Over the past two years, the global M&A market has seen a marked slowdown: higher interest rates, rising inflation, and the Russia-Ukraine war have all had an impact worldwide.
At first sight, Portugal seems to have bucked the trend, with 838 recorded deals in 2023 to date, already 1% up on 2022. But when we look more closely at the figures, we can see that, compared with 2021, deal value has dropped by 39.67% and there were 8.32% fewer deals.
In November 2023, the M&A Community hosted an online event in collaboration with iDeals, where a selection of distinguished professionals shared their perspectives and strategies for the Portuguese M&A market.
The event was chaired by Narciso Melo, Head of Corporate Finance at Banco Finantia.
How has the M&A market evolved in 2023?
We’re actually having a record year, with 5 deals already closed, one due before the end of the year, plus an exit deal. But most of these were already in the pipeline from last year; there were very few new opportunities in the first half of this year, though things have really picked up since September. We generally source our deals on a proprietary basis, dealing with business owners directly, so we are less affected by market cycles and this is probably why we’re doing so well this year.
It’s been a record year for us too, with 10 transactions and new platforms and addons. We haven’t really seen any slowdown in 2023 and our pipeline volume is very similar to last year’s. Generally, there are still lots of opportunities in small to mid-market deals and the market is very liquid. But then we do mainly focus on technology and healthcare, sectors that have not really been impacted by higher interest rates.
We’ve had some great deals this year, just not in Iberia. We couldn’t find any new biomass projects that met our criteria so we focused on distribution/self-consumption and we closed 3-4 small deals across Europe. We did announce 2 big deals, plus 2 asset sales, all in Poland. Interest rates are a big issue for us: not in eastern Europe where projects are scarce and demand is high, but definitely in Iberia where the excess supply of renewables and problems with grid connections meant that higher interest rates definitely affected demand, though asset value is still high.
It’s been a very busy year for us too. We didn’t experience a slowdown either, though the summer was a little quieter than usual. Considering our pipeline to year end, I think 2023 will be our best year ever. However, if you look at some of the market research data, 2023 was more resilient than might have been expected in the circumstances. After a really strong start, the number of deals has slowed, so I’m hoping the fourth quarter will be better, even though globally, there’s been a reduction in deal value because there is less appetite for big ticket transactions. So I think in the end 2023 will be better than 2022 but probably still not as good as 2021.
What were the positives and the negatives of the deals you’ve handled this year?
Most of our deals were small, so quite time-consuming, especially where we wanted to maintain an ongoing relationship with the partners. But the European Commission wants renewables to account for 25 to 30% of electricity consumption by 2030 so there is massive demand, meaning higher interest rates were not much of an issue for us.
But when it comes to the big deals, interest rates do dramatically affect the costs. If we look at the figures, we’re talking about 5.5-6% higher costs for debt in Europe and in the U.S. Investors then want a much higher return than previously, and we’re seeing a huge gap between price and value. This really matters for energy: prices this year were less than the war-related peaks of 2022, and these lower prices have led to a cooling in renewable assets, especially solar, even though energy prices are expected to remain high compared with 2021.
It does depend on which side of the transaction you’re advising and the strategy you use, but I would say that deals are definitely taking longer to complete, continuing the trend we saw during the pandemic of more thorough due diligence, and more complex and longer negotiations.
We are thriving in the smaller deal market because it’s easier to finance a smaller transaction and less challenging in terms of regulatory approvals.
I also think we are transitioning to a buyer’s market. For instance, documentation is becoming more buyer-friendly and we’re no longer seeing the big auctions with a lot of buyers under pressure to be fast and aggressive. Smaller deals give investors more time to assess the deal before making any decisions.
There is still a mismatch of expectations between buyers and sellers. My colleagues at CMSs tell me that valuations in Europe have stabilized but this is not the case in Portugal. We’re also seeing that investors are more cautious when they initiate M&A than they used to be, though they can also be more confident that if they need an exit within the next few years it should be easier than it is at the moment.
And finally, insurance companies are now offering products at reasonable premiums that are more appropriate for small deals. This helps build bridges between sellers and buyers when buyers are looking for assurances that sellers can’t or won’t provide.
What were the main challenges and opportunities in relation to your recent deals?
In Iberia there was a huge curtailment risk, worse than elsewhere in Europe. But Europe is transitioning from its dependence on Russian gas in favor of renewables, which is boosting the new trend towards distributed generation, and bigger investors are now taking an interest. It’s definitely a seller’s market but you do have to understand the difference between price and value and take a long-term approach to this type of asset.
