Global M&A Trends in Industrial Manufacturing & Automotive

Deal activity in aerospace and defence exhibited two contrasting trends in 2023: defence M&A remained stable, while commercial aerospace experienced turbulence. We expect to see an increase in M&A activity in both subsectors starting in the middle of 2024.

The commercial aerospace sector is expected to continue growing faster than global economic growth into 2024. However, interest rates, continued supply chain and production issues, increased competition for talent, and regulatory impacts could slow this growth. Companies are attempting to overcome these challenges through acquisitions and strategic portfolio reviews. Some companies are looking at vertical consolidation to overcome supply chain constraints and production capacity issues while also expanding their focus on the provenance of parts to address growing concerns about counterfeits. Other companies are considering addressing talent issues by acquiring skilled workforces through acquisitions; however, these companies will likely face competition from technology companies looking to hire software engineers.

Forecasts for growth in defence budgets in the medium term may lead to additional dealmaking. For example, we may see increased investment in defence spending in Europe and the Middle East, with a particular focus on sovereign investments. We expect that regulatory and national security concerns will continue to limit the potential for large-scale strategic consolidation.

We expect continuing priorities such as hypersonics, robotics and space to attract investor interest and lead to further transaction activity. Once current financing difficulties ease, we anticipate that private equity will likely have a sizeable role to play in any uptick in M&A activity. Financial sponsors may be particularly attracted to a string of smaller add-on transactions to portfolio businesses aligned with a government budget focus. With larger deals likely to attract greater regulatory scrutiny, we expect the trend towards small and midsize acquisitions to continue in 2024. As with the anticipated trend in the commercial aerospace sector, defence companies are expected to enter into strategic and operational partnerships to address capacity concerns.

In 2024, automotive business leaders will continue to pursue M&A strategies focused on digital, software and electrification innovation. Automotive companies continue to adapt to an electric future on numerous fronts, and we expect to see further M&A activity in electric vehicles (EVs) and connected automated shared electric (CASE) assets. Along the EV value chain, there are growing interdependencies which will lead to acquisitions, joint ventures and strategic alliances. Examples include OEMs investing directly in mining companies or negotiating offtake agreements to ensure security of supply for critical minerals or investing in on-site energy generation capabilities.

The pace of adoption of EVs may differ from country to country, with some governments passing legislation—such as setting quotas on EV sales under zero-emission-vehicle (ZEV) mandates—to help accelerate the transition. Some countries may stop short of direct mandates to allow the necessary EV infrastructure to be built, using other measures such as tax incentives to encourage EV adoption. With recent developments in the Asian auto market, we expect overseas automotive companies to pursue M&A and partnerships with Asian EV start-ups as they compete for market share.

Market conditions continue to be top of mind, and dealmakers will likely remain constrained in terms of capital availability during 2024. The macroeconomic, geopolitical and other factors which muted automotive dealmaking in 2023, while expected to continue this year, appear to be stabilising. High inflation, interest rates, supply chain disruption and labour constraints (heightened due to the recent US auto worker strikes) all add to the uncertainty and perceived risks of dealmaking. As inflation is brought under control, price reductions in certain core commodities and logistics costs will help with profitability. With persistent economic uncertainty decreasing the margin for error, we expect dealmakers will continue to look for lower-risk and more strategic actions to drive value creation.

Suppliers dealing with squeezed margins and higher inventory levels may face working capital constraints and liquidity issues which in turn may create opportunities for dealmakers through M&A, strategic alliances or capital investments. The goal of many OEM suppliers will be to successfully manage through any liquidity crunch while remaining able to benefit from strategic investments in new technologies.

Given the challenges of obtaining financing, more capital-constrained companies may give stronger consideration to divesting non-core parts of their portfolios to free up capital needed to fund investment opportunities. As companies look to the future, a continued strategic focus on core, cash-generating operations will likely drive increased deal activity starting in 2024.

M&A opportunities in the business services sector are expected to remain strong in 2024 with technology disruption being a strong impetus, despite continuing uncertainties in the global macroeconomic and geopolitical environment.

We expect a continued shift from traditional to tech-enabled services to create favourable conditions for M&A, especially for global players. Generative AI may affect legal and professional services, among others, for example.

