Capital Markets 2024 midyear outlook
The IPO window continued its gradual reopening as US equity markets navigated volatility to reach record highs in the first half of 2024.
Strong corporate profits, rising executive confidence and stabilizing inflation are driving an M&A recovery after a sluggish 2023. A fixation on potential interest rate cuts has so far hindered a broader bounceback, but we believe dealmakers should accept the new reality instead of wishing for a return of low interest rates.
This is a critical time for dealmakers. In the US, 82% of US CEOs say the average company in their industry will not be in business in 10 years if it fails to change its current business model, according to a recent PwC Pulse Survey. They have an even more urgent near-term outlook: 34% of US CEOs say an average competitor won't survive three years if it doesn't change. Many of those companies may need to strike transformative deals. With a fledgling M&A recovery already underway, companies that stay on the sidelines risk being left behind. Despite the need for change, many companies haven't adjusted their strategic priorities to reflect the beginning of an M&A recovery. The Pulse survey found that only 28% of business executives say they're planning an acquisition or a divestiture in the next 12 to 18 months.
There are opportunity costs from letting the M&A engine idle. According to our research, dealmaking during the bottom of the M&A cycle can generate returns that are over three times higher than regular investments in organic growth. From a strategic standpoint, early movers also will have their choice of targets, enabling them to transform the competitive environment to their advantage — forcing everyone else to play defense.
Our analysis is based on a view that the M&A market hit bottom in 2023 before starting a recovery at the end of the year.
Trends that shaped our analysis include:
Despite these reasons for optimism, several factors have tempered the M&A recovery so far, including increased regulatory scrutiny and a volatile political and geopolitical environment. But the biggest mitigating factor has been the battle against inflation. Continued, elevated interest rates have resulted in fewer deals for more money; M&A volume has been roughly flat since plateauing in the back half of 2023.
We’re seeing four main M&A trends as we work with clients across industries.
The M&A recovery is born from a mixed — though mostly positive — bag of macroeconomic news. While each week brings new data points that have made the past few months feel like it’s a “two steps forward, one step back” economy, a few trends have emerged:
While the Federal Reserve may still ease rates before year-end, how much and when remain to be seen. Our view is that if or when rates drop, they probably won’t stabilize at levels that many dealmakers are accustomed to. But as rate policy becomes clearer, it will encourage buyers to move forward sooner.
At the same time, pressures on margins remain high, creating a kind of winner-take-all environment: The largest companies are benefiting from their investments in technology, including in generative AI (GenAI), automation and machine learning. They are retaining strong margins and showing the value of innovation investments.
PwC research found that since 2019 the top 25 companies have been responsible for at least one-fourth of all growth in revenue, profit, spending and investment among US-listed companies; the top 50 companies have been responsible for almost one-third of growth in several of these metrics. But many smaller companies’ margins are shrinking, particularly as some consumers trade down to lower-cost alternatives.
These companies thus need to boost earnings at a time when the higher cost of capital has raised hurdle rates for deals. We’ve seen companies compensate by using divestitures to clean up balance sheets and raise capital to reinvest in better strategic fits. The market is rewarding sellers focused on balance sheets: Since the beginning of 2023, the median six-month post-announcement excess return for these sellers was 9.5%, according to a PwC analysis of data from Capital IQ.
Despite the potential benefits, sales and spin-offs of business units are well below their average rate of activity over the last decade. In our experience, companies often hold on to non-core businesses too long due to biases, including management’s overconfidence in its ability to improve performance. According to a PwC study, 57% of respondents who tried to fix a business unit said the unit’s value deteriorated or stagnated.
Corporates in certain industries also are seeing trillions in capital flows from the government, particularly in areas such as infrastructure and defense. As a result, we believe industrial products companies are among those to watch in M&A going forward.
Private equity (PE) firms have a different challenge related to interest rates. During the 2010s and the post-pandemic recovery, many PE sponsors benefited from a rising tide that lifted most portfolio company boats. Exits were often plentiful and profitable. Higher interest rates stemmed that tide. Exits have plummeted over the past few years, leading to a record holding period of around 6½ years. As of early May, PE firms are sitting on more than $1 trillion in dry powder, which is just shy of the previous record high, according to Preqin. Some firms have turned to net asset value loans to help return money to investors.
In our view, PE firms need to focus on diligence and operational excellence in order to acquire undervalued targets — such as mismanaged businesses hidden in large corporates — and improve their efficiency. Leading firms are already focusing on strong fundamentals instead of being seduced by the tantalizing growth projections of yesteryear. To reduce volatility, many of the deals we’re seeing are highly structured, including requests for preferred equity or by providing private credit instead of buying a company outright.
In public markets, the most successful IPOs in 2024 have come from mature companies with strong brand recognition. We continue to advise private companies to focus on operating like a public company in advance of any IPO, with an emphasis on strong top line growth, profitability or a path to profitability, and positive cash flow metrics. Any additional rate cuts would likely serve as a strong tail wind for capital markets activity.
Business imperatives don’t suddenly disappear because interest rates remain higher than the market would like. Dealmakers are starting to get off the sidelines as they accept that the ultralow rates that shaped the economy during much of the past 15 years won’t be returning any time soon. While rates may drop later this year, the Fed’s current posture suggests any easing would be moderate. Proactive companies have already jumped back in the game to strike an eye-catching number of megadeals. PE firms, which still have mountains of dry powder, are identifying targets in which they can improve operational excellence at speed. While expanding geopolitical conflicts or an unexpected economic U-turn could still upend dealmaking sentiment, cautious optimism is slowly returning to the M&A market.
The US 2024 Deals midyear outlook includes a closer look at individual industries in our industry reports. Below, we spotlight three industries that will be especially worth watching in the remainder of 2024.
S&P Global Market Intelligence Disclaimer Notice
Reproduction of any information, data or material, including ratings (“Content”) in any form is prohibited except with the prior written permission of the relevant party. Such party, its affiliates and suppliers (“Content Providers”) do not guarantee the accuracy, adequacy, completeness, timeliness or availability of any Content and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such Content. In no event shall Content Providers be liable for any damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with any use of the Content. A reference to a particular investment or security, a rating or any observation concerning an investment that is part of the Content is not a recommendation to buy, sell or hold such investment or security, does not address the suitability of an investment or security and should not be relied on as investment advice. Credit ratings are statements of opinions and are not statements of fact.