Hello everyone, and thank you for joining us for today's webinar, The 2024 M&A Outlook for the Middle Market. This webinar is presented to you in partnership with Citizens Capital Markets & Advisory. You can use the Q&A feature at the bottom of your Zoom and LinkedIn toolbars to ask questions throughout the presentation. These questions will be monitored, and the panelists will answer as many as possible during or after today's presentation. This webinar is being recorded and will be posted on both Citizens and ACG's website, along with the slides from today's presentation. Thank you again for joining us. Now I'm going to turn it over to Danielle Fugazy, financial journalist and moderator.
Thanks, Holly. Good afternoon, everyone, and thank you for joining us. As Holly said, I'm Danielle Fugazy, a contributing editor with ACG. I will be your host and moderator for the next hour as we talk through, I think, what's really become one of the most anticipated reports of the new year, Citizens 2024 M&A Outlook Report. For anyone that doesn't know, Citizens Capital Markets & Advisory is really a rapidly growing investment bank that offers expertise, sector expertise, and a full suite of coverage from insight through execution, so I'm really excited to see what you guys have in store for us today. This is their 13th annual M&A Outlook, so, you know, this report is just so important because it really helps the M&A community understand what their peers are thinking about as we head into another year of dealmaking.
And it's certainly been. We've certainly seen some interesting findings. I got a little bit of a sneak peek at the report, and I'm excited to show it to everyone. So as we get started here, I quickly have to flash this disclosure for you guys. Just have to put it up for a second, so bear with me. Okay, so with that, let's turn it over and talk about the agenda for a second. For today's event, we'll cover a variety of topics such as the overall economic predictions, thoughts specific to the 2024 middle market environment, and which factors and considerations will impact activity, M&A activity the most. And then we'll have time for the Q&A, as Holly alluded to. Please chat your questions into the Q&A panel that's on your console, and we'll get to as many of those at the end of the conversation as we can.
With that, I think that the best way for us to move forward is for me to ask my esteemed panelists to please introduce themselves. Dave, Devin, why don't we start with you?
Great. Thank you, Danielle. Pleasure to spend our lunch hour together on this topic. As noted, I'm Dave Dunstan. I'm a managing director in Citizens M&A Group. I run our Industrials practice, and I've spent the last 30 years in M&A, so I've weathered a few different cycles. I've worked with large public companies, private companies, private equity-backed companies, mergers and acquisitions, buy-side, sell-side, capital raising matters, and very much looking forward to the conversation today.
Thanks, Dave. Steve Dyott, why don't we turn it over to you?
Great. Thanks, Danielle. Steve Dyott here. Similar to Dave, I'm a managing director within Citizens M&A practice. I've been with the platform and predecessor organization now for about 12 years, but I've spent about 15 years in M&A and restructuring world. Specifically, I sit within our Business Services practice and spend the majority of my time within the human capital management space. So as Dave alluded, I work on primarily sell-side transactions, as well as some buy-side work, both with founder-owned clients as well as sponsor-backed organizations.
Thanks, Steve. And last but certainly not least, Devin. Oh, you're on mute, Devin. Oh, we're having, I think, a little bit of a technical difficulty here with Devin's. All right. While Devin is just working that out.
Danielle, can you hear me now? I'm going to try different.
Yes, we hear you perfectly now.
Great. Sorry about that. So Devin Ryan, I'm actually on the equity research side here, Managing Director. My background is 20 years in equity research covering financial services and fintech companies and really studying the capital markets and the M&A market. So I think, you know, really looking forward to this conversation because it's an area that we spend a lot of time on and what the trends are and what the drivers are and something that our clients care a lot about. So looking forward to the conversation, and thanks for having me.
Thank you. So before we get into the results, I'd like to just do a quick recap of your thoughts of 2023. Any takeaways or things that you were thinking about as we ended 2023 and started on a new year? Dave, can I turn it over to you first?
Sure. Happy to. Like to put 2023 behind us from an M&A standpoint. As many on the video conference may know, 2023 was a challenging environment for M&A. The statistics, whether you look at globally, whether you look at domestically, whether you look at private equity or strategic M&A, whether you look at industrials, healthcare, tech, et cetera, were all down 20%-30%. That's following a down year in 2022. So why is that? What was driving that? The M&A market is very oriented toward either certainty or uncertainty, confidence or lack thereof. And we saw a lot of uncertainty in the last few years. We all lived it. We all have been working through it, whether you're a business owner, private equity executive, or service provider. You're working in this environment with uncertainty around interest rates, the economy, a possible recession or soft landing, global conflicts.
These things make valuation, negotiation, due diligence very challenging, and it results in a lot of companies pulling back from the M&A market. And we saw a lot of that in 2022, and it continued in 2023.
Steve, you feeling the same way, or?
