2023 has been a stronger year for M&A than many were expecting. At the same time, different industry sectors have registered greater disparity in valuations, deal activity and deal volumes than we typically see. Our most frequently asked question from fellow professionals and business owners is “have you seen a slowdown yet”? The answer is no. We continue to have strong demand for acquisitions and more clients bringing businesses to market than in a typical year. This may be isolated to Oklahoma, Texas, and the Midwest, but our feel for M&A is that valuations and activity remain high.

It is difficult to predict what 2024 will look like and the Federal Reserve may have a significant impact. Federal Reserve Chair Jerome Powell said last week “Although inflation has moved down from its peak — a welcome development — it remains too high. We are prepared to raise rates further if appropriate and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.” The Fed paused in June, then raised the benchmark lending rate by a quarter point in July to a range of 5.25-5.5%, the highest level in 22 years. The Fed’s July minutes talked about the economy’s surprising strength and upward pressure on prices, leaving more rate hikes on the table if necessary. By the time we issue our next quarterly report, we will know more and will start the conversation about the 2024 election and its potential impact. With all future uncertainty, many are taking this opportunity to close a transaction while the market is still strong.

A strong tailwind for M&A continues to be the amount of cash available for acquisitions. With many corporations flush with cash, strategic buyers still have reserves available to offset higher debt financing costs. Private equity currently own around 11,000 US companies and are sitting on enormous cash balances. They must continue investing in companies or return funds to their limited partners, so they are heavily incentivized to continue acquiring.

In the section below, we consider the M&A outlook for several key industries in our region.

Aerospace and Defense

Deal activity leveled off in Aerospace and Defense during the first half of the year, down from the end of last year, but consistent with levels from the first half of 2022.  Commercial aerospace and defense acquisition activity are expected to continue at a similar level through the remainder of 2023.

Passenger air travel is thriving in the US, as Americans feel free to travel domestically and internationally, having spent years dealing with COVID travel restrictions. With more passengers flying and increased airline activity, greater earnings, and strong tailwinds, we anticipate increased deal activity among companies that serve the airline industries.

Technology remains a catalyst for change in the industry with AI, cyber, hypersonics, and space as priorities.  3D printing is another revolutionizing technology that creates efficiency in the design and manufacturing of drones and other aerospace equipment.

The Pentagon opposes further consolidation among defense companies, causing defense contractors, manufacturers, and related service companies to be focused on compatible acquisition opportunities or divestitures of non-core assets. However, smaller private companies supplying the federal government are typically under the radar and in high demand from acquirers.

Business Services

Valuation drivers in Business Services continue to be maintenance, repair, service contracts and other sources of recurring revenue. Business Services companies are targeting technology and digital solutions.  Automation, AI, and data analytics will help with innovation and efficiency and are a focus for M&A.  ESG (Environmental, Social, and Governance) is another M&A trend entering strategic directives, to help achieve sustainability goals and enhance their corporate reputation.

The HVAC, electrical, and industrial services industries continue to experience high deal activity.  There are larger HVAC companies that have been diversifying, acquiring electrical or mechanical add-ons to improve their platform diversity and increase growth.  Due to the essential nature and consistency of the industry, deals will continue in this space.

Landscaping and pest control are expected to have continued robust deal activity, particularly in the Southern US which leads in deal volume.  High market fragmentation means many opportunities to gain market share through M&A.

Chemicals

Chemicals M&A activity has rebounded from a low in Q3 2022 and is expected to maintain momentum throughout 2023. Deal activity will be driven by portfolio optimization, solutions for environmental challenges, sustainability, and supply chain security. To mitigate supply chain issues, chemical companies may look for manufacturing capability across multiple regions. M&A offers a faster approach than start up and new-build production.

Companies with strong balance sheets and dry powder can gain the advantage by being able to execute deals quickly, while persistent inflation and inflated costs of financing have companies with less cash looking for alternative acquisition financing.

Energy

The cycle of oil and gas M&A activity is coming back around. While reduced access and higher cost of capital softened deal activity in the first half of 2023, there are many new energy deals about to come to market.  While there are still many financial investors who remain on the sidelines, valuations are starting to pick up again. Deal volume fell in the first half of 2023 compared to the second half of 2022, while deal values stayed relatively stable.  Upstream deals led the way, accounting for approximately half of all oil and gas acquisitions.

