Two recent takeover bids involving Arvida Group and The Warehouse Group have sparked interest in New Zealand’s M&A market, providing a welcome contrast to a challenging economic landscape. Proportionally, retail spending in New Zealand has dropped nearly as much as during the 1980s sharemarket crash and more than during the GFC. Business confidence has dropped for the fifth consecutive month in a row and company insolvency numbers are rising steadily from static levels over the last few years.

These trends reflect a broader economic struggle, with Europe and many countries, including Australia, the United Kingdom, and the United States, also battling the effects of recent high interest rates and inflation. Combined with current global political instability, including the Israel-Hamas war, Chinese-Taiwan tensions, the Russian invasion of Ukraine, and elections in the United Kingdom, the United States, France, and Japan, these factors have created a subdued global economic environment, with significant impact on the New Zealand business landscape.

Decline in M&A activity in 2024

The challenging economic outlook has led to a reduction in M&A deal activity in the first half of 2024, with deal volumes and values down on 2023. This decline reflects the risks that economic uncertainty introduces into the M&A process.

Partner Michael Pollard, NZ Lawyer M&A Dealmaker of the Year, emphasises the greater fragility of M&A deals in challenging macroeconomic conditions. “Economic uncertainty undermines a buyer’s conviction to get a potential deal done, its confidence in the accuracy of its valuation and the trajectory of the investment.” In volatile times, more thorough due diligence is typically seen as essential to assess not just the current valuation but also future risk factors. Purchasers become more conservative with their analysis of the target’s financials, organisational structure and other key business information to better understand business resilience. Increased purchaser due diligence timeframes are leading to deals taking longer to get across the line. This increases the risk of adverse intervening events.

Financing challenges

With the OCR at its highest since 2008, financing is an ongoing challenge. Market volatility during a downturn can affect financing terms, and fluctuations in interest rates will affect financing costs and deal affordability. Banking Partner Josh Cairns notes "Securing financing in this environment requires innovative solutions and flexible terms. It's important to engage with lenders early and explore options to ensure deal viability." Leveraging a mix of debt and equity financing, and considering hedging strategies to manage interest rate risk, can provide more stability in deal financing.

Increased focus on synergies

For companies facing pressure to pay down debt and withstand rising cost pressures, M&A deals achieving scale synergies are especially valuable. KPMG Deal Advisory Associate Director, Sarah Florkowski says they have observed an increase in focus from investors wanting to evaluate synergies and value creation opportunities from acquisitions. Combining operations allows companies to reduce costs and improve efficiency, while providing access to new markets and customer bases, thereby enhancing growth prospects.

Sarah says, “Carrying out operational and commercial due diligence can provide assurance on the value drivers for the market and evaluate the business model to protect and improve margin performance. This helps to provide certainty over what they are prepared to pay for the business as well as identify actionable opportunities to implement strategies following acquisition to improve the business value.” Acquiring another company provides immediate access to valuable resources, including talent, technology and distribution channels, facilitating expansion when financing is tight.

Integration complexities

KPMG Deal Advisory Director, Alan Williams, says “evidence shows that almost two-thirds of M&A deals fail to create value and deliver to their synergy targets.” Merging organisations involves a complex integration of cultures, processes and systems. Complexity can increase in a downturn, due to cost-cutting measures, layoffs, and resource constraints. Downturns can also disrupt operations, affecting supply chains, production and customer demand. Integrating two companies during such times requires careful planning.

Alan says, “It’s complex, technical and risky, so establishing a comprehensive integration plan and core team to provide continuity through the transaction is important.” Integration risk, which can result from overestimating synergies, can be curbed by conservative estimates of synergies. A detailed pre-deal integration strategy will be highly valuable to the purchaser, as well as rigorous due diligence to validate synergy assumptions. A comprehensive integration plan should address the alignment of business operations, technology platforms, and corporate cultures. Alan reinforced the importance of having a strong communication strategy and sound governance structure to ensure the integration process is successful.

Cultural integration and talent retention

Employment Partner Rebecca Rendle says an often-overlooked aspect of merging a target into an acquirer’s business is the need to develop a clear employee integration plan. Not doing so may lead to employee disengagement and low morale, particularly if the merger involves redundancies and changes in leadership. Rebecca stresses “Taking existing and new employees on the journey is vital. Proactive leadership to understand both companies’ cultures and to build a cohesive team, with alignment on workplace culture and goals, helps maintain morale and retain key talent. Poor communication can cause uncertainty and resistance.”

Signs of optimism

Despite the current challenges, relief may be on the horizon. The RBNZ believes inflation will return to its 1-3 percent target range in the second half of 2024, leading to expectations of an OCR cut before year-end. New Zealand pulled itself out of its technical recession in the first quarter of 2024, with growth of 0.2%. The gradual improvement in economic indicators suggests that things could start to pick up towards the end of 2024, although economic recovery, including in M&A, may be slow and steady, rather than a quick rebound.

Commercial Partner James Hawes highlights that New Zealand’s strong fundamentals continue to attract investors. “Robust sectors such as agriculture, technology, and renewable energy, a well-regulated business environment and political stability, make New Zealand an attractive investment destination. The recent Ministerial Directive Letter to the Overseas Investment Office to expedite foreign investment consent processing timeframes, limit verification for low-risk applications and minimise compliance costs, has been positively received. This Directive Letter, along with the recent streamlining of the Overseas Investment Office’s internal processes, demonstrate a clear intention to encourage foreign investment into New Zealand.”

Partner Andrew Matthews notes that high quality deals are still happening in New Zealand, despite the current economic climate. “The recent multimillion-dollar acquisition of Wet & Forget by Direct Capital is a good example of this. Investors are still looking for good opportunities - there will still be strong appetite for robust businesses with demonstrated customer demand and a clear growth pipeline. Strategic investors are poised to act quickly as market conditions improve.”

While decreased M&A activity reflects broader economic challenges, strategic investment opportunities remain. Companies focusing on thorough due diligence, realistic integration plans, and transparent communication can navigate the complexities of the current environment and make strategic acquisitions to position themselves for long-term growth. As inflation drops and economic conditions improve, proactive and strategic companies will be well-positioned to thrive.