Yeah, I think Dave nailed it. Perhaps just to add a comment or two. I mean, I think in terms of what we did see in the market, transactions tend to have longer durations attached to them, just largely for the same reasons that M&A activity overall had declined. I think particularly in segments where there were declines in softness and business performance as well, buyers were using that as an opportunity to elongate the diligence process to get some more data points behind them. So overall, we're looking forward to hopefully a much more active 2024 and particularly seeing some green shoots in terms of overall business performance in some subsectors of the economy that were a little bit softer in 2023. So hopefully those elements combined will result in a little bit more of a normal activity, more akin to what we saw in 2022 and 2021.
Thanks, Steve. And Devin?
Yeah, the only color I would add is really around sponsors, which, you know, are such an important driver of M&A markets. And just to give a couple of stats, you know, sponsor activity last year was down about 40% year over year. Corporates were down from their peak, but were flattish relative to 2022. And so, you know, just gives you that perspective. Sponsors were as slow as they've been since 2013. And if you look at sponsor activity relative to sponsor dry powder, which is a relationship we've always looked at, you know, $2.5 trillion of sponsor dry powder sitting out there. M&A for sponsors is only 34% of that. That's the lowest we have on record tracking back, you know, 30-plus years. Normally that averages around 86%.
So it just gives you the sense that, you know, sponsors were really absent from the market last year. I think we're going to talk about why that was, but also the fact that, you know, sponsors coming back to the market, in our opinion, is very likely. And so that will be a big driver of a recovery as we think about, you know, 2024 into 2025.
Great. Thanks. I think those are really good insights as we move into the report. So, okay, Dave, I just want to give the audience a little bit of context around the report. So can you give us a little bit of background here?
Yeah, absolutely. I've been fortunate to be part of this survey for the last several years. And each year we hire a research and consulting firm to help us with the outreach. And I think this part of it is what makes it most compelling. The outreach is to 400 corporate executives and private equity partners. So we're talking with middle market executives and PE groups who have their finger on the pulse as to what's going on in the M&A market. It's a very educated survey in terms of who we survey. And I think that adds credibility and credence to the results. In this case, and in every year, it's around 400, so it's a good number as well. We get a lot of good feedback there, kind of split between both of those parties.
The results this year, I thought particularly interesting, the momentum and optimism that was clear in the results really stood out relative to the last several years. So you're going to see and hear more about that during the course of the presentation. But again, most important, I think, is the high quality of the respondents and the very educated nature of that group with regard to M&A and related dynamics.
Great. Thanks, Dave. So let's get into our first slide here. Devin, I'm going to be pushing this over to you. I'd like to first start by talking about the slide that people are seeing on the left there. I'd like to understand or give the audience a little bit of color about what the private equity firms and corporate decision makers predicted for the overall economic outlook in 2024, and if you think that this sentiment is accurate, it looks like there's more optimism, as Dave alluded to, which is great considering some of the headwinds we just talked about. Do you think they got this right? Can you take us through that?
I do think they got it right, Danielle, and I think it's actually interesting. If you look at the data, you see that optimism come through and optimism expectations for the economy to improve is obviously up quite a bit from last year, but what you also see is kind of the barbell on the other side at the bottom of the chart, you see that, you know, there's more people that actually think the economy is going to worsen, and I think that really speaks to, you know, what we're seeing in the market right now and talking to clients about. You know, people are feeling better. You know, I think the view of a soft landing has become more of the market's base case scenario, and you see that in market prices and I think in that optimism.
But, you know, we're still dealing with a period of, you know, we'll call it extreme change and coming off of extreme change, particularly in interest rates. And even with expectations for interest rates to stabilize or even move a bit lower, we're still likely to be operating in an environment for the coming years at historically high interest rates. And so you will have to deal with the maturity wall coming in, you know, 2025, 2026, 2027. And so I think that could create some pressure on companies at the bottom of the food chain. And that possibly is getting reflected in this sentiment. But overall, you know, I think that there's a lot of optimism that's been building just in that the market's been able to absorb such change in the backdrop.
And now, a view of where we're starting to stabilize and then you can start to move on with your strategic planning and strategic decisions. So that's what we're seeing. And I think, you know, it's reflected actually quite well in this kind of barbell table here.
Great. Thanks, Devin. So Steve, I want to turn it over to you and point people's attention to the sector breakdowns here. Steve, you want to talk about a few of these sectors for us and what you see here?
Sure. I think as Devin just hit on, we are seeing a lot of optimism really across the board, but it does vary. There is a decent distribution here across some of the subsegments that are presented. Maybe just to hit on two or three of these, maybe we'll call attention to the TMT sector that seems to be really the most optimistic of the group. I think in general, there's a little bit of a mindset that prevails within the tech sector that does skew them somewhat more towards a growth orientation. If you think about it, the tech sector over the last 25 years or so has largely grown unabated with the exception of kind of the 2001 kind of dot-com bubble, the financial crisis. But largely speaking, they've largely been on a very nice growth trajectory.
