2022 was a very good year for M&A, according to Stonewood Capital Management President and CEO Kenn Moritz.
“I think people generally had great deal flow and a lot of closings, a lot of activity,” Moritz said at the Pittsburgh Smart Business Dealmakers Conference. “2023 was very different.”
He says they usually tries to do one or two deals each year. But in 2023, they did none. And it wasn't for lack of effort.
“Looking at headwinds in the economy and just geopolitical uncertainty throughout the year, with rising interest rates, it was difficult to be aggressive in the market as a buyer,” he says. “I think the deal flow that we saw was generally at a lower level, so we had fewer opportunities to find a new platform. And when those opportunities presented themselves, we found our environment was such that we couldn't be as aggressive as we would otherwise.”
So, he says they started to focus more on their portfolio, looking for companies that they could acquire strategically with their portfolio companies. In those instances, he says they could be a little more aggressive because in that way, they could mitigate some of the risk of the investment.
One of Stonewood’s companies that was experiencing significant growth back in 2023 was thought to be a good candidate for a tuck-in acquisition. The company had a strong management team and a lot of bandwidth. He says they spent a lot of time looking for a specific type of company for that business to buy.
“We did find one,” Moritz says. “Checked a lot of the boxes. Was of similar size. It had a niche market that we were looking for. It dovetailed very nicely with the sales channels that we already have in place. So, it would have been a very good acquisition.”
They began a process and got into some of the due diligence. Given all the uncertainty in the market, rising interest rates, etc., he says it made more sense to be aggressive doing the strategic acquisition than it would have been had they looked for another platform.
“We really liked this business,” he says. “We thought the stars were aligning for us to do this deal. But unfortunately, there was another bidder who, I guess, thought much more of the company than we did, and saw a much more optimistic future than we did, so we weren't able to buy it.”
While he says they liked the business, it became a question of what to do with it afterwards, and whether they could make the returns they were looking for given the risk they were taking.
High interest rates, he says, definitely played a role in the decision.
“You're taking more risk,” he says. “The world is less certain. The cost of capital is higher, and you become much more deliberate and much more selective. Whether we would be as aggressive as another bidder might have been in that circumstance would have probably been a different scenario had we felt more comfortable about the future than we did.”
When searching for targets, Moritz says they have a type.
“We like B deals, actually,” Moritz says. “We like deals with some hair on them. We like to think we can make them better. So, buying B and selling A is a good strategy for us. It's been successful for us in the past.”
He says the deliberations and due diligence periods are longer now than they used to be, but they work to get their deals done expeditiously.
“It still drives me nuts, and I couldn't stand still for a deal that took 180 days to close,” he says. “I think it would drive me into the grave.”
However, he says they take their time with the material issues, but they try not to sweat the immaterial things.
“We've had success doing it, so we have experience with it — something with hair on it,” Moritz says. “If we see a path to getting clear of it, we are very excited about potentially buying that business.”
When there’s a gap between the seller’s and buyer’s sense of a company’s valuation, he says it can be difficult to get the deal flow to execute. That can be because the seller’s valuation is based on essentially a zero-interest rate environment that has changed. That can lead to people pulling back and the volume of transactions going down. There was a similar effect through the cycle in 2008-2009, but that was more of an extreme chilling effect.
“It's nothing like that now. But we've gone through these cycles before, where, if the economy becomes uncertain, there are just fewer transactions,” Moritz says. “The spread between what the seller thinks a company's worth and what the buyer is willing to pay widens, and sometimes it's just better for sellers to wait until a better environment comes about. In the meantime, however, there are structures that you can use, of course, to try to solve that problem and solve that gap. There are many of them. Deals are like clay. You can shape it and mold it to the way that you need it to be for everybody to get through it and be able to close. Retained equity is one thing, earn outs are another thing. There's a whole series of things, but structuring transactions like that, of course, takes more time and more thought, and it's a little bit riskier for a seller. So, the chances are that some of them will say, ‘Well, we’ll just wait.’ And so that's kind of the environment we're in. I think deals are still going to happen. And they did happen in 2023. They were just a little bit different.”
