A bumpy and grumpy ride

While we knew that the historically high deal volumes of 2021 and 2022 wouldsubside, it was the changing nature of the deal activity in 2023 that surprised us themost. While there has been a steady flow of transaction activity throughout the year (which is demonstrably down on the last two years), there has also been a surprising amount of bumpiness in the conduct and completion of these deals. Due diligence has taken longer (in some cases months). Negotiations have often been tense or difficult. Processes have faltered, gone on hold or even combusted entirely in respect of a significant portion of the deals we have been involved in. Overall deal timeframes have blown out considerably as a result. In short, deal-making in 2023 has been hard work! But what has caused of all this turbulence?

• Buyers (in particular overseas buyers) are more cautious. Boards and investment committees are more thorough and want to see more downside protection built into deals.
• There is significant disconnect between buyer and seller expectations. The swing from a seller friendly environment to a buyer friendly one has been sudden and ferocious. It’s taken most of the year to find common ground between the two camps.
• Interest rates and inflation have remained stubbornly high. This has added to the buyer/seller expectation gap.

Many have speculated that the impending New Zealand election was partially responsible for the slow down, as buyers waited to see what flavour of government would emerge. Our view is that the election did not have a significant impact. While the uncertainty caused many businesses to express caution, our experience is that buyers did not factor the election into their decision making. Domestic buyers appeared more focused on the macroeconomic issues referred to above. In our opinion, international buyers are barely aware of the differences in policy between right and left in New Zealand. Compared to other parts of the world, the distinction does not seem that great.

Global trends reflected here

The New Zealand experience has reflected global trends in 2023 where there has been a dramatic drop in overall M&A activity. The international economic climate has been strange by any standards as dealmakers face conflicting signals such as rising interest rates but an inverted bond market and accelerated redundancies alongside continuing competition for talent. Inflation has slowed, but still persists in many jurisdictions. The expected recession never actually arrived, but that didn’t stop executives from focusing on cost reduction and defensive strategies. The result of these mixed signals has been commentators noting:

• That buyers still want to get deals done. This is consistent with our soundings here in New Zealand, with PE in particular acknowledging that turbulent times create great opportunities.
• Despite that, deals have struggled to get across the line, perhaps because of the continuing expectation gap. One commentator points out the persisting sentiment that no one wants to sell at the perceived bottom of the cycle.
• Importantly, that no one thinks that the era of M&A has come to an end, with the prevailing view being that this has just been a pause.

It wasn’t all bad news though, with a number of high profile deals being transacted in 2023. Examples include Entain’s selection as the preferred partner to TAB NZ for a 25-year strategic arrangement, Fonterra on the sale of its dairy subsidiary Soprole, Pinnacle Corporation and the Specialised Group’s sale to Qube Holdings, Global Forest Partners sale of a major forest to Ontario Teachers Pension Plan, and Australasian bus transport operator, Kinetic’s, major financing deal with the New Zealand Green Investment Fund to further decarbonise the country’s public transport network.

The banks remained patient throughout 2023 but there is still a gloomy outlook for many businesses that have been affected by the post- COVID macroeconomic conditions.

Still no wave of distress

With the exception of some isolated deals falling out of situations where the banks had no choice but to pull the trigger, the good news was that we have not yet seen the tidal wave of distressed M&A that has been much predicted. The banks remained patient throughout 2023, but there is still a gloomy outlook for many businesses that have been affected by the post-COVID macroeconomic conditions. Advisers continue to gear up for distressed deal making and increased bank activity in December and January suggests that they will be busy in 2024. Buying these kinds of businesses is not for the faint hearted. Distressed M&A is a technical and specialist area. There are traps and fishhooks for the uninitiated. The key message is to get expert advice to avoid a nasty surprise down the line.

Takeovers on the rise

With equity market valuations in freefall in 2023, take-private activity significantly increased throughout the year and we are currently involved in a number of these transactions, including advising Volpara Health Technologies (an AI-powered health technology company) on its Scheme of Arrangement to be acquired by South Korea-based, Lunit.

2023 firmly established the use of Schemes of Arrangement as the preferred structure for taking businesses private. The knockon effect of this is that we see much less hostile activity on this side of the Tasman than our Australian counterparts (because Schemes require full board cooperation to be successful). This has seen boards being willing to knock back deals where they feel the target business has been undervalued. 

Private equity is warming up

We have seen a slow build up of private equity activity throughout the year. A number of New Zealand Private Equity and Venture Capital funds raised money in 2022 and 2023 so there continues to be capital that is in need of a home. We assisted Pencarrow Private Equity to acquire agricultural consumables business Shoof and NZ Equity Partners as they continue to build out the CMSL Business through acquisitions. We advised Next Capital on the acquisition of a majority stake in Jucy Group, and Waterman Capital on its agreement to sell the Fusion5 business to Australian private equity firm BGH Capital. We also helped new fund, World’s Edge, to acquire stakes in KarmaCola, and Clean Collective. Activity has built throughout 2023 as sellers and the funds have slowly moved to the middle ground on pricing expectations. PE has been keen to acquire the right businesses for a reasonable price. They have the same levels of caution as trade buyers, but they are more nimble and more willing to execute deals once the decision to invest has been made. 