And that's certainly we've seen that across our Citizens' historical surveys and then others more broadly, but also influencing, I think, the tech optimism. As we all know, there's quite a large backlog of potential IPO candidates that are waiting for the right timing to ultimately kind of launch. And what we saw in Q4 with the run-up of the public markets and then more recently hitting an all-time high with the S&P 500, I think there's kind of a view that valuations are increasing and that's creating some optimism that a window may present itself in the relative near term and is kind of spilling over to that subsegment's view in terms of overall perspectives on the economy in 2024. Maybe to flip over into the ADGS data point here that's relatively lower at 32%.
Again, I think that this one kind of is less a reflection on kind of reduced optimism across that subsegment, but just when you think about kind of defense and federal spending, this segment really just doesn't operate on the same cycle as many of the other subsectors within the economy. They tend to be much longer-term contracts in nature. So overall, these segments have seen a lot of strength. Certainly, defense budget and spending has been increasing with the conflict in Ukraine as well as Israel over the past kind of one to two years, so that still remains relatively strong.
I think what you'd see, you might naturally assume that because it's the lowest kind of cohort that sits within the improved category, that you probably have a fair number of those individuals that are looking at it on the lower end of the spectrum, perhaps contributing to that 22% in the worsened bucket. But in reality, the ADGS market is heavily skewed towards kind of those that sit in the middle and largely expect results to remain the same next year. And then maybe just touching on the business services sector very briefly, it's really falling in the middle of the pack. And I think that's somewhat reflective of the wide dispersion and types of businesses and business models that fall within the business services segment. So certainly, you see kind of businesses that have largely recurring or reoccurring revenue streams.
And therefore, those businesses have performed well over the last year. And that's driving some optimism in terms of expectations for 2024. Whereas you've got other businesses that might be a little bit more project-based in nature or perhaps are in subsegments that have cooled over the last 12 or so months. And they may not quite have the same level of optimism for 2024, but overall strong results across the board.
Thanks, Steve. Dave, do you want to just touch on a little bit on the industrials or anything else in the sector here?
Sure, happy to. And importantly, you know, we're actively in the market with M&A transactions across the industrial landscape, collecting feedback from the private equity buyers, the strategic buyers, our clients. So keeping our finger on the pulse of what's going on. And it's not surprising to see industrials, you know, as one of the more robust responses with regard to improved economy dynamics. And a lot of that's being driven by some pretty significant secular trends. First and foremost, I would highlight reshoring. We saw certainly during COVID and in the few years since that time, a real emphasis around controlling your supply chain, being able to service your customers. And it's brought a lot of activity and emphasis into reshoring and nearshoring environments, which is very positive from an industrial landscape standpoint. We've also seen a significant emphasis around infrastructure spending.
There's bills, there's demands, there's certainly gaps in U.S. and domestic infrastructure. One of those big areas happens to be electrification. There's been a little bit of a slowdown around EV dynamics, but the need for electric vehicle charging stations and other demands, even other demands of alternative energy that require a more robust electrical grid and infrastructure is driving significant investment and opportunity across that space. We're seeing it in other end markets across other trades, HVAC, I mentioned electrical, plumbing, roofing, a number of categories where we're seeing significant momentum and interest. I think the other couple of areas that have also been very positively influenced over the last few years driving industrial activity around data centers, semiconductors, and automation. A big variable is AI, yet to be determined its impact.
Some of those more core secular significant trends have a real impact today, but will have really, we think, a five- to seven-year impact, which will draw investors and opportunity for growth. Certainly not a surprise that participants in the industry see the economy in some upside.
Thanks, Dave. I think we're going to talk about AI a little bit later. It's hard to talk about anything today without talking about AI, but I want to get to our next slide.
Danielle, can I just add one comment there? Because I think Steve hit a great point on TMT. But, you know, if you look at the sectors, I think it's pretty important that you had TMT and healthcare with optimism because those are really the two largest sectors of the economy from an M&A perspective. And so, you know, that's roughly a third or more of M&A every year. And so having those two verticals being constructive. And so, you know, I think Steve hit on some of the reasons why. Those were also two of the sectors that were most negatively impacted by, you know, the Fed pivot and the really abrupt move higher in interest rates. And so with the view that interest rates are potentially stabilizing or even moving lower, I think that's quite constructive for those areas.
And then on top of that, you know, areas within technology as an example, you know, there was the mentality of growth at all costs, which then became, as interest rates were moving higher, you had to get your business into a profitable point or at least have a very credible path to profitability. And so I think that that's happened over the past two years. And so you have these businesses that are in a much better position. And then on top of that, some of the headwinds to both their valuations, but also their business models being interest rates and valuations, you know, have really moved into a better position. So I think that is relevant as we think about kind of the industry drivers and, you know, tech and healthcare being important aspects of probably driving the broader M&A market and psyche into a better place.