I would say there have been two main challenges. Unbalanced supply and demand post-Covid has led to rapid fluctuations in price and in many cases a spike in demand. So some companies have done pretty well over the past two years which is attractive to investors, even if the average margins don’t look that great. The other main issue we’ve found is that post-Covid valuations are a little bit inflated. But on the positive side I would say that we have seen very pretty good dynamics in terms of the willingness of the sellers to do deals.
Taking the longer view, one really encouraging sign for the Portuguese market, especially in the lower mid-market, is the improved reputation of private equity among business owners.
On the negative side, it’s not so much the increased costs of financing, more about the lack of financing options. So in Portugal we are almost exclusively reliant on commercial banks, as we still don’t have a private debt fund and this is a major disadvantage compared with Spain and other mature markets.
The positive news from the financial sector is the quality of assets now available. Portfolios have been reshaped and businesses are being fine-tuned. There is also more willingness to consider other options when companies have no obvious succession route. Owners are becoming more sophisticated and there are new employers, new funds coming in, and big plans for recovery and resilience.
We’ve also been trying to promote innovative products with some funding facilities for PE. I think people are doing more bilateral deals and while I’m more optimistic than Luis, it is clear that deals are taking longer, and evaluations are much stickier.
Are you seeing a trend for more fairness and retention payments?
Yes, though I can’t give you a percentage. It’s now very common to retain payments against unseen contingencies.
Yes, but I wouldn’t say it’s common. We generally try to cover the downsides and the risks with different payment instructors, and also by using legal tools such as escrow accounts.
So do we. You can always get creative with the instruments that are available. But keep it simple.
What are your expectations for 2024? Do you see any big deals happening?
I think, for 2024, at least in my industry, the big issue is that renewables require a lot of capital which means a lot of debt. So our most important consideration at the moment is clearly interest rates. At the last ECB meeting it was suggested these might have peaked and this has affected share price valuations which should increase the appetite for renewables. But inflation is still an issue and we don’t know if interest rates have really plateaued so we are still seeing share prices going down.
One other concern, maybe a bit of a wildcard, is geopolitical instability. We saw the Ukrainian war have a huge impact on the energy markets and in people’s minds, and now there is the Israel/Gaza conflict.
But clearly the biggest issue for everyone in the energy business is interest rates and if they do go down in the second part of this year that would lead to a significant increase in transactions.
Based on our current pipeline I expect things to get better in 2024.
I am anticipating an increased appetite for illiquid assets among large and institutional investors, leading to more competition. Plus more bilaterals, as you mentioned, and more sophisticated approaches to companies, and especially to entrepreneurs, which should help develop the Iberian M&A market. So we are optimistic that next year will be very busy, subject to any major geopolitical issues.
We see ESG being an important differentiator. Investors are concerned about it and the CMS’s latest annual report found 85% of the respondents considered that increased ESG regulation would have a big impact on M&A activity.
As to 2024, I’m an optimist. I think the President approving a state budget was a good sign, even if it does get amended by the next government. Next year’s elections could be tricky because if we don’t end up with a stable government that could have a negative impact on M&A activity, with some investors putting their investment decisions on hold. We’ve just published a survey which concluded that Iberia was one of the regions that should see an increase in M&A. And if Portugal continues to be perceived abroad as an economy that is doing well because we have a budget surplus and public spending is under control, I think that could be important in attracting new investment for the country.
Which 3 sectors would you would bet on for 2024?
This year started well for TMT, energy (especially renewables), and real estate. But compared with 2022, there’s been an increase in TMT deals and a decrease in energy and real estate. So for 2024 I’m betting on TMT and energy.
I’d say anything interest rate driven, like energy and life infrastructures, will probably have a good year. I could elaborate on other sectors but we do still have this geopolitical risk so I’ll leave it there.
The first one I would list is energy efficiency. Not only in generation, but also in industrial services, technical services etc. Everything related to energy efficiency. Healthcare in general would be my second choice.
Definitely healthcare. But for me, inflation is the big question and how long it will take to come down. We need to be very careful with businesses that have high exposure to inflation.
I would add niche industries. There are some very good companies in this space with their own position and business model.
The picture for 2024
Overall there is a degree of optimism about Portugal’s M&A market going forward. There are various concerns, of which the most urgent is high interest rates, though inflation, national politics and global geopolitical uncertainties are also in many experts’ minds.
However, Portugal is viewed as a stable and fiscally responsible democracy, and while available funding mechanisms may not be as varied as in other countries, and there is still some mismatch between costs and perceived values, there are encouraging signs that company owners and would-be investors alike are becoming more sophisticated. Certainly the prospects for the small to mid-market transactions are very promising, with larger deals maybe more contingent on falling interest rates.