Like many sectors, last year was not a great one for M&A in the industrials sector. Following on from bumper activity over the previous two years, the question is – with geopolitical and economic turmoil – was this a trend or just a blip?

PwC’s recently published Global M&A Trends in Industrial Manufacturing comes down on the ‘blip’ side of the argument. Recognising that 2023, despite the fall in activity, still contained M&A at the level of the late 2010s, the report noted that “market challenges such as inflation and higher interest rates are likely to ease, along with greater flexibility in dealmaking” as tech advances in AI and automation provide a strategic area of focus for M&A opportunities. 

A combination of private equity dry powder and alternative structuring approaches would help companies “engage in M&A to respond to disruptive forces or to transform and reposition themselves as disruptors through acquisitions of start-ups or other players”, it said.

Deloitte M&A industrials partner, Thomas Frankum, says the 2023 decrease in M&A volumes, which was most acutely experienced in the large-scale end of the market, was due to macroeconomic, geopolitical, regulatory and financing challenges, as well as reduced private equity activity.

“We have been operating in a challenging environment with significant uncertainty, where financing costs have changed rapidly over a short period of time. This has impacted both deal confidence and affordability parameters, which has resulted in a subsequent drop off in M&A activity.” Any future reductions in interest rates will undoubtedly be helpful, thinks Frankum, “but dealmakers in general are adjusting to the ‘new normal’ when it comes to the cost of financing deals.

“I think a number of corporates are under increased pressure and scrutiny as they tend to be during downturns,” he adds. “Management teams ask themselves whether their operations are core and fit for purpose? Are they future-proofed? Are they getting the right performance from their assets? And, frankly, there’s always the decision about whether they’d be better off selling a business, recycling the capital, and using that money elsewhere in their group.”

If non-core divestments are a feature of all sectors, the specifics of environmental, social and governance (ESG) and future-proofing in industrials means there will potentially be more recycling of assets in this space. Bain & Co’s 2023 report on Diversified Industrials identified ‘deals that advance environmental and social agendas’ as a driver for both corporate strategy and M&A, and 2024 is only going to see that trend intensifying, with Frankum saying: “The targets corporates are acquiring are assessed very carefully as to whether they help them achieve their sustainability targets.”

Every seller needs a buyer, of course, and if these ‘assets’ are an issue for their corporate owners, will there be a market to buy them? “We are seeing some businesses, for example in the energy industry, where there is a second tier of buyers who are willing to acquire assets at a price, recognising that there is sometimes significant residual value that can be exploited and monetised by those who are able to operate the assets efficiently and effectively,” says Frankum.

“As an example, you see energy majors, which are looking to reduce their carbon footprints and divest some of their legacy hydrocarbon production assets, divesting assets to next-tier players who are willing to take on and operate more mature assets.” 

Greening industry

For Darren Jukes, a PwC corporate finance partner focused on industrials, “Those organisations looking to reshape portfolios and move towards energy transition or decarbonisation, looking for some of those new growth sectors, are trying to respond to investor pressure that asks: ‘What is your clean energy position? What’s your strategy for capitalising on the net-zero agenda?’ If investors can’t see the relevance of some products, services or technologies in that new world, the urge for divestment increases.

“Some of the traditional hydrocarbon sector is looking to redeploy capital into greener, cleaner tech,” he adds. “But the other point is that some organisations have recognised there are pockets of their business that are evolving, with new technologies or market sectors where perhaps they feel they don’t have the level of expertise or the right resources to actually enable that business to grow, develop and flourish. In those situations, what they’re doing is divesting themselves of those businesses sometimes in whole or part, to allow alternative investors to come in and actually capitalise on the opportunity before the opportunity’s gone.”

The first scenario (the ‘greening’) is, according to Jukes, leading to traditional M&A, while the second dynamic leads to “partnerships, joint ventures and other forms of divesting, as organisations still recognise the value and the opportunity that does exist with the asset and would like to stay involved in some way as that business has proved itself”.

Jukes’s colleague, Cara Haffey, PwC’s UK manufacturing and automotive lead, says: “The questions for industrials are: What’s the opportunity for us in the green market? What skills do our businesses already have that are relevant? Can others be repurposed? I think there are certainly private equity funds that are seeing that as an opportunity,” she adds, “because we will still need hydrocarbon businesses for a while yet. So can you gather those together and get the synergy from that?”

Jukes says he thinks the traditional markets of Germany, Switzerland, and the DACH region will continue to be attractive propositions: “You still see opportunity for some of the US groups investing into those areas, as well as other European players and some of the industrial private equity funds in Europe. I think we’ve probably seen a bit of a decline in Asian geographies investing into those markets. Historically they were very active in those spaces, but their appetite has diminished a little bit over the last few years.”

While a typical private equity play would drive efficiencies, build profit and sell on to a corporate at the end of their horizon, there are also large European family offices focused on the industrials sector that could, according to Jukes, become the ultimate acquirers, and private equity will also be looking to pivot their businesses to be more relevant to those acquirers in three to five years’ time than they are today. “It could either be an optimisation or an evolution strategy,” says Jukes.

“The play theoretically could be a dividend play for some of the players who don’t have to see an exit within three to five years,” says Haffey. “But actually, it’ll be interesting to see how that develops – which businesses make the right acquisitions on technology, because a lot of these businesses find it very difficult to bring in new technology and get it working for them.”

However, Jukes cautions: “If you look at the industrials market, multiples are probably down from where they were 18 months to two years ago, and that’s regardless of whether you are new energy, green or dirty – cost pressures have reduced margins, and interest rates have increased the cost of borrowing and therefore the cost of the acquisitions if they’re being made.”

Bucking that trend, Jukes says, is “autonomy or robotics in all shapes and forms” and “anything IoT-related [internet of things] around sensors, measurement and data capture. They’re still attracting premium valuations.” Haffey adds that “AI and anything around speeding up processes and using your engineering resource well” are hot areas for deals or investment.

Quality matters

“I think there’s a cautiousness and real focus on quality at the moment,” says Frankum, surveying the whole market. “We saw two years ago that, in a buoyant M&A market, sellers were able to get a multitude of assets away for decent prices. This was helped by high market confidence, pressure to deploy capital and relatively cheap debt, driving competition for assets. 

“What you’re seeing now is that while there’s still competition for assets, it is focused on the really high-performing assets that have the right ESG profile, sit in the right part of the market, and are exposed to the right macroeconomic drivers that investors are looking for. The question for 2024 is how many of this sort of asset will be on the block.”