Dealmakers will be particularly interested in subsectors within business services that offer the digital capabilities to transform business models. Sectors such as managed IT, commercial and residential services, and testing and inspections services present attractive opportunities for a roll-up strategy, likely spurring robust M&A activity in 2024. Smaller bolt-on deals are expected, although private equity firms may continue to exercise caution due to high interest rates and challenges in raising financing.

Outsourced services will continue to attract investment, as business leaders prioritise profitability and cost reduction. However, supply chain disruptions may discourage some companies from fully outsourcing as they seek to build resilience into their business models. Inflationary pressures have affected the profitability of outsourced service providers to different degrees based on their ability to pass on higher costs to customers. This in turn has affected deal valuations, with companies that can maintain margins continuing to achieve high multiples.

M&A activity is expected to increase in the professional services subsector. Consolidation will enable small accounting and professional advisory firms to gain scale, enhance brand value and make digital investments. This could lead to a divergence in strategies between highly specialised firms and those offering a range of services, each with a different geographical reach.

The choppy trend in engineering and construction (E&C) deal activity in 2023 is expected to continue through the middle of 2024, with many corporate and family-owned businesses remaining cautious about the macroeconomic environment and geopolitical unrest. However, as inflationary pressures have eased and interest rates have stabilised, our outlook for 2024 is cautiously optimistic. This view is supported by the number of corporates that are searching to deploy their capital towards areas of value creation and the substantial dry powder held by private equity to invest. We believe 2024 may provide an opportunity for some players within the E&C sector to capitalise on lower valuations as more risk-averse players remain on the sidelines.

The residential construction landscape may be poised for growth as interest rates have stabilised and may start to decrease during 2024. However, in countries where residential mortgages are on relatively short-term fixed rates, a higher-for-longer interest rate environment may introduce a new wave of stress when these mortgages come up for renewal.

The commercial construction sector faces a more challenging environment, marked by stagnant projects, margin compression, upcoming refinancing milestones and the looming possibility of debt defaults. The continued preference of workers for remote or hybrid work has reduced demand for office space, although some new office buildings are having an easier time finding tenants than older ones which need retrofitting. Construction companies heavily exposed to the warehousing and manufacturing subsector may find downward pressure on valuations due to market contractions from recent highs.  These uncertainties underscore the importance of making well-informed choices in capital allocation for E&C companies.

E&C companies continue to innovate, which is highlighted by the early adoption of AI and sustainability standards for competitive advantages in initial design automation and product development. Firms specialising in engineering services, intelligent transportation, and power and telecommunications continue to be attractive assets in this environment. Investors are also likely to seek companies that demonstrate a commitment to sustainable practices, specifically those that focus on decarbonisation or disposal of carbon-intensive elements in the construction process.

Dealmaking activity in the industrial manufacturing sector is expected to remain broadly stable at the beginning of 2024 before ramping up activity levels mid-year, especially among small and medium-size companies, despite uncertainties in the global macroeconomic and geopolitical environment. Consistent with 2023, inflation, interest rates and high valuations will drive industrial players to target smaller acquisitions to fill key strategic capabilities more often than larger, more transformative deals.

Companies continue to engage in portfolio reviews to identify and divest non-core assets. This frees up capital for investment in areas that better align with their strategic priorities or that will help them reinvent their business models as they look to the future. Buyers for these assets will likely be corporates and private equity portfolio companies with strong balance sheets seeking to expand their capabilities as well as private equity firms considering a roll-up strategy.

To remain competitive, industrial manufacturing companies are seeking digital assets to increase manufacturing efficiency and reinvent business processes. Artificial intelligence, machine learning, 3D printing, robotics and predictive maintenance are areas expected to expand efficiency and nimbleness. Given the ongoing risks and uncertainties in the geopolitical environment, there will also be a continued focus on supply chain diversification and near-shoring—two key areas that are likely to drive M&A activity in 2024.

As end markets, customers and investors increasingly focus on sustainability considerations, industrial businesses are looking for products and capabilities to help them achieve their goals. We expect attractive targets to include companies focused on decarbonisation, renewable energy and the electrification of industrial equipment.