Capstone Partners Reports: Middle Market M&A Valuations Soften, Market Participants are Optimistic for a Recovery in 2024

Rhea-AI Summary

Capstone Partners' 2023 Middle Market M&A Valuations Index reveals a decline in average M&A valuations to 9.6x EV/EBITDA due to transaction costs, cash flow uncertainties, and a reserved private equity buyer pool. While some deals transacted at premium valuations, the median EBITDA multiple fell to 8.0x EV/EBITDA. However, certain industries showed improvement in purchase multiples, indicating resilience and recovery prospects for 2024.

Positive

• Several industries displayed improved three-year average EBITDA purchase multiples in 2023 compared to the previous year.
• Buyers in middle market M&A processes showed increased discipline, resulting in fewer market clearing bids at higher EBITDA multiples.
• The average enterprise value of sold target companies decreased significantly in 2023, reflecting a challenging valuation environment.
• Quality companies with strong financials and stable end markets are expected to attract buyer interest in 2024, leading to a potential rebound in purchase multiples.
• Private equity buyers are anticipated to reenter the M&A markets in 2024 after a period of activity in 2023.
• The valuation environment may require time to recover, but the overall M&A and macroeconomic landscape in 2024 is predicted to be favorable for sellers seeking optimal exits.

Negative

• Average M&A valuations experienced a decline in 2023, with median EBITDA multiples dropping compared to the previous year.
• The percentage of transactions closing at 10x EBITDA or higher decreased in 2023, indicating a shift towards lower levels of the middle market.
• The average enterprise value of sold target companies saw a substantial decrease in 2023, potentially impacting overall transaction value.
• Private equity buyers faced partner pressure in 2023, leading to reduced activity in the M&A markets.
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Market Research Analyst

The middle market M&A landscape has undergone significant changes, with average valuations declining to 9.6x EV/EBITDA from the previous year's 9.9x. This adjustment is a reflection of the market's response to macroeconomic shifts, notably the interest rate hikes. The decline in median EBITDA multiples to 8.0x from 8.5x further emphasizes a more cautious investment approach by private equity firms and strategic buyers. The drop in the average enterprise value of sold target companies from $139.3 million to $89.4 million suggests a retraction in market activity and a pivot towards smaller deals, which often carry less risk and require a lower capital outlay.

Despite the downward trend, the resilience in sectors such as Business Services and Technology indicates that certain industries can withstand broader market volatility. This resilience is often attributed to these sectors' ability to demonstrate sustainable demand and financial stability. The shift in buyer behavior, with a reduction in transactions closing at 10x EBITDA or higher, signifies a disciplined approach to M&A, likely driven by the increased cost of capital and a strategic reassessment of long-term value creation.

Financial Analyst

The decline in middle market M&A valuations could have varying implications for investors and stakeholders. In the short term, the reduced valuations and transaction volumes may present buying opportunities for investors with available capital and an appetite for risk. However, the long-term perspective is cautiously optimistic, with expectations of a market rebound. This forecast is predicated on the alignment of seller and buyer expectations, which could lead to increased transaction activity and potentially higher valuations. The report's anticipation of private equity buyers reengaging in the market could inject liquidity and drive competition, potentially resulting in an upward pressure on valuations.

It's important to note that the cost of capital is now a significant factor in deal structuring and valuation, as the Federal Reserve continues to adjust interest rates to meet its economic objectives. Investors should consider the impact of interest rates on leveraged buyouts and refinancing strategies within the middle market. Quality companies with strong financials are likely to remain attractive to buyers, but the valuation multiples may remain subdued until the broader macroeconomic conditions stabilize.

Economist

The report's findings are indicative of broader economic trends affecting the middle market M&A sector. The Federal Reserve's interest rate policy, aimed at controlling inflation, has increased the cost of borrowing, subsequently affecting deal valuations and the willingness of buyers to pay premium prices. The downward adjustment in valuations can be seen as a market correction following a period of high liquidity and low-interest rates, which had inflated asset prices.

Looking forward, the potential realignment of buyer and seller expectations suggests that the market is adapting to the new economic realities. This adjustment phase could lead to a healthier, more sustainable M&A environment. However, the economic outlook remains uncertain and the pace of recovery will likely be influenced by factors such as inflation rates, consumer confidence and global economic conditions. While the report projects optimism for 2024, stakeholders should closely monitor these macroeconomic indicators to gauge the trajectory of the middle market M&A sector.

