There’s nothing like a crisis to focus the mind.
Back in the wake of the global financial crisis, businesses looking to sell quickly realised they had to meet the market.
Deal multiples — the ratio of enterprise value divided by EBITDA — fell sharply, from just under 11x in the three years before the 2008 crisis to as low as 6x in the following years.
Sale volumes retreated, the average deal size took eight years to recover, and business owners who had been hoping to sell quickly learnt that holding out didn’t help.
But 2021 is shaping to be very different.
After a disastrous first-half last year, Australia’s economy has clawed its way back, lockdowns are largely lifted, border restrictions are finally coming to an end (again), and many companies have seen an uptick impossible to imagine a year ago.
For those in the market, it’s a good time to buy.
Pitcher Partners’ annual Dealmakers report, produced in collaboration with Mergermarket, finds Australia leads the world as the location for M&A opportunities, beating even Southeast Asia, which is expected to see a quicker economic recovery.
Three-in-five dealmakers expect Australian M&A to rebound to pre-pandemic levels by the end of this year; 40% believe it could be back to full speed within the first six months.
Even better, 84% of the dealmakers expect to conclude M&A deals in Australia in 2021, which would be an excellent turnaround after 2020 saw a 19% fall in sale volume and 17% fall in deal value.
Underpinning dealer enthusiasm is two key assumptions: dealmakers expect sellers to be more realistic about their valuations, and they also believe the competition for prime targets to have reduced.
We found 73% of dealmakers think valuations of Australia mid-market companies are attractive right now, and half see better alignment between sellers and buyers as a key driver of mid-market M&A.
Perhaps optimistically, 75% expect no increase in competition for targets in the year ahead, as foreign investors grapple with tighter regulations and closed borders.
But on the other side of the fence, vendors are also more optimistic.
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A slew of companies that held off selling their businesses in 2020 are now confidently eyeing a strong stock market, buoyant retail environment, the relaxation of lockdowns and border restrictions, and the imminent rollout of a vaccine.
Vendors who delayed are expected to be eager participants in M&A this year, with business succession the strongest sell-side driver of activity for the mid-market.
There’s a clear sense that Australia has dodged a bullet with its management of the virus, while vendors looking to the stock market for clues to investor sentiment are seeing optimism there as well.
Having hit a low of 15.3 in March 2020, the price-to-earnings ratio for the ASX All Ords hit historic highs by the end of year. The market is up nearly 50% since its March lows, and rising public stock valuations tend to make private sellers bullish as well.
And while the economy is still soft and many sectors face a slow road back to normal trading, the bounce after lockdowns has created a sense of momentum.
It’s a pretty good feeling to discover unexpected resilience in your business and people, and knowing that — despite everything — the world didn’t end.
Businesses coming to market now are likely to have performed well in the face of the pandemic, a one-in-100-year event, otherwise, they would wait until their earnings return.
If anything, vendors are likely expecting a premium for their business as they have proven to be almost bulletproof.
So will all this disconnected optimism translate to deals?
Our take is that for vendors, 2021 is not the year to be coy. There are buyers ready and interested, they aren’t looking for distressed bargain assets, but equally, they expect realistic valuations.
Nine-in-10 of the dealmakers surveyed said they would apply a risk premium on any deal, and nearly half expect that premium to be 10% or more.
Vendors should not expect a flood of foreign buyers to be pushing up prices. Roughly 45% of dealmakers expect an increase in foreign inbound M&A but that is tipped to be moderate at best, feeding the expectation of reduced competition.
Vendors with a strong record and performance can still find an excellent match, but a lot will depend on how we can demonstrate ‘normalised’ earnings after a year of extraordinary circumstances.
For buyers, finding the right target and right deal structure becomes more critical, especially as funding could tighten over the year.
Uncertainty around the economic recovery is a challenge cited by 40% of dealmakers; they want to pick the right target and do thorough due diligence, focusing their attention rather than placing wild bets.
Deal structure is also emerging as a key risk management strategy, and we are seeing more interest in mechanisms such as earn-out structures that tie a portion of the price to future earnings.
This helps to bridge the valuation divide and demonstrate the importance of getting strategic advice. It also enhances the risk to a vendor, so needs to be well understood.
It’s going to be a big year for Australian M&A whatever way you slice it — but tempering the enthusiasm of both sides with measures to manage risk and expectations is more critical than ever.