Despite the economic uncertainty, we expect changing consumer preferences to continue creating dealmaking opportunities as companies endeavour to transform their business models and reposition themselves for future growth opportunities. There are still hotspots in the consumer sector – notably consumer health, health and beauty, pet products, groceries and e-commerce – which saw powerful growth during the pandemic and which are still attracting the interest of dealmakers. Now that lockdowns have been eased, however, consumers are increasingly shifting their spending from goods to services. Another major factor influencing spending patterns is inflation, which is likely to reduce demand for consumer durables and discretionary items to the benefit of staples and non-discretionary goods.
Furthermore, higher anticipated energy and wage inflation will have a negative effect on operating margins for some companies around retail and consumer. On top of that we expect operating cash flows to also suffer, as working capital and capex management will continue to be challenging. Supply lines remain disrupted and consumer volumes have recently dwindled due to higher pricing. As we hear from consumer goods companies, trading down on goods and services has accelerated. These effects will make inventory management more challenging in the quarters ahead. To make things worse, we have noted that corporates are having to continue investing in new technologies, machinery and distribution in order to escape the wage inflation dynamics.
Based on these tougher operating environments, which will result in deteriorating cash flows, we expect some corporates to continue to focus even more on their core businesses. We conclude that top management could now be more willing to exit some of the weaker businesses they own in order to continue to improve operating margins. This trend could even accelerate in the next few months.
Against this backdrop, investors are having to scrutinise potential M&A candidates more closely to make sense of recent performance and an uncertain short-term outlook. To back up valuation inputs such as future demand, pricing and cost mitigation strategies and the resulting margins, buyers are having to resort to broader, data-driven reviews – with the result that deals are taking longer.
The major themes we outlined in our start-of-year report – demergers and divestitures, supply chain and logistics issues, and online platforms and e-commerce – will continue to propel dealmaking through the rest of 2022, but have been joined by new themes and hotspots emerging from the events of the first six months.
Main themes driving M&A
Online and quick commerce face obstacles to growth
Online shopping saw an incredible influx of new customers during the pandemic, and even after the easing of restrictions many consumers continued to do business online. However, inflation is forcing people to re-evaluate their buying choices, prompting a shift back to value and bricks-and-mortar channels (think value retailers and discount groceries) in search of lower-cost options. We believe omnichannel retailing will become an increasingly important feature of the landscape.
The shift back to bricks and mortar has resulted in lower valuations in the e-commerce and quick commerce sectors (the latter not yet so prevalent in Switzerland but trying to make inroads). Although the market is still young it’s already crowded, and there are signs that lower-than-anticipated growth potential is already resulting in consolidation. Look out for distressed M&A or restructuring in the next few months. With a wide consumer reach and plenty of available capital, major players in the fast-delivery space look more likely to succeed in the longer term than smaller players, who will need to diversify their operating models to survive.
“After a surge in online business propelled by the pandemic, fears of inflation are driving consumers back to bricks and mortar in search of value. Some smaller players eying rapid growth in the quick delivery business have had the rug pulled from beneath their feet – and could be picked up by larger operators with a firmer foundation of customers and financial resources.”
Supply chains continue to disrupt
A combination of lockdowns, specific incidents and rapid changes in patterns of demand has led to major disruptions in supply chains, a situation that is likely to persist as the Russia-Ukraine conflict continues to play out. We’re probably going to see a direct impact on supplies of certain raw materials and energy, compounded by greater tension and export controls.
With stakeholders pressuring many multinational consumer players to reassess their relationships with Russia, some have put sales there on hold, have closed stores or are even abandoning their investments in the country altogether. This is having a negative impact on investment decisions in businesses with material ties with Russia.
Beyond the conflict, the reversal of globalisation has prompted business leaders to assess their supply chains as part of a re-assessment of their overall risk profile. During the second half of 2022, look out for companies taking measures designed to rebalance supply chains, including the acquisition of key suppliers, operational changes such as moving production closer to end markets, and looking into potential alternatives to existing inputs.
Capital availability and valuations
Despite the fact that economic uncertainty has led to tighter capital markets and a decline in debt issuance, there is still capital available for mergers and acquisitions. With global IPOs practically at a standstill and special purpose acquisition company (SPAC) activity much lower than last year, companies seeking an exit may seek alternatives such as extending venture capital funding or looking into the possibility of a private sale.
Private equity (PE) has record levels of dry powder and continues to be extremely active in the consumer markets space. We anticipate an increase in public-to-private transactions and in private equity houses picking up non-core assets divested by large corporates. We also expect to see PE going for lower-risk transactions such as bolt-ons and structured deals.
We’re now seeing some corporates setting up venture capital arms to acquire minority interests in innovative or tech-focused businesses. Partnerships and joint ventures are also an increasingly popular option for accessing capabilities in areas such a cyber or opportunities in emerging spaces such as non-fungible tokens (NFTs) and the metaverse. Another development we anticipate is strategically sound but financially weak businesses seeking outside backing.
What about M&A in the Swiss retail and consumer sector?
From our discussions with corporates and the recent releases of interim results of FMCG companies and retailers in Switzerland, we have learned that the business environment will continue to be tough. Operating margins and operating cash flows continue to deteriorate. Company guidance and outlooks point to higher organic sales growth due to higher inflationary pricing, but margins will continue to suffer. To preserve cash and stabilise margins, we think that top management will be much more willing to exit underperforming activities that are nice to have but not need to have.
On the other hand, corporates with solid market positions and strong business cases which continue to have higher gross and EBITDA margins than their peers, as well as generating solid free cash flow, are scrutinising the capital and private market for potential acquisitions. We are currently not seeing declined interest on the part of corporates in changing structure, carve-outs or spin-off businesses at the moment. We are hearing that corporates as well as private firms are willing to snap up some of these spin-offs. Private equity firms continue to have ample cash on the basis of their long-term investment cases. They are therefore still on the buyer-side.
Finally, in our recent analysis we have seen a discrepancy in valuation multiples between the private equity market and the market for listed companies. This gap has recently widened. Overall transaction volume has thus declined, as investors take more time to analyse the businesses on offer despite the willingness of sellers and buyers to do a transaction.
And the outlook: M&A activity in the consumer industry set to remain healthy
It’s clear that the economic outlook and the impact on consumer spending is uncertain, but with business leaders focused on value creation and capital resources available for mergers and acquisitions, demand for assets in the consumer markets should remain intact. We predict healthy dealmaking for the remaining months of 2022, even if it fails to reach the record levels of 2021.
Mid-year outlook: healthy M&A activity despite lack of economic and sociopolitical certainty
Despite an unpredictable operating environment dominated by economic and sociopolitical uncertainty, M&A activity in the health industries will remain lively. PE funds have significant dry powder at their disposal, and large corporates are still endeavouring to achieve growth through deals and softer biotech valuations might fuel M&A from big pharma to fill their pipeline. With PE and corporate capital competing to acquire innovative small and medium-sized businesses with new technologies and digital capabilities, dealmakers are in for a busy time in the remainder of 2022.
