What is the future of M&A, how to successfully face the challenges of transactions and how to make the most of the opportunities offered by (not only) modern technology? This and other topics were discussed by representatives of companies who were guests at our recent event.

The last meeting in May at Deloitte was dedicated to the topic of how to face dynamic changes in the market in times of uncertainty. The market is currently being impacted by negative macroeconomic factors such as inflation, higher interest rates, slowing economic growth and the reverberations of supply chain disruptions.

Our guests spoke about the issues of the dynamic market, acquisition financing, new technologies and related experiences and insights: Zbyněk Pela, Acquisition and Syndicated Finance Manager at Česká spořitelna and Petr Rieger, Associate Director at Carlyle Group, one of the largest US PE firms. The meeting, moderated by Jan Brabec, Partner in the Financial Advisory Department of Deloitte, was held as part of the Deloitte Business Club.

The initial topic was market volatility. How has business been done for the last 3 years in this environment?

"In our case, I wouldn't say that these factors have affected us in any major way. The local banks in the Czech market are very well capitalised so there were certainly some risks, including rising interest rates and the energy crisis, but we generally experienced the most uncertainty in the first few months of 2020 when the covid broke out in Europe, but otherwise the uncertainty was more limited to specific projects/opportunities", said Zbyněk Pela, adding that there was certainly no evidence so far that the bank had no capital or appetite to lend.

Peter, although you are a large PE fund, you have been very active in the Czech Republic in recent years. You bought Memsource (Phrase) and more recently Tescan. What is interesting for you in this region?

"There are several factors why we are more active in the Czech Republic than in the past. One of them is simply that we have to do more transactions. We're opening our fifth fund, which will be about €3.5bn. The primary mandate is Western Europe, but given the amount of deals we have to do, we need to be more creative and go into a region where historically we haven't had that kind of presence. After our first deal in the Czech Republic (Memsource) we found that the businesses in Central Europe are not inferior, in fact they are slightly better because they have a very strong technology base and a strong financial backer can help with the rest. Another advantage is that there is no competition from other PE funds yet, so there are potentially many opportunities that we can take advantage of", explained Petr Rieger.

The most common form of financing in the Czech Republic is credit financing. Does the increased activity of private equity funds open up space for other types of financing (whether senior or junior)?

"I represent classic senior financing, classic multiples, where we feel comfortable. For the largest deals, I haven't yet come across PE funds asking for junior funding. With SME's it can be encountered and Česká spořitelna is currently considering expanding its services in this type of financing", Zbyněk Pela opened the debate.

Petr Rieger added: "In the Czech Republic, we were very pleasantly surprised by the banks' approach to clients. There is not the classic case where you send an email and nothing happens for three days, but they actively attend to you and the depth of financing is also there. The terms and conditions could be worked on though, the financing comes with certain restrictions that you don't have in Western countries, but you can see that these restrictions are already starting to change slowly."

Regarding acquisition financing. It has been said that Czech banks have the capital and the appetite to finance, and therefore do not usually refuse. But what are the main reasons in case of refusal?

Zbyněk Pela said, "It will be different in the SME area, where the client may be thinking too boldly and the transaction may not make sense to the bank on paper. For opportunities from larger players, I can't imagine them coming up with something that doesn't make complete sense. But what could mess up a potential financing are those terms mentioned earlier, where foreign clients demand terms that are unacceptable to us. Sometimes it can happen that the risk department rejects it, but that's not that common and usually it's some very bold business plan. The most common form of acquisition financing is still 70% corporate investments and 30% are LBOs (PE but also family office). For leveraged finance, the two most important financial covenants are the net debt to EBITDA ratio and the debt service ratio."

We are seeing an initial decline in transactions in the M&A market. How do you see it from your point of view?

"We see it similarly, the market is now negatively impacted by interest rates, financing is expensive and the macro environment is negatively impacting company growth. So overall the market is slower and what we are seeing is a split into 2 big camps. Companies that have not been negatively impacted by the macro environment still exist and there I would dare say that valuations have increased even more because there is still a lot of capital and companies have to show activity and do transactions. And then companies that are affected by more negative factors are feeling a bigger discount. So from the perspective of many sellers, it's advantageous to wait another 12-18 months for an exit, when interest rates are likely to come down, and potentially get more value for the business," explained Peter Rieger.

Zbyněk Pela added: "We are a little behind in the cycle, so we are not feeling the market cooling yet. The second thing is that we are doing transactions from CZK 40 million, so there are still plenty of opportunities for our smaller team. However, I can confirm what Peter said, which is that there are still sectors that are experiencing record years despite the more negative market environment."

The next topic is ESG. Some people are probably tired of this topic, but others understand that this topic is not going away. Does this factor affect the decision-making of Czech banks in larger transactions over hundreds of millions?

"It's certainly being taken into account, but Western Europe is definitely further along in this. Gradually, this trend and the monitoring of ESG standards is spreading in Česká spořitelna and competitor banks. For example, financing fossil fuel extraction projects is already very difficult. So it is definitely a big issue not only in substance but also in process in banks and it will definitely get tougher in the future," said Zbyněk Pela.

Petr Rieger added: "I can confirm that ESG is part of all our Due Diligence. By focusing mostly on technology companies, ESG tends to be less of a burden. However, in other parts of Carlyle, such as the energy fund, it is definitely a more lively topic than in our business. I even know of one transaction where it was a tea manufacturer that didn't complete because of non-compliance with ESG standards at its factory in India."

And one current topic for the end. Which industries will be most advanced by new AI technology?

Peter Rieger opened the debate. I think it is good that companies are experimenting with AI to streamline processes, but we are still in a period where it is a riskier investment, and only time will tell what the real "business case" is for companies using AI.

Zbyněk Pela added: "Česká spořitelna is active in the field of new technologies, we have a Seed Starter fund that works similarly to Venture Capital and finances promising start-ups in the Czech Republic, and our CEO Tomáš Salomon is a great visionary. What industries ChatGPT will touch the most, I dare not say, but we have provided this platform to all employees of the savings bank as part of their education."

The Future of Deals event focused on the challenges and opportunities in a dynamic market in a time of uncertainty. While negative macroeconomic factors are impacting the market, businesses are feeling varying degrees of their impact. The Czech Republic is attracting interest from private equity firms due to its strong technology base and many attractive opportunities, with Czech banks ready to finance potential deals.