Thank you, Devin. All good points. So with that, I am going to move to our next slide, which is engagement in M&A activity in 2024. So let's talk a little bit about the impact of the M&A market specifically. Steve, I'm going to start with you. It looks like there's been a shift in sentiment from unlikely to pursue M&A to a more balanced view. Can you talk a little bit about what that's about?
Yeah, I think you're spot on there. There's definitely been a shift in sentiment largely driven by some of the perspectives we just touched on in terms of people's overall view surrounding the economy. But what you're seeing here is a much more even distribution in terms of that sentiment, really with a one for almost a one for one movement from that not likely to pursue category into the significantly more likely to pursue category. So really great to see that. One thing to really call out here is that, as Dave touched on earlier, we've really been running this survey for 13 years now. And when we look back at some of the results, this particular data point for 2024 with 29% of the respondents indicating that they're significantly more likely to pursue M&A, that's quite a high statistic.
It's higher than what we saw in both 2021 and 2022, and I think most of the participants on this call can relate and recall exactly what we're feeling in the market, particularly in 2021, where there was really a feverish level of M&A activity. So I think that that's particularly telling as it's a great indication that that activity will pick up here, which I think really begs the question when, and that's covered on the right hand of the slide. Kind of clearly about 50% of the respondents indicate that M&A activity will pick up very dramatically in 2024. Interesting to note if you unpack that a little bit further, the majority of the respondents think it's more likely to take place in the second half of 2024 as opposed to the first half.
I think that's particularly interesting when you recall what at least all of us deal professionals were kind of hypothesizing around last year, kind of expecting a wave of deal activity after Memorial Day, which didn't come and pushed to, okay, it's coming after July 4th. It didn't come again. Then it continued on until Labor Day. So I think perhaps there's a little recollection of what we all experienced in 2023 and a bit more conservatism in terms of when this wave might take place in the coming year.
Thank you. Dave, can you just talk a little bit maybe about what we're seeing on that chart on the right-hand side, the graph between the mid-market companies and the PE firms, how that kind of compares and contrasts there?
Yeah, I think it's you can see from the percentages, the PE firms seem a little more bullish about the first or second half of 2024, whereas the mid-market companies are a little more conservative around timing. It's not surprising. PE firms really do have their finger on the pulse with regard to M&A activity. They're very in tune with private companies in terms of their own outreach. They're very active with dialogue with the M&A firms. We're regularly in conversation talking about pipelines and timing. So a little that is their full-time job. They're very active in M&A and I think have maybe a little closer perspective as to the timing of when deals are going to come to market, and they are very aggressive. I mean, there's been two years of downturn in PE activity that has been pretty significant.
So they're very much looking forward to a more robust M&A market. And I think you see some of that in the optimism of the statistics. The only other thing I'd say with the mid-corporate companies, the mid-market companies, you know, while we do have more clarity as we enter this year, they're coming off of a very volatile time. The inflation had been passed on that had driven a fair amount of growth for companies over the last few years. As inflation abates, you really got to start looking at volume and whether you can continue to drive growth in your business at levels that replicate some of the more recent historical growth rates when you don't have price as such an aggressive lever. So, you know, under those circumstances, M&A will become important to them to drive growth as price abates again.
More likely, those are transactions that you engage in later in the year as you get a sense of your own organic volume growth, and you could see that being a 2025, 2026 kind of dynamic in terms of closing and really seeing the impact of that activity, and I believe that that had something to do with a little bit of the misalignment around certain of the statistics.
Okay. Devin, I don't know if you want to add anything to this. I'm eager to get to your next slide here, but.
I think the next slide maybe dovetails nicely with what Dave was just talking about.
Okay, so Devin, I know this is really up your alley. You've been looking at the historical M&A data, and I wanted to just make sure we gave the audience a little bit of this context here, so I'm going to turn it over to you.
Absolutely. So just to be clear, this is not part of the survey, but this is historical global announced M&A data that we look at. And really the point of it is that, you know, when we talk to our clients, it's to remind them that M&A is a secular growth business, but it's also quite cyclical. And so if you look at kind of the chart here, you see that red dotted line, which is kind of that long-term baseline or trend line, but then you see the actual M&A volumes kind of well above it and well below it over time. But the good news is that over time, M&A tends to grow in the upper single digits to low double digits just because all the reasons we're talking about is such an important strategic tool for companies to grow their businesses.
And so as we think about the market today and kind of where we've come from, 2021 was by far a record for announcements. And we all know that that type of environment was probably not normal. And so we went from one extreme in 2021 to a complete other extreme, which you see in kind of the last two dots on the far right of the table, where 2022 and 2023 are well below that historical trend line. If you think about history, it generally takes one to two years from peak to actually trough, which would put us into 2023. So our base case is 2023 was the trough. And then it generally takes one to two years to get back to the baseline.
