Fourth Quarter Update 2023

Happy New Year from EPOCH Pi! As we look back on 2023, we are deeply thankful for the clients who entrusted us to help them raise capital, sell their business, or strategically acquire a competitor. What unites these exceptional leaders is an inclination to consider all stakeholders with a commitment to do what is right for everyone involved. This ethos mirrors the principles by which responsible businesses operate. As we anticipate the possibilities that 2024 will bring, we remain committed to partnering with companies who share our vision of responsible and conscious businesses, interested in doing the right things for all their stakeholders. 

In November, one of our partners, Lynn Carpenter, was featured as a speaker during the Women’s Entrepreneurship Day Ohio event, held at Case Western Reserve University. She shared her insights on what entrepreneurs should think about when looking to sell their business or raise capital, offering EPOCH’s unique approach to helping companies find values-aligned parties so they can grow or transition the business to new owners, continue to do financially well and create a great place for employees and value for customers, suppliers, and community. 

Kyle Regan welcomed his third child, a baby boy to the world in December. Kyle joined EPOCH officially over the summer after graduating from Case Western Reserve University’s MBA program and also serves in the Army Reserves as an engineer. 

In this newsletter, we’d like to share our take on the Q4 2023 markets and our thoughts on the outlook for 2024.

Market Performance: The 4th Quarter of 2023 saw improved equity market returns, but continued declines in deal flow and overall deal value. A recession is not out of the question for 2024 and the consensus is that market growth will slow before triggering possible rate cuts by the Fed in mid to late 2024. Lower rates typically increase deal flow due to the reduced cost of borrowing to finance investments, acquisitions or other transactions. 

Our index comparison includes the JUST 100, Change the World, and Firms of Endearment indices. These indices are rooted in the belief that when companies act responsibly for all stakeholders, align their operations with their values for a greater benefit, they can create financial value without sacrificing profit. At EPOCH, we believe responsible companies seeking to do the right thing are more resilient and therefore fare better than those focused solely on the bottom line. In Q4 of 2023, the JUST 100, Fortune Change the World, and Firms of Endearment indices all outperformed the S&P 500. Each of our tracked indices gained at least 3% with the Fortune Change the World index ending 6% higher than the S&P 500 for the quarter.  Q4 saw our four tracked indices grow on average by 33% whereas Q3 saw an average of 12% growth across our tracked indices. Slowing inflation, continued consumer spending, and the final easing of pandemic-related supply chain disruptions contributed to the market’s improved Q4 quarter performance. 

Deal flow: In Q4 deal volume continued to decline with a total of 1,444 PE deals (a proxy for the overall lower middle market) executed in the lower middle market ($500MM and lower in value), a 30.3% decline compared to the same period in 2022. With interest rates likely peaking and multiples continuing to decrease into Q1 2024, M&A activity may pick up later in the year. The stability of rates during the initial quarters of 2024 is poised to provide companies with more predictable debt terms. High rates in the short term could compel companies with highly levered balance sheets to divest underperforming assets, in part because higher rates make it difficult to favorably refinance existing debt. In a period of anticipated lower economic growth, strategic acquisitions emerge as a viable avenue for revenue expansion, offering access to new markets, technology, and organizational efficiencies. In light of these dynamics, we believe companies with available cash reserves and debt capacity are well-positioned to strategically capitalize on the emerging macroeconomic landscape through thoughtful acquisitions. 

In terms of the broader M&A and deal market, Pitchbook has released new deal and valuation momentum scores by sector. The scores range from -2.0 to 2.0 and establish a relative evaluation for each sector, showing which way deal multiples (EV/Revenue) are trending. The basis of these scores is the percent change over the prior quarter and trailing 12-months. In summary, Pitchbook reports that “B2B and IT fared the best, seeing multiple expansions with scores at 0.58 and 0.52, respectively. Conversely, the materials & resources (sectors) saw multiples contract, with a score of -0.76. More than half of the sectors saw positive expansion in deal multiples as valuations continue to recover, albeit slowly.” (Pitchbook, 2023 Annual Global M&A Report) Sectors with contracting multiples could see increased deal flow from value-oriented buyers. 

Regardless of the economic environment and the impact of interest rates, enduring, sustainable mergers hinge on the work done pre-close. This involves a concerted focus on aligning values, integrating operating models, establishing clear financial objectives with well-defined execution strategies, and retaining key talent. The optimal execution of these strategic themes is most effectively realized when companies possess internal expertise or engaged seasoned advisors capable of shepherding them toward success. 

At EPOCH, we advocate a holistic approach that includes the owner's vision of an ideal outcome, the company’s strategic, competitive and/or market needs, as well as other stakeholder considerations important to continued success. We encourage a comprehensive approach that includes integration planning recognizing that sustained value post-close is intricately tied to how well organizations integrate. Our commitment to the nuanced aspects of M&A transactions extend beyond financial metrics, delving into strategic fit, penetrating new markets, introducing innovative products, and, crucially, the understanding of leadership styles, people philosophy, decision-making processes, measurement frameworks, conflict resolution or collaboration styles, and core values. 

For more on our perspective, we invite you to read our blogs, namely “Four Key Performance Drivers in an M&A Transaction” and “ Quantifying and Assessing Culture Is the Key to Successful M&A.” Additionally, PWC provides a comprehensive summary of their findings on the imperative nature of intentional integration, which further underscores the multifaceted considerations integral to the long-term success of an M&A transaction here. 

What we found interesting:

First Solar (NAS: FSLR) and Fiserv (NYS: FI) entered into the first known solar Tax Credit Transfer Agreement (TCTA) in December 2023 worth $700 million. The Advanced Manufacturing Production Tax Credit (AMPTC) was established by the Inflation Reduction Act of 2022 to incentivize the production of eligible components within the United States, which include certain solar energy components. According to First Solar, “The liquidity generated as a result of this transaction is expected to accelerate the timing of enhancing our cash position in the US through the monetization of the Section 45X credits, further strengthening our balance sheet and allowing us to continue investing in key aspects of growth, such as research and development.” The funds from this deal are expected to support manufacturing and R&D investments. Citigroup Global Markets placed the transaction.

We hope you enjoyed reading our 4th quarter newsletter and found something of value here. If you have any questions or comments, please reach out to Kyle at krr@epochpi.com.