Recession, a breeding ground for M&A opportunities

Property and construction sectors are likely to see most M&A deals in 2023 


DEAL practitioners are prepared to take advantage of the economic downturn and are awaiting a recession to get the best price in merger and acquisition (M&A) deals. 

Although dealmakers will pressure targets for the lowest price possible during the acquisition process, the valuation will not be too far off from the market pricing and valuations. 

A finance analyst in the stock broking industry said unless the company being acquired is in deep trouble, its valuations will be similar to market pricing. 

“I do not think the valuations will be too conservative, I think it will be at a good range in market valuations. 

“The valuation will not be too far off because they also have to take care of shareholders and minority shareholders’ interests,” the analyst told The Malaysian Reserve (TMR). 

The Melaka-based analyst said opportunities abound for M&A during the downturn and companies can take advantage of it by beefing up their money or gearing activities. 

“The acquirer has to have a strong balance sheet, as long as they have cash they can gear up which also means they are low-gearing and they can issue their shares; it could be to their advantage during this downturn. 

“While for the target, if they want to offload their shares or companies, they need a track record. I think those that have a good track record or those without track record can be competitive on pricing,” said the finance analyst who requested anonymity. 

However, he was unsure which industries will fetch the highest valuations. 

Manufacturing to See Some Megadeals

Megadeals are expected to occur within the manufacturing sector. 

The analyst said in the past few years, plastic manufacturers were absorbed in industry deals, thus, the emergence of M&A deals in the glove industry. 

“In 2020 and 2021, many companies ventured into the glove manufacturing business, now they might be suffering because of poor average selling prices and declining sales. 

“The industry is in a gloomy state. For glove manufacturers who started the business during the pandemic, they have the opportunity to be absorbed by bigger players,” he said. 

Meanwhile, the property and the construction industries are likely to see most M&A deals in 2023, he said, and the factors defining their valuations are capability and earlier management style. 

“If a company has been good at management, I believe the price will be higher, but for those in a dire state, their pricing will be much lower. 

“Smaller-sized property and construction companies will most likely be acquired by bigger industry players. Labour and cashflow issues might be one of the key factors for M&A this year onwards,” he said. 

On the other hand, Ian Yoong Kah Yin, who is a high-net-worth investor and former investment banker said deals could emerge in the banking and packaging sectors. 

“It is likely that Bank Negara Malaysia (BNM) will encourage small domestic banks to merge with larger domestic banks to shore up balance sheets. The banking sector as a whole is sound. 

“Malaysian banks’ Tier-1 capital structure is mainly equity-based. Malaysian banks’ average Common Equity Tier 1 (CET1) ratio is a strong 14.5%. 

“Granted there is no necessity at this juncture to raise additional capital, M&A in the banking sector to fortify balance sheets will further inspire confidence among depositors,” Yoong told TMR. 

He said the passing of Public Bank Bhd’s founder and chairman emeritus, director and advisor Tan Sri Teh Hong Piow could be a catalyst for heightened M&A activity in the banking sector. 

Yoong cited Section 92 of the Financial Service Act which prohibits individuals from owning more than 10% of shares in a finan- cial institution as paving the way for a corporate exercise. 

He said the most popular reason for major shareholders selling their controlling stake was a lack of successors from their families or their heirs having little interest in managing their businesses. 

Will the banking crisis in the US and Credit Suisse’s collapse affect valuations and M&A activities here? 

The analyst said the banking crisis in the West would not affect Malaysia as the country does not have a similar equation to what happened to the banking industry in the US. 

“That is why it will not influence valuations and M&A activities here. There should not be any correlation for now in Malaysia,” Yoong said. 

Contrary to the above, he said, global M&A activity was impaired by high-interest rates. 

“US interest rates, as an indication of global interest rates, have accelerated from near-zero to between 4.5% and 5.25% in 12 months,” TMR was told. 

M&A Opportunities in Times of Turbulence 

Management consulting firm Bain & Co’s research on M&A in times of turbulence validates how M&A was part of the winning response in previous down cycles. 

“We examined the acquisition activity of 2,845 companies from around the world during the global financial crisis and economic downturn in 2008 and 2009. 

“We found that in the long run, companies that executed at least one deal per year during the economic downturn earned 120 basis points more in total shareholder returns than companies that were inactive in M&A,” the Global M&A Report 2023 read. 

In 2008 and 2009, numerous industry-defining deals positioned acquirers for faster, more profitable growth out of the downturn, it further said. 

“In the current cycle, too, companies with a strong market position, cash on hand, and debt capacity will have the upper hand to execute transactions. 

“These companies should be confirming their strategic M&A roadmaps, revisiting deal models and laying the groundwork to move fast on desirable targets (large and small). Nearly every sector has a few cash-rich market leaders. 

“Energy, industrials and technology stand out as sectors in which the top players have solid balance sheets to make bold moves. Strong performing companies with an experienced track record of M&A will be the best positioned to do the largest transformational deals,” it added. 

Advice for Investors 

Investors can look out for illiquid targets that have a lot of value with decent management and a very strong share-holding structure. 

The analyst said an illiquid business had huge unlocked value which the owner could not unlock. 

“Investors can look for companies with illiquid assets but they have to wait for the right time for a return. Some of these companies have to wait for another 10 years before their M&A deals come in. 

“Investors can consider companies from illiquid to suddenly becoming actively traded. These companies have earnings but with low price-to-book value (P/B),” the finance analyst said. 

Meanwhile, Yoong said investors should focus on net cashflow rather than price-earnings ratio and P/B valuations. 

“Cashflow in businesses is equivalent to blood circulation in the human body. Many listed companies are trading at steep discounts to book value but with very weak net cash, the prospects of survival are low,” he said. 

  • This article first appeared in The Malaysian Reserve weekly print edition