January 22, 2024
A striking mergers and acquisitions (M&A) trend is set to gain momentum in 2024 – driven by the escalating cost of debt. Companies are looking to bolster their equity positions as a strategic response to the burden of high debt costs, according to Translink Corporate Finance’s ‘2024 Megatrends Report’. Featuring insights from global Translink partners, the report identifies six top trends that will shape the M&A landscape in 2024 and beyond.
The equity-focused trend signifies a potential transformation in deal structures and valuations as businesses seek to minimise their reliance on debt financing and its associated risks.
Equity trend highlights discussed in the report include:
- Escalating debt costs and equity shift: Companies are bolstering their equity positions, moving away from the norm of easily accessible funding. The rising cost of borrowing and the desire to mitigate the financial burden and risks associated with high debt, drives this shift.
- Changing deal structures and valuations: There is a notable change in how deals are structured, with a growing emphasis on equity components. This shift creates more creative and flexible deal structures, like stock-for-stock mergers and strategic alliances.
- Sectoral impacts and strategies for growth: Certain sectors, like luxury goods and construction in Sweden for example, face challenges due to the economic climate and changes in financing dynamics. There are, however, growth opportunities, especially for companies with strong equity positions.
- The need for diversified financing strategies: CEOs should focus on unique offerings and strategic positioning in the market. Alternatively, if time allows, waiting approximately six months might lead to more favourable market conditions for sellers. Patience can enable a more strategic decision-making process.
Fredrik Ullberg, Partner at Translink Corporate Finance Sweden, unveils a series of unique drivers of the 2024 equity M&A trend. Ullberg says, “The current financial landscape suggests we might be approaching the peak of debt costs. We anticipate that debt will likely be more affordable this year, albeit in a different manner than in recent years.
The strategic shift towards strengthening equity positions in response to rising debt costs signifies a significant change in the financial landscape. CEOs and dealmakers must prepare to navigate this transition as it could substantially impact M&A deal structures and valuations. While debt financing remains attractive, diversifying financing strategies becomes crucial for ensuring long-term financial stability and resilience. In the dynamic realm of M&A, adaptability and a sharp focus on mitigating financial risks are paramount for success.”
Escalating debt costs
Translink says financing has emerged as a formidable challenge in the current landscape of dealmaking processes. Merely a year ago, funding was abundantly available, almost effortlessly acquired as money seemed virtually ‘free’. However, the scenario has dramatically transformed. Financial advisors now find themselves compelled to collaborate in a more intimate capacity with buyers, often actively participating in bank meetings to secure optimal financing solutions for their clients. This paradigm shift starkly contrasts the experiences of the past year. Previously, securing approximately 50% of the equity value was the norm; however, this figure has dwindled to a mere 25% in the current market environment.
Ullberg says, “As interest rates continue to rise and the cost of borrowing capital climbs, companies are re-evaluating their financing strategies. CEOs are acutely aware of the implications of high debt costs, which can erode profitability and strain cash flows. A fundamental shift is underway in this environment, with businesses seeking alternatives to mitigate the financial burden.”
Translink’s report also indicates that CEOs realise the benefits of minimising their reliance on debt financing and how pivoting towards bolstering equity positions provides a more stable financial foundation. This approach reduces vulnerability to interest rate fluctuations and financial market uncertainties, enhancing long-term resilience.
Reshaped deal structures
Translink says the shift towards equity is reshaping deal structures. The report anticipates increased transactions structured with a greater emphasis on equity components. “Equity-funded deals can provide more flexibility and reduce the financial strain associated with servicing high debt levels. This may lead to creative deal structures, such as stock-for-stock mergers and strategic alliances,” says Ullberg.
Translink’s report also points to a discernible trend in private equity firms. Most companies are reducing their debt, shifting their reliance towards equity, even in technology and Software as a Service (SaaS) sectors. Sweden, which once saw ecommerce companies achieving high valuations, has declined significantly.
In this complex and volatile environment, cross-border transactions provide a crucial strategic advantage. Translink’s extensive global footprint of country offices equipped with deep local knowledge makes it invaluable in finding buyers and sellers across different jurisdictions.
“Presently, an opportune moment has emerged for prospective investors eyeing Sweden, driven by the Swedish krona’s unprecedented depreciation against the dollar. This is compelling buyers seeking entry into the Nordic region to engage in heightened inbound M&A activities. The favourable exchange rate positions Sweden as an attractive market, encouraging strategic investments and fostering increased M&A endeavours,” adds Ullberg.
Translink says a decisive shift has occurred in the valuation landscape, marked by a significant decline in general valuations. Ullberg says, “Sellers are gradually adapting to this new reality, acknowledging the adjusted valuation figures. These changes underscore a transformative period in the market, indicating a departure from established norms that may persist throughout our lifetimes.”
Translink’s report says the paradigm has shifted for younger companies. Earnouts, once attainable through conventional means, now necessitate enhanced performance. Collaboration with older, established firms still provides avenues for success, albeit contingent upon rigorous demonstration of capabilities. This evolving dynamic requires a higher level of worth from emerging companies, requiring them to showcase their value proposition and competence more convincingly than previously.
Companies seeking to strengthen their equity positions may prioritise long-term strategic synergies and growth potential over immediate financial returns. This shift may lead to nuanced valuation methodologies and traditional metrics re-evaluations.
Some sectors impacted more than others
Translink says minimising debt exposure becomes an essential risk management strategy in an environment where economic uncertainties persist. For example, in Sweden, the luxury goods sector is currently facing challenges, and so too is the construction sector due to expenses, rent control, and the pandemic-prompted remote work phenomenon causing extensive empty office space. New construction has slowed, but opportunities exist in home repairs and renovations. Companies with robust equity positions can achieve growth despite economic uncertainties.
Ullberg adds, “Another key driver is that bigger payers are doing the deals. Presently, transactions are predominantly driven by established investors and buyers. In the Nordics, particularly in Sweden, most compounders rely on various types of bonds for financing. However, these bonds have become prohibitively expensive, with interest rates ranging from 11-14%. Consequently, smaller players find it challenging to compete in the bidding process due to the complexity of these calculations, putting them at a disadvantage in the current market environment.”
Strategies for growth
Translink says companies, even when capable of securing financing at 2.5 times Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA), often opt for a more conservative approach, aiming for a ratio of 1 to 1.5. “This strategic choice allows them to pursue aggressive expansion plans in the future. Many companies leverage their existing sellers to reinvest additional equity into the new venture. Additionally, they are exploring financing options from banks,” says Ullberg.
Translink says these businesses engage with financing from the outset, ensuring they have the capital to fuel growth, pursue acquisitions, and successfully enter new markets. This proactive financial planning is becoming integral to their strategies for building and expanding their enterprises.
What CEOs should consider in 2024
Translink says outstanding companies with unique offerings continue to command strong valuations, especially in Sweden and similar markets where financial buyers are eager to invest. These top-tier companies generate significant interest. However, businesses lacking key attributes face challenges in securing deals.
“For urgent sales, a targeted approach involving a select group of four to five potential buyers can yield favourable results. At Translink, our extensive global footprint is crucial in identifying suitable partners across borders. Translink also boasts a dynamic debt service poised to assist our clients in navigating this evolving landscape. Our expertise can guide businesses through this journey, ensuring informed and strategic financial decisions,” concludes Ullberg.
Read the full Translink 2024 Megatrends Report HERE