To just get back to that historical trend line, let alone anything that's called frothy, there needs to be about a 40% increase in announced M&A activity just to get there. You know, our expectation and our base case is that, you know, 2024 is a transition year towards that baseline. And so we think that you probably see a 20% or so increase from the 2023 level and then another roughly 20% getting you into 2025. And so there's a lot of momentum coming off of 2023 trough. And I think it all kind of comes back to the optimism that's building and then the reasons why, you know, companies are thinking about doing M&A today.
But I think this just kind of gives that level set of where the market came from and then where we are today and what getting back to normal will look like.
Thanks, Devin. I want to just take a quick second just to remind people that they can chat their questions into our Q&A panel, and that we'll get to them at the end of the presentation. Okay. So let's move on to our next slide. So I really like this slide, reasons for expected deal flow increase in 2024. Dave, I want to turn it over to you, and I'd like to talk a little bit about these factors and what's influencing potential deal flow and valuation in 2024. So let's start with the deal flow, and then I kind of gave it away. We'll talk about the valuation next.
Yeah, sure. Absolutely. Well, maybe not a surprise given the slide that Devin just shared. There's been a decline in M&A activity for the last two years that suggests a pent-up supply of companies that are looking for opportunity to sell their business and do an M&A transaction. It really follows that trend that Devin just highlighted. So we know there's a lot of private companies as well as companies in PE portfolios that have been looking for some green shoots, looking for more certainty, all the things we've been talking about. That pent-up supply will drive some of that growth that Devin was referring to over the next 12-24 months without question, especially now that we are starting to see opportunity for a soft landing, more clarity on interest rates, et cetera. So that all makes a lot of sense.
I think importantly too, structurally for private equity groups, which, as Devin referred to earlier, are a really big component of middle market M&A. It's really become the fuel that many, many years ago, the public equity markets fueled that smaller, lower middle market growth. That is not the case today. It really is private equity. They have a life, a structure to their funds, usually a 10-year fund, five to seven years to deploy capital. When you lose two years, like we did in 2022 and 2023, they have really a high interest. They're not going to make bad decisions, but they have a high interest in deploying capital, in selling assets, in raising their next fund.
So there are a lot of structural as well as economic factors and sort of a pent-up supply of private companies that really bode well when you look at these sort of top factors for increasing deal flow that resonate. And so more reason to be optimistic as we think about 2024 and 2025 M&A activity.
Thanks, Dave. Steve, I'm going to ask you to sort of cover some of these other factors. We alluded to it before, AI. Also, we have a 2024 election. Can you just talk through some of these other factors for us?
Sure. I think as you just hit on, there's a couple of factors that are appearing as material influencers in our survey results this year that we probably wouldn't have seen a couple of years ago. AI in particular being one of them. Clearly, there's been a lot of excitement and really a fever in the headlines surrounding AI over the last 12 to 18 months. I think initially it was all surrounding everyone trying to gain an understanding of what the capabilities might yield as well as the VC community largely funding some earlier stage startups. But I think we're increasingly seeing AI start to impact the middle market. So people are finding ways to leverage the technology to not only drive kind of cost efficiencies, but also provide some very significant operating leverage to their business in terms of enhanced efficiency.
So I think that as evidence here, roughly a quarter of the respondents are indicating that they have a desire to either acquire an AI platform or AI capabilities within an organization. It's definitely going to be kind of fueling M&A activity this year. I have seen some people refer to 2024 as a year that kind of AI pivots from a theme of AI enthusiasm to AI impact. So we'll see if that plays out in the middle market. And then Danielle, as you just mentioned, we also have the election coming up later on this year. So typically the kind of election, like other things that create uncertainty, tends to actually be a bit more of a damper on overall M&A activity because of the unknowns.
I think what this is telling us is that we're going to see a fair amount of M&A activity take place this year, perhaps in advance of the election in November. Some parties are going to try and kind of get up and down in the market and execute a transaction before there's any real kind of noise or potential for noise in November so that they don't have to manage through that during a marketing process. Overall, a number of factors here that are perhaps kind of that go beyond a step beyond the broader macro indicators that are going to help kind of improve M&A activity in 2024.
Thanks, Steve. Devin, I'm just about to put you back on the hot seat right now with the next one. I don't know if you wanted to add anything here, but I think you'll have an opportunity in a second when we're talking here about company value expectation, company valuation expectations, excuse me. Why don't you go ahead and dive into this, Devin, and tell us what you think that this is showing us? And again, if our respondents got this right.
I think if you obviously look at this, you see there's optimism around valuations. Clearly, that's an important ingredient, as we've already been talking about, to getting M&A done. I think it's important to remember where we've come from. You know, the equity markets peaked in late 2021, and you had the Fed pivot, you had the war start. We headed into 2022 with really extreme uncertainty. Equity markets, if you look at the Russell 3000 as a proxy, declined by about 25% from the beginning of 2022 through September. You know, that generally corresponds with a recession outlook. That's the type of move you historically see when people are expecting a recession. At that time, you know, talking to our institutional clients, there was a large degree that thought we were heading pretty quickly towards a recession.