International buyers are still interested in New Zealand

We saw a number of large, global players invest in New Zealand in 2023 – Entain, Dai-ichi Life, Bertelsmann, Pinnacle Corporation, Ontario Teachers Pension Plan, and Inchcape acquired New Zealand assets in deals we were involved with. International investors still see New Zealand as an attractive place to place capital. Our world-beating technology, healthcare and financial services sectors remain attractive, and we continue to produce privately held companies that are of sufficient scale to interest them.

Deal terms have shifted

It is clear that we are now in a buyers’ market. Valuations have come under greater scrutiny with downside protection being baked into many deals that we advised on in 2023. We have seen regular use of earnouts to bridge pricing expectations – which essentially challenge sellers to deliver on forecasts to achieve desired prices. We have also seen greater use of material adverse change (MAC) clauses which reflect buyer concern in unpredictable times. Buyers are more focused than ever on downside protections, with fulsome warranty and indemnity regimes being required, often backed by warranty and indemnity insurance. None of these trends are new. They are simply part of a cycle which currently leans towards buyers’ interests.

The year ahead

Our view is that deal activity will strengthen in 2024, as buyers come to terms with the new normal and sellers begin to re-set their expectations. We expect PE to be very active in 2024 and are already engaged on a number of live transactions for our PE clients. International buyers will continue to arrive at our shores as more world class private businesses come to the market. In the public markets, take private activity will continue to build in 2024.

But we expect that deal terms will continue to favour buyers, with downside protection continuing to be a focus. Buyers will want comprehensive warranty and indemnity packages to underpin their offers. They will also want to see a way out if circumstances deteriorate and so we expect MACs to remain prevalent. Earn-out mechanisms will continue to be used to bridge pricing expectations.

Distressed M&A activity will likely tick up this year. The banks have been patient but can only hang on for so long and recent increased activity suggests that patience may be coming to an end. We think we will see consolidation in sectors such as construction, retail, food and beverage and hospitality as the big players mop up their smaller competitors whose lack of scale has proved too hard to manage in the headwinds.

We hope there will be continued interest in direct investing from our Kiwisaver providers. In recent years, some existing firms (such as Simplicity, Booster and Milford Asset Management) have dipped their toes in this market. 

Buyer remorse

After two frantic years of materially increased activity, it is perhaps obvious to note that we are already seeing an increase in post-transaction claims. With competitive, time-pressured processes and high prices, comes buyer remorse, and we are already acting on numerous warranty and indemnity claims and post-completion adjustment and price mechanism disputes. We expect this trend to continue throughout the year. Pricing mechanisms in particular, are complex in nature and are played out at the intersection of accounting concepts and legal drafting. It is vital to make sure that the right experts are involved in the construction of these mechanisms. If they are not, disputes will follow and we are already seeing that play out. 

The new government has settled nerves

After 40 days of speculation, the new coalition Government was finally announced in late November. One consequence of the historic three way tie-up of National, ACT and NZ First, is a well telegraphed and detailed policy schedule. This has ‘calmed the horses’ for businesses who can now go and execute their strategies with some confidence. While we did not think that the pre-election uncertainty prevented dealmaking in 2023, we do think that this post-election certainty will create a bigger stock of marketable businesses with a clear strategy and some certainty about the environment that they will be operating in. We think this will translate to more dealmaking in general terms, in particular by trade buyers who find it easier to sit out of the market when conditions do not suit them.

The rise of AI

Global commentators are identifying the explosive arrival of AI as a key trend for 2024. Clearly, companies with an AI focus or developing AI technology are, and will continue to be, hot property for dealmakers.

We think this will be generally reflected in New Zealand with a continued focus on our ever-impressive technology sector. New Zealand technology businesses will continue to be attractive to international investors for the foreseeable future. Kiwi ingenuity is internationally recognised and we already have clients buying and selling in this space. 

AI has been much talked about as a tool for use in the M&A process. Our experience of legal AI tools in the M&A context is that they have some way to go before becoming truly useful. Due diligence tools currently consume more time than they save and often result in unusable work product. However, the rate of AI development means that we fully expect that a workable solution will be available in short order. So watch this space.

However, commentators also report that AI is already being used extensively by dealmakers to source deals, build use cases and models, analyse key metrics and develop Information memorandums. We expect to see more visible use of AI in these situations throughout the year.

Sustainable finance

We hope to see more use of sustainable finance products in M&A funding in 2024 as global use of these products ticks up. The New Zealand experience to date has seen these structures put into investments post-acquisition (with more normal lending used to fund the actual deal). 

Hot sectors

As in previous years, the sectors which drove the most activity in 2023 were technology, healthcare and financial services. We expect this trend to continue. 

New Zealand continues to be renowned for its hi-tech leaders and more and more international investors are appearing on our shores in search of the technology that our No 8 wire DNA produces. With more and more capital being funnelled into the growing New Zealand venture capital industry, we expect this to be a long-term trend.

In 2023, we assisted ANZ to acquire Wellington-based data analytics business, DOT Loves Data Limited. Healthcare remains a globally popular investment class and New Zealand continues to pump out world class healthcare businesses. We advised Volpara Health Technologies, on its sale (by scheme of arrangement) to Lunit, and are currently assisting a PE client on its exit from a large New Zealand healthcare provider.

There has been a lot of activity in the financial services space, including the above mentioned DOT Loves Data acquisition. We see this continuing in 2024, with several financial services deals already being talked about in the market.

Strap in

With so much uncertainty continuing to surround the global economy, we think that this year will be another rocky one. There is money to invest, and deals will get done. But the year will be a bumpy one so strap in and enjoy the ride!

Read the M&A Forecast 2024