For M&A, how high is up? | Grant Thornton

Respondents expect deal volume, valuations to keep climbing

Grant Thornton’s current survey of 156 M&A professionals found that 68% expect deal volume to increase from already torrid levels over the next six months. A recent report from Refinitiv showed M&A activity for the first nine months of 2021 up 92% from year-ago levels—the strongest showing for the first nine months of any year since records began in 1980. When it comes to deal activity, how high is up, and what keeps driving deals?

“I think there is a little less concern about tax and legislative changes,” says Grant Thornton Mergers and Acquisitions National Managing Principal Elliot Findlay. “Also, there are a lot of companies that have been having strong years and are waiting to get full calendar 2021 results on the books. They continue to beat forecasts, so they don’t want to leave value on the table. We’ll see many of these companies coming on the market in early 2022.”

Slightly more than half of survey respondents—53%—also expect valuations to continue to increase.

“Interest rates are still low,” says Findlay, “and buyers are still willing to pay for strong assets. We’ll just have to see where the ceiling is.” But can valuations get much higher? “They’re at unprecedented levels now,” says Eric Burgess, a partner in Grant Thornton’s strategy and transactions practice. “I just don’t see room for them to go up too much more.”

“Over 25% of our survey respondents described their role as private equity investors. Our Private Equity clients have participated in setting a record-breaking deal volume in 2021 for private equity” says Grant Thornton National Managing Partner for Private Equity services Carlos Ferreira. “According to recent Pitchbook data, US PE deal making notched a record $787 billion of deal value through Q3 2021 with add-ons increased to 73% of total deals closed.”

Tech, healthcare and life sciences and services are hottest industries

When asked in which industries they expected the most deal activity, respondents most frequently pointed to technology, media, entertainment and communications (53%) healthcare and life sciences (43%) and services (33%). “We’re seeing a lot of non-tech buyers for tech companies,” says Findlay. “The pandemic accelerated the transition from brick and mortar to digital for a wide range of businesses, so they are trying to catch up on digital transformation.”

Technology is also driving some of the action in the services sector. “Business services is booming in private equity as a buy-and-build play, especially IT services,” says Burgess. “It started to ramp up three or four years ago and is really hot right now.”

How will the Biden agenda impact deals?

When asked how the Biden administrations agenda would impact M&A plans, respondents reported the most concern when it came to financial regulations (53% negative impact), taxes (50% negative impact) and labor regulations (45% negative impact). When asked about specific tax proposals, the 15% minimum tax and a corporate rate increase drew the most concern. The proposed infrastructure plan drew a more favorable reaction, with 57% saying it would have a positive impact.

Policy changes have less impact on private equity firm deal activity than they do on corporate buyers. “For private equity firms, not making deals isn’t an option. You have all of these funds that have had record returns since the great recession,” says Burgess. “Cash on their balance sheets is at all-time record levels. They’ve got to spend that money to make money. Until all of that is invested, you’re going to see a strong deal market. For private equity firms, the changes in administration and tax policy don’t matter that much. They have to keep making deals.”

Will dealmakers ramp up hiring to handle volume?

When asked if they will increase the number of investment professionals at their companies, 50% of respondents said yes. Given that most expect the already record pace of deal activity to increase, that finding seems conservative.

“I don’t know a private equity firm or corporate buyer that isn’t looking to add people,” says Burgess. “Many private equity firms are trying to add an M&A team to each portfolio company, which I didn’t see a few years ago.”

“The 50% number seems counterintuitive,” says Findlay. “Companies are already at capacity, so it just makes sense that they will have to add talent to handle any increase in deal volume.”

But is the much-discussed war for talent making finding the right people difficult? “This is even starting to impact private equity recently,” say Burgess. “While a lot of very qualified candidates want to join private equity firms, demand is starting to outpace supply. Corporations and private equity portfolio companies are having even more trouble filling needs.” Grant Thornton’s recent workforce in America survey offers insights into workforce issues facing employers.

ESG matters, but what to do about it?

ESG is clearly on the mind of dealmakers. When asked whether a target’s ESG program and reporting capabilities mattered when considering a deal, 97% of respondents said yes. Grant Thornton’s recent CFO survey underscores the importance of ESG, with 87% of respondents saying ESG is a significant consideration when it comes to corporate decision making.

“I’m seeing more buyers consider ESG when making deals,” says Findlay. “Given the workforce issues confronting a lot of employers now, how a company treats its people matters to a buyer—that can be a strategic differentiator. Most buyers don’t have a formal ESG due diligence process in place, but we’re moving in that direction.”

“Private equity firms with large global limited partners demanding increased focus and investment in social and environmental reforms are challenged when deal-making with middle market targets,” says Ferreira. “They know their targets won’t have very mature ESG programs compared to larger organizations. This this an opportunity to increase awareness of ESG and provide the resources to transform these companies in ways that a private company with no institutional investors can’t.”

Jim Burton, who directs Grant Thornton’s ESG and sustainability services, says it’s important to demystify ESG and offers some advice for buyers when it comes to evaluating ESG capabilities and developing a strategy to address them. “ESG can be a confusing topic,” says Burton. “Companies are getting pushed by a lot of constituencies—their employees, customers, investors, even the public. But they don’t have to address everything at once. Take a bite size approach. Do an assessment, find out what matters most to your key constituencies, and make sure you have the information and tools in place to set goals and measure against those metrics. Figure out what’s first and what’s later. Don’t try to do everything at once.”

COVID’s not gone, nor forgotten

When this survey was taken in late September, the spike in infections due to the Delta variant was still significant. While that has waned, COVID and its aftermath remain a concern. At the time of the survey, 94% of respondents expected COVID to have a negative impact on deal activity.

“Absent something unexpected, and COVID has certainly surprised us before, I think we’re moving beyond concern about the disease itself,” says Ferreira. “Our private equity respondents are bit more optimistic, with 73% of PE responses indicating that they expect somewhat or no disruption on deal making from COVID cases in the U.S., while approximately half of the our M&A corporate clients expect deal making will be negatively impacted over the same period. But businesses are certainly still dealing with the aftermath of the pandemic. Labor shortages, supply chain issues, those are very significant concerns.”

Burgess agrees. “Supply chain issues are huge. Sellers want to forecast what their results will be when they get their supply chains sorted out, but buyers aren’t taking that on faith, so they are a major driver for earnouts right now.”

On the plus side, with borders opening up, cross-border deals are increasing too. Almost two-thirds (65%) of respondents expect an uptick in cross-border deal activity.