Some companies see this environment as a time to strengthen balance sheets and offload non-core businesses, while smaller privately held companies may find attractive targets in these divestitures.

For other oil and gas companies, this is a suitable time to acquire assets that support long term strategies, which could be beneficial in a future regulatory environment. Upstream is not expected to account for such a high proportion of energy deals in the remainder of 2023 unless they are complementary assets for access to new reserves, innovative technologies, increasing synergies or lowering costs.

Engineering and Construction

Construction technology is a big theme for M&A activity in this sector, with companies looking to speed up and gain efficiency in design work and operations.  Companies who have implemented these technologies will be prime targets in 2023.

Housing starts and building permits were up during the second quarter, but labor shortages remain a headwind for the industry.

In addition to technological advances, engineering and construction companies have real opportunities to benefit from tax incentives tied to decarbonization.  Acquirers are looking for targets with lower carbon technologies, offsite construction, and responsible sourcing. There is also high demand for construction companies in infrastructure (water, wastewater, roads and bridges).

Higher interest rates have affected the cost of M&A, but the right deals can still create value with new markets or synergies that fit a company’s long-term growth strategy. Divestures can also impact deal activity as companies offload businesses that do not fit with strategic goals.

Since the passage of the Bipartisan Infrastructure Law, project applications continue to flow into the department and around 37,000 projects have been approved and funded in all 50 states.  Projects include clean water infrastructure, repaving roads and rebuilding bridges, upgrading the power grid, affordable high-speed internet, and increasing infrastructure resilience.

Healthcare

Deal activity in healthcare has been and is expected to remain resilient. Deal volume decreased modestly in the first half of this year, but was still well above historical deal volumes, twice the levels of 2018 through 2020.  Deal value declined but mirrored the trend of smaller roll-up or add on transactions.

Groups with the highest share of deal value included Other Services, Home Health & Hospice, Labs, MRI and Dialysis, and Hospitals.  Other Services is composed of a range of companies: contract research organizations, ambulatory surgery centers, home infusion services, and medical office buildings.

A few notable megadeals this quarter included CVS acquiring Signify Health and Oak Street Health and Walgreens-backed Village MD acquiring Summit Health.

Higher interest rates have impacted earlier stage public biotech companies with large R&D budgets and higher costs of financing. Pharmaceutical M&A has hit record highs as larger companies looked for innovation by acquiring earlier stage biotechnology companies. M&A transactions have focused on drug research with higher likelihood of clinical trial success and a large market in the event of approvals, including cancer, rare diseases, and immune system disorders. However, these acquisitions have been in high demand, so valuations have been remarkably high.

Industrial Manufacturing

Coming off some banner deals in 2022, industrial manufacturing deal activity has normalized in the first half of 2023. The US manufacturing Purchasing Managers’ Index (PMI) registered six straight months of contraction.  The manufacturing backlog has been robust, but new orders are down. However, growth has been reported in nonmetallic mineral products, furniture and related products, fabricated metal products, and transportation equipment.

Higher interest rates have led companies to focus on portfolio alignment to fill strategic gaps or divest non-core assets. Industrial manufacturing remains a high demand sector for acquisition activity and many more acquisition opportunities are expected to hit the market in the remainder of 2023.

Shoring up supply chain vulnerabilities and pressure to automate and digitize will continue as themes driving industrial manufacturing deal activity.

Transportation and Logistics

Transportation and Logistics deal activity remained muted for the first half of 2023 due to macroeconomic conditions and lower freight rates.

Supply chain disruptions look like an ongoing issue for Transportation and Logistics. Retailers are investing in technology to help manage and increase the efficiency, sustainability, and transparency of their supply chains. Reshoring pieces of the supply chain takes time; technology and data science can help companies predict and adjust more quickly in the meantime.

Forecasting technology is another focus area companies have been looking to acquire rather than build.  E-commerce has added complexity and unreliability to logistics forecasting.  Hiring knowledgeable talent or acquiring technology will help companies analyze trends and improve timely supplier communications and inventory adaptations, all of which impact Transportation and Logistics M&A activity.