Is 2023 a return to the “old” normal for the A/E industry?
What was accepted as normal before the COVID-19 pandemic might be returning to the A/E industry.
- Industry consolidation dropped 18% in the final quarter of last year compared with the same period in 2021.
- Announced deals dropped from 259 in the first half of the year to just over 200 in the second half—a 22% fall-off in activity.
- There are many clues in the broader economy that suggest certain socioeconomic swathes are returning to pre-pandemic norms.
A review of M&A activity and valuation trends from the second half of 2022 and early this year has me wondering if 2023 is going to be a replay of 2018. Why? Let’s read some tea leaves.
M&A stalling out?
Industry consolidation dropped 18% in the final quarter of last year compared with the same period in 2021. Announced deals fell from 121 in Q4 2021 to 99 in Q4 2022. That’s the first time we’ve seen a drop in Q4-over-Q4 deal-making since 2016/2017—and back then it was just a 7% hiccup. The overall result is deal activity rose just 6% year-over-year as opposed to the 10% increase we were forecasting. It’s also notable there were fewer deals announced in our first M&A update of 2023 compared with the first week of 2022. Which way is consolidation headed in 2023? We think it will accelerate, but we’re actively revising our forecasts.
The difference in deal-making that took place between the beginning of 2022 and when the ball dropped at midnight December 31 is even more telling. Announced deals dropped from 259 in the first half of the year to just over 200 in the second half—a 22% fall-off in activity. We’ve only seen this pattern once since 2016. In 2019, deal-making dropped 21% from the first half of the year to the second. The number of sellers in the market last year didn’t decline, but it sure looks like demand choked. In large part this was due to smaller private equity and family office investors getting spooked by rising interest rates. For context, the second half of last year was still the fourth most active for industry consolidation on record.
The return of the employee-owned buyer?
While the pace of industry consolidation cooled in the second half of 2022, the profile of the typical buyer changed too. Back in 2018, employee- and ESOP-owned firms were the dominant buyers in the market. They were the apex predators on the savannah, accounting for almost three-quarters of all acquisitions that year. But then private equity arrived on the scene with fistfuls of cash at close and business plans akin to blank canvases that allowed sellers to keep their brand names. The result? The percentage of industry deals done by employee- and ESOP-owned firms declined steadily and precipitously, bottoming out in 2021 at just over 50%. But that changed last year, with deals by employee- and ESOP-owned firms rebounding to almost 58%. As smaller private equity firms and family offices continue to spend more time examining and less time acquiring, and as more and more mature ESOP- and employee-owned firms realize that an internal business transition is not viable, we’ll be looking to see if this buyer type becomes more prevalent in 2023.
Return to a buyer’s market?
Perhaps the most relevant indicator as to whether 2023 might signal a return to the “old” normal is where M&A valuations appear to have been trending. One of the datasets that we watch closely to get a read on where the industry is headed is comprised of those transactions that are not yet completed but are under LOI and expected to close somewhere between 30 to 90 days from now. We refer to this as the “pending deals” dataset—and it’s a good forward-looking indicator on valuations. Right now, the median and upper quartile adjusted TTM EBITDA multiples in this dataset are down meaningfully from their historical highs of 7.64x and 11.58x seen in 2022 and now are much closer to levels not seen since 2018. Will this downward trend continue? We’re keeping a close watch on this.
Back to “normal?”
There are lots of clues in the broader economy that suggest certain socioeconomic swathes are returning to pre-pandemic norms (see layoffs at Salesforce and Amazon and last year’s swooning stock market for examples). A/E industry executives and investors have become accustomed to rapid industry consolidation and rising valuations. Could those be reverting to pre-pandemic levels in 2023? We’ll know more for sure as the year progresses.
Morrissey Goodale is a CFE Media and Technology content partner.
Original content can be found at Morrissey Goodale.