Global Economy

Capstone professionals joined merger and acquisition (M&A) advisors from more than 25 countries in Paris in April to discuss the global economy, the tragic loss of human life and the international implications of Russia’s war on Ukraine, geopolitics, market volatility, and the potential impacts that these far-reaching challenges could present to business owners and the dealmaking environment.

“As with any disruption, there are always opportunities for M&A, but the trick is to differentiate between short-term disruption and long-term fundamental change,” said Jurgis V. Oniunas, Chairman of IMAP (International M&A Partners), a leading global middle market M&A partnership with 450 advisors across Europe, the Americas, Asia, and Africa. More than 130 advisors from partner firms as well as guest speakers joined the bi-annual IMAP conference to discuss and help distinguish between the short- and long-term disruptions, which have become increasingly difficult to navigate amid lingering COVID-19 supply chain issues, rising commodities prices, prolonged inflation, fuel shortages, increasing interest rates, and sanctions against Russia, all of which have collectively caused ripple effects worldwide.

Krisztián Orbán on How Russia’s War Against Ukraine Expedites Dual Economy Era

Krisztián Orbán, Founder and Managing Partner of private equity firm Oriens and former McKinsey & Company consultant, shared his perspective on the long-term impact of Russia’s invasion on Ukraine, which he described as being a catalyst to expedite the division into a dual world economy. This division would be characterized by a Transatlantic-centric economy driven by the U.S. and by a China-centric economy aligned with Russia, with several countries including India, Brazil, and South Africa still in question as to how they will align. Importantly, this schism is expected to create two disparate economic climates and businesses should not expect the same rules to apply across the bifurcated economies.

U.S. Secretary Janet Yellen recently commented on this division of international order during a speech to the Atlantic Council on April 13: “The course of the global economy over the past two years has been shaped by COVID-19 and our efforts to fight the pandemic. It’s now evident, though, that the war between Russia and Ukraine has redrawn the contours of the world economic outlook. Russia’s horrific conduct has violated international law, including core tenets of the U.N. Charter, challenging countries to demonstrate where they stand with respect to the international order that has been built since World War II. Therefore, when I speak about a changed global outlook, I’m not just talking about growth forecasts. I’m also referring to our conception of international cooperation going forward.”

The reorder will create challenges for the two economies, according to Orbán, as synergies disappear and each order must create a self-sufficient ecosystem. For the Transatlantic-centric economy, key focus areas will likely include securing commodities; protecting logistics in grey areas of the globe where pirates will take advantage of the lack of order; reindustrializing the West; immigration and wage increases to bolster the tight labor market; and increasing long-term Western public budgets and deficits due to elevated spending on defense and green/local energy initiatives.

Business owners within the U.S. have already been facing many of these challenges due to international disruptions caused by the pandemic, and Russia’s war on Ukraine and the growing divide in the economies will likely only serve to heighten these challenges. Namely, 95% of business owners in Capstone’s Q1 Middle Market Business Owners Research Survey said that they already faced notable challenges to their business, with the top three cited as economic uncertainty, supply chain disruptions, and workforce shortages. Among the CEOs that cited economic uncertainty as a prime challenge, 87% pinpointed rising inflation as the leading issue. Additionally, among those owners afflicted by supply chain issues, 71% cited materials availability as a premier issue, followed by rising input prices (62%), production constraints (40%), and trucking bottlenecks (38%).

What Do these Changes Mean for the Global Business Environment and How Can Companies Prepare?

The changing contours of the global economy will impact companies, perhaps not immediately, but certainly in the long term. “First of all, it means less profit. It means less financial engineering and it’s more focused on efficiency,” according to Orbán. “Costs will be higher. Taxes will be higher. Corporate taxes will be higher. Thereby profits will be lower.”

So, what can companies do now to prepare for these negative impacts?