Since markets bottomed, we've actually rallied about 35% from below. And now the Russell 3000 is back to the high today. This morning is trading right at its all-time high. And so it just gives you that sense that we've had this, you know, really material round trip in valuations. And buyers' expectations always reset faster than sellers' expectations. And sellers' expectations are generally tethered to their previous high- water mark. And so the good news is that we've had this really material move, but now we've come a lot closer to what I would argue are the highs. And so that's going to enable, you know, sellers to get back into a position where they can negotiate.
Buyers are obviously in a position where, you know, if they're looking at the interest rate curve and the macroeconomic environment, we had a good GDP number today, you know, they're generally feeling better as well. So if you think about a bid-ask spread, it was incredibly wide through early 2022. It's been closing, and now we've kind of round-tripped back in the public markets as a proxy. We're right back to all-time high. So I think, you know, this data, we'll see kind of what actually happens from here, because I think there's always a difference between expectations and market valuations. You know, it's obviously difficult to predict the future on valuations, but having that optimism is important to think about moving forward on strategic decisions. So that's the way, you know, we're thinking about it right now.
Thanks, Dave. Thanks, Devin. Dave, I want to turn it over to you and just talk a little bit about what Devin was just touching on, the buyer and seller expectations and disconnects and what you're sort of thinking there.
Sure. And I, you know, I highlighted some things related to industrials where I spend more time. And you do see here a pretty bullish perspective around valuation for industrials in this chart. Some of that is driven by those big mega trends that we highlighted earlier. Some of it is related to very specific operational metrics and hurdles that some of these companies have cleared in the last few years that gives them, again, more clarity and more organic growth opportunities as we think about 2024. But what's very important, and that I think Devin really was hitting on, is, you know, is there, can you find agreement between where a buyer and a seller rest on that valuation? Is there a gap?
Very important in any process, in any sector, for a company to be having conversations, whether it's a Citizens' M&A advisor or another party, but finding someone who's an expert in their industry, who's an expert in M&A, to help them understand the current environment and valuation expectations, so you start to, you know, educate the seller on what the environment is today, why valuation metrics may be up or down based on a variety of factors, and those go well beyond the specific broad macro factors we've highlighted today, and you really start to delve into very specific company performance. One thing I can tell you, certainly from my experience over now 30 years of M&A, for very high-performing companies, they get high multiples and significant interest in almost any environment.
It's really the sort of companies in the middle that are performing about at industry standard, whose margins are about at industry standard, you know, moderate growth, et cetera, where the dynamics around the haves and have-nots and the big multiples that you might hear at the country club that may or may not apply to another company and so having those conversations very early around how to think about the value of your industry and then how the value of your company relates to the broader industry and where you fit in it is really important before you go to market so that you are better aligned with the likely inbound interest you'll receive from private equity or strategic buyers.
So that process is really important to kind of get everybody on the right page and be level set on what appropriate expectations are in the environment you're in and where your company fits along the spectrum of, you know, top tier, mid-tier, or maybe somewhere below that. But happy to chat more about that as we think about 2024 and the different buyer universe, whether it's a strategic buyer and their synergies, what might be an international buyer looking for a domestic footprint, a number of factors that are beyond, again, this macroeconomic and broad sort of industry matters we've discussed, it can really influence valuation materially in an M&A process.
Thanks, Dave. I want to turn over to Steve for a moment so he could just talk through some of the sector-specific valuations here too. Steve.
Yeah, sure. I mean, first, I couldn't agree more with some of the commentary that Dave was just providing. I mean, as you can see here, business services is a little bit kind of more balanced in terms of expectations here. But overall, there is a view where valuations will increase in the coming year. But as Dave was touching on, a lot of this and a lot of where we spend our time is focused on educating specific businesses and how we would expect kind of their particular business to be viewed by the market. So what we've seen over the last kind of year is that in some cases for kind of best-in-class assets, we're seeing valuations kind of that were just as high as they were previously. And valuations have really held up, whereas kind of for other businesses, perhaps they've certainly come down.
So it's certainly a kind of market by which you really need to evaluate the individual asset and from there can provide kind of guidance to business owners in terms of what the market will bear. But we're definitely seeing kind of green shoots in terms of increasing valuations across the board.
Thank you, so those are all really great insights. I think we're ready to maybe take some questions here. Yeah, so I want to say that we have more questions than we probably have time for, but we will try to get through as many as we can, and I also want to just say that there's a lot of great resources available. If you're interested in learning more, you should go to the URL on the bottom here, which is citizensbank.com/ma-outlook. Again, a lot of great resources there, so with that, if you guys are good, I'm ready to take some audience questions. You guys good for that? Okay, so I also want to say that after we finish some, I'm going to come back to each and ask you for a 30-second key takeaway. So I want you to have that in the back of your mind. Okay.
