image from tweet for MBRIFund Innovators programme
Watch out for the Gulf's SWFs to initiate more deal-making plays in 2023. Image Credit: Twitter/@MBRIFund

Mergers and acquisitions in the Middle East have seen a slowdown in 2022 as corporate and financial investors turned cautious amid rising interest rates and increasing economic anxiety. While M&A activity remained resilient in the first few months of 2022, it lost some momentum as macroeconomic conditions started to deteriorate through the year.

Multiple economic and financial headwinds have complicated dealmaking globally in 2022. A key deterrent has been the tightening of credit conditions, with banks pulling back the financing of leveraged buyouts amid rising interest rates and a broader risk-off environment. Leveraged loans issued to fund private equity (PE) acquisitions have largely dried up across Europe and the Middle East.

In the Middle East, however, the number of deals decreased only slightly from 366 in the nine months to September 2021 to 343 in the nine months to September 2022. Companies headquartered in the UAE, Saudi Arabia, and Israel were the most targeted by buyers, accounting for 20.7 per cent, 9 per cent and 54.2 per cent of the total deals in the region, respectively.

As the economic climate grew tougher, we observed that most of the M&A activity across the Middle East concentrated in recession-proof sectors, including non-discretionary consumer and healthcare with technology, media, and entertainment broadly continuing to be attractive sectors. Infrastructure transactions have also been a bright spot.

2023 outlook: a new dealmaking environment We expect that the same headwinds that impacted activity in the last few months of 2022 will continue to slow the M&A market in 2023, especially in the first half. Performance outlook, public-to-private opportunities, distressed situations, and generally lower valuations may create new opportunities and release pent-up deals.

However, in this more complex environment, timelines of deals will likely be longer and risk execution higher.

Other trends shaping the M&A market in the months to come include:

Dry powder: While in the short-term strong corporate buyers may have an advantage, sovereign wealth funds (SWF) and financial sponsors still have high levels of dry powder to deploy and will remain important players in the M&A market. As the pace of fundraising slows and the economic backdrop changes, we expect funds to be more selective, preferring resilient and cash generative businesses as well as investments aimed at consolidating and enhancing their current portfolio.

Bolt-on acquisitions: As long as the financing market remains constrained and large-cap opportunities continue to be scarce, sponsors might turn to smaller, bolt-on acquisitions instead. These add-ons can increase value of SWFs’ and PEs’ portfolios companies, especially as traditional growth routes available to portfolio companies are cut off and exit options narrow. Investing in known businesses and platforms may also make more sense for SWFs and PE in times of uncertainty.

Distressed M&A: Perhaps unexpectedly, we have not seen a significant uptick in distressed M&A opportunities in so far in 2022. This might change in 2023 as tougher economic conditions weaken balance sheets, forcing companies to sell assets and restructure operations, thus creating opportunities for distressed M&A.

Carve-outs: We expect carve-out opportunities to ramp up as choppier economic waters force large businesses and conglomerates to refocus their strategies and divest non-core assets. In addition, activism investment continues to be a powerful driver, with many investors able to initiate positions at lower prices in a weak stock market. For SWFs and PEs, carving out non-core business units from their portfolio companies, though more complex in nature, can offer superior returns.

ESG: Corporate and financial acquirers are increasingly looking at targets with an ESG lens, a trend that is only likely to accelerate in 2023 and beyond. Issues related to environmental impact, board diversity, governance, and supply chain management, among others, are now integral to investment committees’ decisions and can ‘make or break’ a deal. They can also affect the availability of funding, potentially giving sponsors’ an edge when looking for debt financing.

Winners and losers: Willing buyers will continue to pivot to more resilient sectors such as non-discretionary consumer, healthcare, infrastructure, and certain sub-sectors in technology, media and entertainment in 2023. Businesses in these sectors are better able to weather economic turbulence because of high demand, recurring revenue models and/or ability to pass on rising operating costs from inflation more easily. The continuing trend of digitisation within organisations will help keep up momentum in technology-linked sectors. Infrastructure assets will also be targeted, as the sector can offer stable cash flows and downside protection due to its tangible, asset-heavy nature.