3 charts: Downturn in M&A spending worsened in Q3

Extended interest rate uncertainty and, for some buyers, limited access to debt pressured the global M&A market in Q3, dragging down quarterly deal value to a decade-low point.

The Federal Reserve's unexpected rate increase at the end of the quarter, the temporary threat of a government shutdown, and geopolitical tumult in the Middle East have also pushed back the industry's expectations for an M&A recovery.

Once one or more of those factors recovers, preconditions are set for new deal activity, with lower valuations in some industries and sky-high piles of dry powder available for corporations and financial sponsors alike, said Tim Clarke, PitchBook's lead PE analyst.

"All you need is a catalyst, and you're not going to get that when new wars are breaking out," Clarke said.

Data from our latest Global M&A Report explains how and why M&A dealmaking faltered in Q3 and how private equity fits into the landscape.  
There hasn't been major growth in global M&A activity for several quarters, but the worst that could be said in Q2 was that the market was stagnant after four quarters of roughly flat deal value.

That's changed. Buyers pulled back on M&A spending by 20% from Q2 to Q3, according to the report. It was the lowest quarterly total in over a decade.

The deals are happening, but they're much smaller: Despite the nosedive in M&A deal value, the total number of deals is only down about 2.5% so far in 2023.    
While financial sponsors, like VC and PE firms, have in some cases struggled to access debt, corporate buyers have additional tools available to finance M&A—namely, cash from operations and corporate bonds, according to the report.

That's why sponsors are responsible for a smaller share of the M&A market than in 2022, in a reversal from the past decade-plus, when the proportion of sponsor-backed deals climbed in comparison to corporate M&A. On deal value, however, sponsors have continued to climb in market share over corporations.

The median debt-to-enterprise value ratio plummeted from 50.8% in 2022 to just 43.9% through Q3—which is also the lowest figure since at least 2005, according to LCD data. That means debt is forming a smaller portion of the capital used in leveraged buyouts.

Debt has been harder to access this year. Higher interest rates have shifted companies' interest coverage ratios—a measure of how easily a business can pay off its debts, calculated by dividing its earnings by its interest expense over a given period.

Higher interest coverage ratios have stopped banks from lending quite as much for leveraged buyouts, Clarke said.

"They won't lend an amount that would immediately bankrupt the company," he said.    
Across the economy, the median enterprise value/revenue figure—used to compare valuations between companies—is about the same in 2023 as the previous year, moving up slightly from 1.5x to 1.6x. But there's been some variability between industries.

Higher commodity prices and market confidence that crude oil prices will remain robust for the long term have boosted valuations in the energy industry over the past 12 months, Clarke said, making it the strongest sector for valuation growth.

As an industry, financial services—which comprises many spread-based businesses—has suffered the biggest decline in valuation multiples in the past year.

High funding costs have played a role, especially for banks, but the collapse of Silicon Valley Bank in early 2023 and the subsequent banking crisis have also challenged the industry.

"Deposits are leaving banks, and at the same time they're not able to make the sexy loans like private credit, or they’re being told they have to reserve more cash," Clarke said.

Insurers, which tend to function like asset managers, have struggled from a separate issue, he said: losses in the fixed-income markets that feature prominently in their holdings.

Related read: Q3 2023 Global M&A Report

Featured image by Punnawit Suwuttananun/Getty Images

This article originally appeared on PitchBook News