than in a stable environment.
The demand is becoming more qualitative and tailored, and we plan to go to the United States in the near future, where due diligence is still too limited.

Due diligence is also getting longer because finance departments are relatively weakened as increased turnover has left vacancies or the new owners have no memory of the company. “Finance departments are struggling to recruit and retain highly qualified staff,” says Eric Demuyt. The accounting professions are no longer sufficiently represented.

“Institutional and financial buyers demand clear and precise contractual guarantees on CSR and compliance issues. They reject anything resembling limitations of liability.

Price supplements are not enough to reconcile buyers and sellers

Earn-outs, which can sometimes be used to reconcile differences between buyers and sellers, are not always sufficient in the current economic climate.
Most sellers still focus on the closing price,” notes Patrick Perreault, co-head of mergers and acquisitions at Société Générale.

The volatility of recent years suggests that we should be cautious about betting on the future. There is quite a reluctance to make adjustments based on future financial indicators,” says Anne Fréchette-Kerbrat, mergers and acquisitions partner at Fidal. The trend is to link earn-outs to certain operational events, such as the granting of a patent, the outcome of a lawsuit or, increasingly, CSR targets.

“Having had to adapt to brutal environmental changes in a hurry, businesses are only receptive to the ‘perfect match”.

A contractual balance still in favour of sellers 

The slowdown in transactions, however, has not yet led to a change in the contractual terms established between buyers and sellers during the fifteen or so years that ‘free money’ exacerbated the conflict.
“As long as the market was hungry for takeovers, buyers tried to distinguish themselves by their speed of acquisition,” recalls Guillaume Piette. Nowadays, buyers are more demanding and selective, even if there are still some opportunities that justify competition.

At the moment, however, contracts are not particularly favourable to buyers. “Buyers and sellers have learned that warranty claims and price adjustment claims are lengthy, contentious and uncertain,” says Anne Fréchette-Kerbrat. Even in a weakening market, it is still common practise to focus on due diligence and derive targeted asset and liability warranties and, increasingly, to take out insurance to cover these warranties.”

Brokers who specialise in this type of insurance share this view. “Andras Haragovitch, director and co-head of France at broker Howden M&A, is enthusiastic. The ubiquitous presence of private equity funds over the last fifteen years has standardised due diligence and purchase agreements, enabling insurers to make offers within days.”

While the accumulation of exogenous shocks and rising interest rates initially led to a general wait-and-see attitude, strategic buyers seem to have returned to the path of external growth, as evidenced by the large acquisitions of the past (Bolloré Logistics, Majorel and Creed) and the stabilisation of small caps. However, the market is becoming more complex and selective under the triple influence of increased CSR requirements, the difficulty of identifying normative performance and the rise in borrowing costs.