First question. How are you seeing EBITDA multiples trending through 2024 to establish pricing?
Maybe I'll start for a moment. I think there's an academic calculation of valuation based on interest rates and returns, which would suggest, given the current high interest rates, that overall multiples may be down and may be improving as interest rates come down over the next 12 to 24 months as expected. And related to my earlier conversation, well, that is true. And certainly any finance class you take, it's easy to improve the value of something as you decrease the cost of capital associated with that valuation metric. However, the real art of this, that's the science. The art of valuation is far more complex. The science matters, but we're also looking at a stock market reaching all-time highs. That's influential.
We're also, as talked about earlier, thinking about who the buyer is, the strategic fit, the other attributes that make a company more or less valuable in the eye of the beholder. So we know, for example, private equity groups that have significant interest in industrials that may very much want industrial distribution or niche manufacturing. And we know of strategic buyers that are looking for add-ons that provide, you know, new product categories or new geographies. And finding companies, buyers that covet the certain attributes of the companies you're working with can really drive M&A multiples outside of sort of the academic sense of what the calculation might suggest. And so that the science of it is one thing, the art is another. And so it makes it hard to answer the question in general.
But based on the science, overall, with higher interest rates, you would expect lower multiples. And as interest rates start to come down, more opportunity for multiples to expand. However, there's a lot of art wrapped around that that is really more influential than a point or two on the interest rate.
One thing that I might just add on to what Dave was touching on, certainly there's a lot of kind of company-specific factors that really drive valuation, but we also can't kind of reminisce and not speak to kind of the impact that just competition in any given market has in driving up valuations and multiples. So certainly, as we look at some of the broader results here in the survey, clearly, it looks like there's going to be significantly more M&A activity. And the more parties that you have surrounding any particular transaction, the more enthusiasm there is. And that pushes valuations in many cases above levels that you might kind of expect just purely based upon kind of the broader, kind of as Dave alluded to, more academic methodologies in determining valuation.
Thanks. Okay. You know, I want to answer a question really quick. I'm just seeing as we go through ADGS, somebody asked what it means. It's Aerospace Defense Government Services, just going back to that slide. So next question for you guys. What challenges in the 2024 M&A market are you keeping an eye on?
I'll be real quickly. I would just highlight, I think we've seen intensity in regulatory review. I guess that's not specifically 2024, but more recently in the last few years, certainly a heightened scrutiny around HSR, CFIUS, and other regulatory matters. I would also say the diligence in the number of parties involved in M&A transactions, the level of detail that both strategic and private equity groups go into today with all the various experts. Of course, you've got your accounting, legal, M&A, but much below that, the HR and environmental and operations and just the level of scrutiny extends timelines and creates some amount of risk. Time is generally not your friend once you sign a letter of intent. Those dynamics are something that we try to drive timeliness and clarity around as aggressively as possible as an advisor.
But it is some of those things, regulatory and other matters, you have to deal with the environment you're in. And it has created some challenges around timing and clarity around closing.
I'd just add one point that's going to be very much kind of company or sector-specific. But coming out of 2023, where business performance and results were certainly mixed across subsegments and even at the specific organization level, right? That certainly puts an increased spotlight on kind of trending from a financial perspective and other key KPIs. And that's certainly something that there's a lot of conversations for certain organizations in terms of, okay, when does it actually make sense to launch in 2024 relative to that business performance? So kind of that's one element too that I think will impact M&A for certain organizations. Clearly, that's not something that's a factor across the board.
Great.
And the only thing I would add there is the macro. The macro has been such a driver of sentiment, and there's been such extreme moves over the past two years. And so right now, you know, that sentiment, as we've talked about in the conversation today, is in a much better place. But the one thing we also appreciate is the degree of change that we've just gone through and potential for more change from here. So I think there's still that lingering aspect of things could change again. And even though confidence is rebuilding, it's fragile. And so, you know, I think that's really kind of the question mark of navigating this year from a macro perspective, what happens with interest rates. I think just a stable interest rate environment will be favorable.
We don't need to see the full degree of the Fed cuts that are maybe in the curve today, but I think there's still quite a bit of uncertainty around some of these really big factors and more so than you would say is normal. So that is still something that is kind of looming out there.
Okay. Next question. If you actually think back to, sorry, this was in relationship to a slide that we had, which was the one, when do you think M&A activity will pick up? And it was like 54% for the PE firms. Somebody's actually asking, do you think that's the first sign of froth in the market?
No. I wouldn't necessarily say that we're anywhere near a point of feeling a lot of froth in the market right now. So I think that we're expecting a rebound, if you will, in terms of M&A activity. But we're not anywhere near what we were seeing in 2021, where you could argue that there was some froth in the market at that point in time, just given all that activity level. So we've got a ways to go.
