The United Kingdom has seen its fair share of economic recessions in the past few decades, but the last couple of years have been much harsher than before. Many national and international companies, no matter their scale or size have navigated financial challenges to maintain their operations or expand. Mergers and acquisitions (M&A) forms part of the strategy to grow a business during such tough times, as it not only enables financial growth, but also ensures a strategic upper hand. 

While there are multiple benefits of purchasing or merging with other businesses, M&A can also be quite complex in terms of legal and financial due diligence. Added to this, the general trend for such activity during economic recession is a decline in M&A as companies focus more on safeguarding current operations, and not necessarily taking on more expansion. However, there is strong evidence to suggest that during times of economic downturn, the most successful deals are made. In fact, companies with the courage to do this often outperform their competitors in the long run. 

The current state of the UK market

It is no surprise that economic recovery after the unprecedented Covid-19 pandemic has been difficult. Each industry has its own definition of “a new normal”. The year 2022 started out with widespread optimism on this front, however, these hopes were brutally dashed by Russia’s invasion of Ukraine in February. Apart from the physical and emotional pain that the event led to, it was also accompanied by rapidly rising costs of raw materials, energy and labour. 

Plummeting consumer confidence, rampant cost inflation and serious supply chain disruptions have given rise to a new level of uncertainty. These last two years have been particularly tumultuous for the UK with two prime minister changes, losing its longest serving monarch and the highest cost of living. But all hope is not lost.

However, inflation is forecast to fall sharply from 10.7% in December 2022 to approximately 5% by the end of 2023. It is also worth noting that even though the value of the British Pound has weakened recently, there seems to be a positive growth outlook for the UK stock market. A majority of companies listed in London generate a significant portion of their revenues and profits from international markets, and thus forecast a streamlined market growth in the near future. 

The economic downturn’s impact on M&A

With the US dollar at a 20-year high, American companies, especially private equity firms, have been actively seeking acquisitions in European countries with weaker currencies. This trend is expected to continue driving M&A activity even if economic conditions worsen in 2023. The more volatile the environment, the higher the chances are for well-funded US buyers to pursue distressed and strategic takeovers across Europe and the UK. 

The first five months of 20222 saw strong dealmaking activity, building on the momentum of a blockbuster year in 2021. But June saw increasing global interest rates which furthered macroeconomic uncertainty and slowed down deal activity. Megadeals over $10 billion were put on hold and smaller deals also slowed down, leading to a 36% decline in annual M&A deal value to $3.8 trillion. Despite this setback, deal volumes only dropped by 12%.  

In the UK, stringent tightening of financing conditions will be the major hurdle for buyers looking to acquire new firms. Banks and private equity lenders are also likely to scale back their M&A investments in the midst of this economic downturn. It is also possible that financing sources including potential sponsors will become more risk-averse, and only a rigorous due diligence process will be able to tide deals ahead. Lenders are set to remain more focused on scrutinising buyers’ acquisition plans to ensure that their M&A activity generates value for all parties involved.

Undertaking M&A in the present business landscape is not without its challenges, but it is evident that those who possess the ability to leverage market trends can successfully navigate these obstacles with steadfast commitment. 

Opportunities for undertaking M&A during recession

In 2022, M&A demonstrated resilience, primarily supported by robust levels of private equity capital and cross-border acquisitions. Despite a decline in deal value, it still exceeded market expectations, with Europe recording a record 17,900 deals, representing an 11.9% increase in deal volumes. Resilience is not solely about withstanding change but also being agile and adaptable, a trait that can be challenging to prioritise when merely focused on survival. Adopting a defensive M&A strategy cultivates resilience not only within a company’s internal stakeholders, but also optimises its portfolios and bolsters market positioning. A few ways in which companies can show this resilience to strengthen dealmaking in today’s climate include: 

Analysing excess liquidity: Companies holding excess liquidity may encounter more conservative shareholders and boards. Share buybacks and dividend payments may be constrained for the foreseeable future, and firms will need to maintain higher cash reserves. One option to use any surplus cash that could generate long-term value is to invest in dealmaking with businesses that are mindful of the “new normal” and seeking potential investors to navigate the economic uncertainty.

Complete Diligence: While remote diligence has become the norm, it may increase the time taken for the process, particularly if onsite visits are necessary. In this environment, conducting thorough balance sheet stress tests and cash flow forecasts for the next 12 to 24 months is crucial. Cyber diligence is also increasingly important as reliance on technology grows. Longer diligence processes will ultimately lead to more resilient businesses.

Align business models to current needs: Corporate agendas and investment priorities continue to focus on supply chain resilience, portfolio optimisation, ESG, digital transformation, and security. To generate long-term returns, companies should incorporate these priorities into their approach to dealmaking.

Sectors to keep on your radar for M&A activity

Healthcare and Hospital Management: Given the impact of the Covid-19 pandemic, it is not surprising that healthcare sectors face complex challenges with rising labour costs and a shortage of skilled professionals, especially in the UK. Hospital systems and their logistics are also adversely impacted by supply chain issues relating to biopharma and medical device firms. As we enter 2023, buyers in these sectors are focusing on strengthening key areas such as improving operational efficiency, expanding into new platforms and offerings, enhancing technology, and gaining a competitive advantage in the post-recession environment.

Financial Services: During financial hardship, customer guidance and support can build loyalty. Fast-moving FinTechs rely on data for a better understanding of customers, offering industry leaders opportunities for portfolio expansion and long-term credibility. Private equity accounted for over 40% of 2022 deal values, with successful ARR financings, especially in tech. Once interest rates are capped in the latter half of the year, M&A may increase as stalled deals take advantage of stability.

Consumer automotive: Europe led the world in M&A activity in the Transportation and Automotive industry with 6,263 deals, followed by Asia Pacific with 5,406 deals and North America with 3,985 deals. Smart connectivity is expected to be present in most cars by 2035 due to consumer demand and regulations. With an increasing interest in geographical expansion, product innovation, and emerging technologies for delivery logistics and sustainable products, the market presents a promising opportunity to explore.

Conclusion

Even if a company appears to be performing well and is financially stable during a downturn, it could quickly change if other businesses within its supply chain are affected. To successfully navigate M&A in a constantly volatile market like today’s, it’s crucial to carefully evaluate the post-Covid-19 recovery curve scenarios that target businesses are likely to face. As discussed, their liquidity situation and capital requirements are likely to evolve quickly, and keeping a track of such market trends will go a long way in charting long term growth strategies. Acting boldly and confidently during this challenging time can lead to solid investments!