BOSTON, March 21, 2024 /PRNewswire/ -- Capstone Partners, a leading middle market investment banking firm, released its 2023 Middle Market M&A Valuations Index, reporting that while equity markets largely shrugged off the rapid succession of interest rate hikes in 2023, middle market merger and acquisition (M&A) valuations experienced downward pressure. Elevated transaction costs, uncertainty over projected cash flows, and a reserved private equity buyer pool contributed to average M&A valuations falling to 9.6x EV/EBITDA in 2023, compared to 9.9x in 2022. Several deals that transacted at premium valuations helped to bolster this average, while the median EBITDA multiple fell more drastically to 8.0x EV/EBITDA compared to 8.5x in the prior year. While business owners encountered a challenging valuation environment, several bright spots of the market have provided optimism for resilience and recovery in transaction value in 2024. Notably, average three-year EBITDA purchase multiples in the Business Services, FinTech & Services, Industrial Technology, Technology, Media & Telecom, and Transportation, Logistics & Supply Chain industries improved on a year-over-year (YOY) basis.

Buyers demonstrated heightened discipline in middle market M&A processes in 2023, refraining from overextending themselves to acquire target companies. While high-quality assets still commanded solid buyer interest and competition in bidding, market clearing bids were less frequent than in prior years. In 2023, 31% of transactions closed at 10x EBITDA or higher—a decline from 38% in 2022 and 43% in 2021. This may have coincided with buyers moving to lower levels of the middle market, a common occurrence amid market uncertainty. The average enterprise value of sold target companies amounted to $89.4 million, a substantial drop from $139.3 million in 2022. When buyers did pay premium multiples, typically these businesses had demonstrated gross margin defensibility, healthy revenue visibility, and sustained product or service demand.

Many dealmakers are optimistic that 2023 marked a trough for both middle market M&A volume and pricing, with 2024 positioned to experience a rebound in purchase multiples. Seller and buyer expectations are anticipated to become more aligned after such dislocation post-pandemic, when purchase multiples at times became detached from fundamentals. For the first time in nearly a decade, the cost of money is meaningful, and likely will be for the foreseeable future as the Federal Reserve works to meet its mandate. However, quality companies with sound financials and resilient end markets are poised to garner buyer appetite. Private equity buyers, facing limited partner pressure to generate returns, are expected to reenter the M&A markets in 2024 after sitting on the sidelines for much of 2023. The valuation environment may take some time to recover, but the M&A and macroeconomic environment in 2024 is expected to present a favorable backdrop for many prospective sellers to achieve an optimal exit.

Also included in this report:

• A breakdown of three-year average middle market M&A valuations by industry.
• Discussion of middle market M&A transaction volume on an industry level.
• Commentary on the operating performance of target companies sold in 2023 compared to prior years.

To access to full report, click here.

ABOUT CAPSTONE PARTNERS

For over 20 years, the firm has been a trusted advisor to leading middle market companies, offering a fully integrated range of investment banking and financial advisory services uniquely tailored to help owners, investors, and creditors through each stage of the company's lifecycle. Capstone's services include M&A advisory, debt and equity placement, corporate restructuring, special situations, valuation and fairness opinions and financial advisory services. Headquartered in Boston, the firm has 175+ professionals in multiple offices across the U.S. With 12 dedicated industry groups, Capstone delivers sector-specific expertise through large, cross-functional teams. Capstone is a subsidiary of Huntington Bancshares Incorporated (NASDAQ:HBAN). For more information, visit www.capstonepartners.com.

For More Information Contact:

Sarah Doherty
Director of Market Intelligence
sdoherty@capstonepartners.com
617-619-3310

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SOURCE Capstone Partners

What was the average M&A valuation in 2023 according to Capstone Partners' report?

The average M&A valuation in 2023 was 9.6x EV/EBITDA, down from 9.9x in 2022.

Which industries showed improvement in purchase multiples in 2023?

Business Services, FinTech & Services, Industrial Technology, Technology, Media & Telecom, and Transportation, Logistics & Supply Chain industries displayed improved purchase multiples in 2023.

What contributed to the decline in middle market M&A valuations in 2023?

Transaction costs, cash flow uncertainties, and a reserved private equity buyer pool contributed to the decline in middle market M&A valuations in 2023.

What is the expected outlook for middle market M&A in 2024?

The outlook for middle market M&A in 2024 suggests a potential rebound in purchase multiples, alignment of seller and buyer expectations, and increased activity from private equity buyers.

How did the average enterprise value of sold target companies change in 2023 compared to 2022?

The average enterprise value of sold target companies decreased from $139.3 million in 2022 to $89.4 million in 2023.