Yeah. If you look at PE announcements, you'd have to increase 115% for sponsors' volume just to get back to a trend line, let alone anything frothy, so essentially, you could more than double their level of activity from 2023, and you would just be at a long-term average of activity, and then you put that against the record amount of dry powder. The relationships are way out of balance right now, and you can see really material recoveries without really getting to anything that's close to what you would call frothy.
Thanks. Thanks for putting that in perspective. Okay. Last question I'm going to ask here. Will the role of the M&A advisor change in 2024? If so, how do you see it changing?
Yeah. I don't think, you know, I've been doing M&A, as I mentioned, since 1992. And the reality, finding an M&A advisor you trust, who knows the industry, has significant M&A experience is critical if you're going to be successful. Actually, I'm stealing my 30 seconds. Actually, that's what I was going to highlight. But anyway, that's critical to the success of M&A. Build those relationships early. Find people that have their finger on the pulse, that are active in your sector, that are, and that also goes to lawyers and accountants and other advisors. Building that is important. So, you know, being a trusted advisor, being someone that you can, as a company, reach out to, finding that person, that team, that firm is important. And doing it well before you intend to execute M&A is really a best practice.
Yeah.
I don't know if our colleagues believe there may be some nuances. I've done this for 30 years, so it's like the old dog. There's probably some new tricks Steve may have up his sleeve.
I mean, in terms of the most important factors now, I don't think that you'll see things change, right? I think that particularly in environments like what we've been experiencing in 2023, coming out of that into 2024, it's all that more critical that your advisor really understands the fundamentals of your business, can really identify, because of their experience in the segment, how your asset may be differentiated relative to your peers so that they can come up with very compelling positioning. And then on top of it, have established relationships with the buyer community, both on the strategic side as well as the financial sponsors that play in that particular sector, so that they can run a very high-touch process whereby they're kind of individually pitching, if you will, your asset relative to others that may be in the marketplace.
And I think that that's critical in an environment like we're in right now, where you're not just seeing kind of deals get done left and right. There's a lot more one-on-one selling that's required in order to have a successful outcome and certainly to drive a premium multiple for your business. So I wouldn't necessarily say that's new to 2024, but certainly a critical element here in this market environment.
Thanks, Steve. So I just want to take a minute to thank all three of you for really sharing your insights. I also want to thank Citizens for giving us this great Outlook report every year that we can look at as we look for the future of the year. And with that, I know we only have a couple of minutes left. I want to go around and kind of put each of you on the spot. What are your key takeaways? What are you thinking about as you look at transacting in 2024? So, Devin, why don't we start with you?
Sure. Well, first off, great to do this. Great to be here. And really enjoyed the conversation. What I would say is that it's always good to have historical context. And we went from kind of this perfect environment in 2021 to the last two years, kind of the complete opposite. But the last two years have been an aberration as much as 2021 was an aberration. And so our view is that 2024 into 2025 is a transition year. And you will see improvement. I think the optimism from the survey really hits on that. But M&A is an important strategic tool for companies and sponsors. And there's a long-term secular growth underpinning to it. And hopefully, you know, that came through today. And I also think that if we're in a higher interest rate environment for longer, you're going to see a lot more rational behavior.
And so that's actually going to be really healthy. The M&A that happens will be high-quality transactions. So I do think we're normalizing. We're not going to go from where we are today to a normal environment overnight, but it's a process, and the process is underway.
Great. Steve?
Sure. I'll try not to be repetitive there, but in general, I think probably safe to say by the commentary on this call, we're all excited for what 2024 will bring, be able to put 2023 in our rearview mirror. Overwhelmingly, the sentiment is definitely that the market environment will improve. I also think it's important for anyone that is contemplating a transaction, if there is a real need to transact in 2024, to kind of prepare even in advance of when you think that window may explicitly be open in order to try and be on the leading edge of businesses in your subsegment to go to market as opposed to running the potential that you face a crowded market later on in the year. But overall, I think kind of that additionally helps in the mindset of the election in November.
So being able to get it out ahead of any potential turbulence at that point in time. But overall, I think we're excited for 2024 and anticipate a lot of healthy market activity.
Thanks, Steve. And Dave?
I will close that out just by reiterating the importance of building a team both internally and externally. The value of that is significant in being successful in M&A, whether you want to be a buyer or a seller. Finding experts, finding teammates within your organization, incorporating it in your business planning and strategy and quarterly reporting, monthly, whatever that metric is, incorporating it in your day-to-day activities and being able to converse in the language of M&A, what you want to accomplish, setting goals and objectives. Those best practices make for much smoother, better executed acquisitions, divestitures, or sale transactions.
Thank you, Dave. Once again, Devin, Dave, Steve, thank you so much. And thank you to Citizens for presenting this Outlook to us on behalf of ACG. Thank you to everyone for joining us today. Have a great day. If you want to download the full report, please go to citizensbank.com/mna-outlook. Thank you. Have a great day, everyone.
Thank you.