M&A Outlook - the Continuing Impact of the War in Ukraine
At a recent conference our Key Capital Corporate Finance team attended in Paris with our IMAP colleagues from around the globe, we discussed the impact of the war in Ukraine on the global economic outlook and on the M&A market.
Krisztián Orbán, Founder and Managing Partner of Oriens was guest speaker at IMAP’s Geopolitical Panel session and provided the current geopolitical backdrop and macroeconomic trends which preceded a discussion by IMAP partners on the challenges this brings to the M&A dealmaking landscape globally. Here is a summary of that discussion and our thoughts on the impact for the Irish & UK markets and businesses.
The key changes:
The relationship with China has changed – for many years the West has courted the Chinese, that position has now changed. China has undoubtedly been put into a position they didn’t want to be in, its alignment with Russia means that China’s desire for a special relationship with the EU is now looking unlikely.
International alliances are now under scrutiny – Russia, China, India, Iran, SE Asia, LATAM, Brazil, South Africa, and even Kazakhstan are assessing their allegiances and plotting a route forward with trading partners. Many are still to decide which side of the fence to fall on.
The future of globalisation looks very different – current divisions would suggest a move towards two trade blocs, a Western Bloc and a Russia / China led bloc. Trade within the blocs will continue largely unchanged, but trade across the blocs is likely to be challenged in the short to medium term and is likely to face significant disruption. Tariffs, inflation and supply chain will be key points to watch for.
Importance of commodities – ironically, most of the global supply of commodities is outside of the two blocs. Securing access to commodities will be a critical challenge in the short term. The short-term impact from war will give way to a race to secure supply in the medium term.
Securing access to commodities will be a critical challenge in the short term.
What does all of this mean for corporates?
Stockpiling – supply of raw materials and management of costs will be critical in ensuring continued supply to customers. Stockpiling is likely be a key feature with management devoting increased capital and resource to managing this crucial component. (Anecdotally, we are seeing this playing out with senior management spending a lot of their time focussing on supply chain challenges).
Vertical integration – with the need to secure supply, we are likely to see a renewed focus on vertical integration. The trend towards optimising efficiencies with a focussed approach will give way to security of supply and retaining control.
Digitisation and Automation – western economies have relied on low-cost labour around the globe to avoid spending on digitisation and automation. In the face of labour shortages across Europe and the US, alongside increasingly strained relations with markets that typically offered a low-cost work force, the emphasis on optimising efficiency through automation and digitisation will increase. The investment case for large-scale automation projects will begin to look more favourable.
Profits will be impacted – increased raw material costs, plus escalating labour costs coupled with inevitable tax increases to support energy transition and defence spending will have an impact on corporate profits.
With the need to secure supply, we are likely to see a renewed focus on vertical integration.
What does this all mean for M&A?
While Irish & UK companies with direct exposure to Russia are in short supply, it is clear the macro environment and the trends outlined above are having an impact locally. While M&A continues and there is little sign so far of a slowdown, there are new challenges for companies and advisors alike.
To date, the impact on M&A has been muted, with cautiously optimistic sentiment being shared among our partners in Paris. The potential for opportunities arising from the current disruption was something multiple partners noted, PE’s need for inflation-beating returns, large corporates seeking to secure supply, and a greater focus on “local” supply.
While Irish and UK companies with direct exposure to Russia are in short supply, it is clear the macro environment and the trends outlined above are having an impact locally.
The dry powder in Private Equity Funds in the short term was a consistent theme with Kris Kippers, from Degroof Petercam – IMAP France & Belgium, noting that “When valuations at the stock market are getting low, PE might come to the rescue as they currently have burning cash in their hands and want to spend it, certainly with the inflationary environment we’re in”.
Axel Fuhri Snethlage from IMAP Netherlands, echoed those sentiments when he said “With a high level of capital in the market, no yield and the stock market volatile, the middle-market is attractive to PE in order to secure stability, therefore, we are expecting lots of PE activity.” While there is plenty of dry powder, likely increasing interest rates to curb inflation will inevitably have a knock on impact on the cost of capital, reducing leverage and potential for returns for PE.
During the course of the conversation at the conference, regional variances became very apparent. According to Kenneth Wasik from Capstone Partners – IMAP USA, “Middle-market in the US is a laggard indicator to the world economy, having less exposure to international sales. However, we are seeing buyers becoming more concerned with impacts of macro conditions on consumer targets in the US. Specifically, how their businesses are affected by supply chain disruptions, inflationary pressure, and the impact of a COVID year in year over year comparisons. Higher Gross Margins businesses are being prioritised by buyers. The thought being that higher gross margin businesses are better positioned to counter these negative trends.” The other key trend seen by our colleagues in the US was a “flight to quality”, a reference to margins, growth rate and track record.
While the US middle market is somewhat insulated, our partners in Egypt noted that their economy is much more severely impacted. According to Khaled El Ghannam, from Intelligent Way Capital Partners - IMAP Egypt, is suffering on several fronts – Russian and Ukrainian tourism, a major source of earnings has collapsed, and together with huge increases in the prices of wheat, cooking oil and petroleum, this has led to a devaluation of the Egyptian pound against the US dollar of around 18%.
Finally, Carsten Lehmann from IMAP Germany was emphasising the sectors likely to benefit in the short and medium term saying, “as we do not expect interest rates to keep up with inflation rates, investment flows into real value assets will remain strong. The sectors largely unaffected by the geopolitical reshuffling like IT / Software, Healthcare and Consumer Goods will gain in relative attractiveness which should support valuation levels.”
It is clear that while some of the macro trends have had a direct impact on Irish and UK companies, direct exposure to the conflict has been limited to date.
There are undoubtedly new challenges ahead for Irish and UK businesses, with cost inflation and security of raw materials being a key factor.
While there is likely to be specific sectoral nuances, overall we don’t foresee a material impact on M&A in the short to medium term. As costs creep up we expect a renewed interest from trade buyers coming out of Covid with a greater degree of certainty looking to acquire businesses to drive efficiencies and enhance vertical integration.
The interest shown by PE in the Irish and UK markets is unlikely to dissipate either. The dry power available to deploy is well documented, while structural shifts, such as Brexit are still driving M&A activities in Ireland and the UK.