To start the year, Class VI issued our 2024 Middle Market M&A Outlook. We reported an overall decline in deal flow and quality over 2023 alongside optimism about increased dealmaking to come this year.
How have these expectations shared by private equity and institutional investors fared in the marketplace?
In short, 2024 hasn’t seen the quick return to M&A that many expected, but there have been steady improvements. Let’s examine the environment.
A State of Continuity
The close of Q2 2024 featured many of the same macroeconomic conditions that defined 2023, including a vibrant labor market and high interest rates. With a post-COVID recession avoided and inflation cooling, the Fed indicated in March that three rate cuts were likely in 2024, but time may be running short to implement so many.
Unfortunately, inflation hasn’t achieved the desired levels, and in response, the Fed has maintained a cautious hold on the federal funds rate going into Q3. This keeps the cost of doing business high for PE and other investors, which is, in turn, inhibiting a full rebound in dealmaking volume.
Signs of Improvement
Despite the continuing macroeconomic pressures, 2024 has seen modest year-over-year increases in deal activity. In our conversations with investor audiences, we’ve learned that April and May brought a surge of launched M&A transactions in most sectors. This included deals for family and founder-led companies, as well as PE exits. In fact, we’re hearing from many fund managers that they put in more M&A bids in the first two quarters than they have since 2022.
Additionally, growth equity has been fairly high in 2024. PE firms opted for growth investments in 21.3% of their deals in Q1, considerably higher than the five-year average of 18.6%.
Finally, analysts are optimistic that the Fed will take action in September given July’s news that inflation is at its lowest level in three years.
Reasons for Caution
Not all indicators are positive, however. Valuations were relatively low for completed PE exits in Q1. The $15.7B total was the lowest PE exit amount of the last few years. This might reflect caution around interest rates and stagnant valuations.
We’ve also seen a lack of high-quality, high-value deals coming to market. The upside, when such deals appear, investors engage in a competitive feeding frenzy in an ongoing “flight to quality” we’ve been reporting for some time. Finally, median EBITDA multiples essentially stayed the same in Q1 2024 compared to 2023. The multiple for M&A transactions announced or closed in Q1 was 9.4x versus 9.5x for all of last year.
What We’re Watching
Here’s what we’re looking out for in the second half of the year:
- Interest rates. Will the long-awaited cut to the federal funds rate arrive in September? If so, how quickly will this affect M&A transactions?
- PE exits. Will investors begin exiting in droves or will we see only a cautious trickle?
- Deal volume and quality. Are buyers going to start deploying their dry powder for more deals, deals with higher valuations, or both?
We’re curious to see whether 2023 will turn out to be a trough year for M&A dealmaking. The first half of 2024 indicates that things are looking up, but we remain only cautiously optimistic.
AUTHORED BY:
Bobby Motch | Head of Sponsor Coverage | Class VI Securities, LLC
As head of Sponsor Coverage, Bobby is responsible for managing financial and strategic sponsor engagement, developing sponsor-related content, and managing Class VI’s Buyer CoPilot program. Prior to his role as Head of Sponsor Coverage, Bobby was responsible for executing and closing transactions and supporting Class VI clients through financial analysis, modeling, market outreach, industry research, and valuations.
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