Middle Market M&A Persists Amid Volatile Conditions

Middle Market M&A Persists Amid Volatile Conditions

Middle market deal volume continued to outperform the broader M&A market in the first quarter

Capstone Partners has published its first quarter Capital Market Update and reports that total middle market merger and acquisition volume declined 14.3% year-over-year in Q1 2023 resulting from macroeconomic headwinds.

However, Capstone further reports that middle market deal volume continued to outperform the broader M&A market which saw a total volume decline of 25.2% year-over-year in Q1. While buyers have demonstrated increased selectivity, quality companies with strong margin profiles have continued to command M&A interest at premium valuations. The Federal Reserve’s ability to navigate a soft landing will likely prove consequential for middle market M&A throughout 2023.

According to Capstone, uncertainty is seldom received favorably by capital markets and the lack of economic visibility has caused angst among many market participants. The Federal Reserve has yet to settle on a terminal interest rate, with the continued strength of the labor market complicating the task of whether to hike or pause.

Inflation and elevated interest rates have continued to pressure M&A valuations in the middle market.

In addition, recent turmoil among regional banks has contributed to the tightening of the U.S. economy—an element that may be difficult to quantify in basis points. As the U.S. navigates a higher-for-longer rate environment to quell stubborn inflationary headwinds, confidence in a smooth recovery has often fluctuated with equity market swings, leaving many to wonder when the U.S. will enter a recession, or if the economy is already in the midst of one. As the economy eyes an emergence from monetary tightening, there is hope that the M&A market may have reached a modest trough—presenting a strong backdrop for a recovery in middle market dealmaking.

Inflation and elevated interest rates have continued to pressure M&A valuations in the middle market. However, there has been evidence of some upward pricing momentum in early 2023. The average EBITDA multiple amounted to 9.1x in Q1, following a decline to 7.2x in Q4 2022.

Interestingly, it is the large-scale transactions that have seen the most significant pullback in pricing. The core middle market – $100 million to $250 million in enterprise value – has continued to be the bellwether of middle market pricing. Valuations in this range have held steady at a 10.9x EBITDA multiple, nearly mirroring the prior year’s average of 11.1x.

Business owners, dealmakers, and lenders will be closely monitoring the monetary policy environment and its reverberations on the broader economy. If the U.S. has reached, or is approaching, its trough in the M&A market, there is a precedent for what is to come. Sellers can expect exuberant interest from buyers looking to reengage in inorganic growth upon a market recovery. Timing and asset position will be key as a substantial level of pent-up demand can be expected to create healthy levels of competition in the middle market.

“As has traditionally been the case, M&A market valuations and activity levels are driven more by credit trends than by equity market levels,” said Phil Seefried, an executive advisor at Capstone. “Tightened credit conditions have decreased the amount of debt available for transactions as well as increasing the cost of that debt. With higher required equity contributions and more expensive debt, valuations have adjusted downward to maintain returns. Further, the natural flight to quality in times of uncertainty has further reduced supply in the short term. We look forward to the inevitable rebound in activity as conditions stabilize.”

Capstone’s investment banking services include mergers and acquisitions, capital advisory, financial advisory, special situations and restructuring. Managing Director Brendan Burke leads Capstone sponsor coverage team.

Capstone has more than 175 employees and is headquartered in Boston and Denver with additional locations in Chicago, Dallas, Detroit, Los Angeles, New York, Orange County, Philadelphia, San Diego, and Tampa. In June of last year, publicly traded Huntington Bancshares (NASDAQ: HBAN) acquired Capstone Partners.

Huntington Bancshares with $189 billion in assets, provides banking services to consumers, small and middle-market businesses, corporations, and municipalities. The Columbus, Ohio-headquartered bank was founded in 1866 and has more than 1,000 branches in 11 states.

To see a full copy of Capstone’s first quarter Capital Market Update click HERE.

© 2023 Private Equity Professional | June 22, 2023

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