  • Move Towards Vertical Integration to Secure Supplies – While outsourcing products and services along the supply chain has traditionally allowed companies to decrease costs, Orbán argued that companies will be able to streamline operations, cutting costs and disruptions, by purchasing stages of the production line.
  • Focus on Implementing Digitization and Automation – Already supercharged by the pandemic, the move towards digital strategies and automation will be more important than ever before, as companies seek to increase productivity while mitigating wage pressures.
  • Invest in Research & Development – Companies should spend the money now to become more efficient and to tackle endemic challenges such as the energy transition to mitigate the future impact and create more sustainable profit margins.

The pressure to really implement digitization and automation will be much, much bigger than before and ultimately, in the long term, that is the thing that can help the West escape from this high-inflation environment.

Krisztián OrbánFounder and Managing Partners, Oriens

What Do these Changes Mean for M&A in the United States?

These geopolitical and economic changes will ultimately result in less profit, less leverage, and a less robust M&A environment globally, Orbán predicted. Additionally, within the U.S., the Federal Trade Commission’s (FTC) recent commitment to strengthen existing antitrust laws and close loopholes in the Hart-Scott-Rodino (HSR) filing requirements will impact large corporations’ ability to do M&A and potentially push more activity into the middle market.

The U.S. Middle Market was initially slow to be impacted by geopolitical and economic events, being somewhat shielded by the hard charging U.S. consumer. However, we are seeing buyers becoming more concerned with impacts of macro conditions on consumer targets in the U.S. Specifically, how their businesses are affected by supply chain disruptions, inflationary pressure, and the lapping of a COVID year in year-over-year comparisons. Higher gross margin businesses are being prioritized by buyers. The thought being that higher gross margin businesses are better positioned to counter these negative trends.

Kenneth WasikHead of Consumer Investment Banking, Capstone Partners

Future Trends in M&A

The shift to a dual economy will also create opportunities in the domestic market and Capstone expects the trends below to become more prominent in M&A activity.

  1. Special Situations M&A – Lower profits will test the success, if not the survival, of businesses.
  2. Relocation – Businesses will focus on moving operations across all stages of the production chain to Western countries.
  3. Market Shift from China – Businesses will shift their target growth markets from China to the West.

Private Equity to Continue to Drive Demand

Private equity investors will undoubtedly continue to drive demand for U.S. sellers over the coming years due to a record level of private equity dry powder and strong fundraising activity. Armed with approximately $1.2 trillion in unallocated capital, general partners (GPs) are under increasing pressure to put capital to work quickly in the M&A market and achieve returns for their limited partners (LPs), according to PitchBook. Companies that generate strong recurring cash flows, operate in non-cyclical industries, are low-capital intensive, and have strong management teams often make attractive private equity targets. Capstone’s ongoing conversations with its Private Equity Caucus have revealed the current top three sector preferences for private equity targets are Food & Beverage, Healthcare Services, and Industrial Services & Distribution. Professional Services followed in fourth place with the sector seeing a recent increase in sponsor interest in the second half of 2021, as private equity buyers sought to capitalize on the sector’s rising demand amid the Great Resignation.

Over the past several years private equity buyers have continued to claim a growing share of M&A transactions in the U.S. In 2021, 41.4% of private companies in the middle market were acquired by sponsors. This percentage has increased from 29% in 2015 and 26% in 2010, according to Capital IQ. The rise has largely been driven by the increase in add-on acquisitions. In 2021, 31.3% of middle market private companies were acquired by sponsors making an add-on acquisition compared to 18.3% in 2015 and 17.4% in 2010.

Deal multiples paid by private equity buyers have also been robust. In 2021, sponsors paid an average of 11.0x EV/EBITDA for middle market add-on acquisitions, up from 9.9x in 2020, according to Capstone’s 2021 Middle Market Valuations Index. This figure could rise even more going forward as competition among private equity increases and firms seek to bring in the optimal target to enhance their buy-and-build strategy and maximize returns.

To learn more about how current macrotrends are impacting businesses in your industry, or to discuss optimal timing for an exit with one of our sector experts, please contact us.


This article was originally published on 5/3/22 and updated on 8/24/22.

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