The UK FinTech sector will experience an upswing in M&A towards the end of 2023, as companies look to consolidate their positions in the market and take advantage of the potential for growth and innovation.
By Konstantin Dzhengozov, Co-Founder and Chief Financial Officer at Payhawk
While headwinds such as the turbulent geopolitical landscape, volatile stock markets, and rising interest rates and inflation have meant both companies and investors have remained cautious throughout Q1 and into Q2, pressure is mounting for them to complete transactions.
According to data from Prequin Pro, this is particularly pertinent to private equity firms that are sitting on a record level of $1.96 trillion (about £1.5 trillion) of dry powder. Thus, we will soon see a switch out of defensive cash strategies and into M&A. Figures from Ernst & Young’s latest CEO Outlook, for example, show that 50% of UK CEOs are planning to make acquisitions in the next 12 months and 67% are considering joint ventures.
VC funds, on the other hand, will not have the same capital reserves and might struggle to fundraise since they are unable to showcase success stories to potential investors in the current macroeconomic environment. This means they will start to pressurise their companies to consolidate, merge and create bigger organisations that will appear more capital efficient and thus have the potential for a more meaningful exit down the line.
Time to focus
Although most of the movement in this space will be motivated by necessity, there are countless advantages to M&A in the current environment. Firstly, it pushes companies to conduct vital internal evaluations to determine which assets are core to their business, allowing them to divest those they consider non-essential. This will ultimately result in a more mature company with a bolstered focus and cash to spend.
Secondly, it allows cash-rich companies to purchase spin-offs at a reduced price and go on to achieve better returns. According to PwC analysis, deals done during a downturn are often the most successful. Data from the 2001 recession, for instance, indicates those that made acquisitions had a 7% higher median shareholder return than their industry counterparts one year later.
M&A for geographical expansion
This concept will also prove useful when it comes to using M&A for geographical expansion. FinTechs that are already successful in the UK will likely look to acquire or merge with strong yet struggling competitors in other countries instead of enduring the rigmarole of setting up there from scratch. We have already seen the number of cross-border M&A announcements increase, with data from Investment Monitor’s Global FDI Annual Report 2022 showing a 45.2% jump in 2021 compared to the previous year – a trend we can expect to continue in 2023.
Some of the key growth areas for M&A in the FinTech space will be Banking as a Service (BaaS) and Gen AI. As customers become increasingly dissatisfied with existing offerings, BaaS providers are rapidly gaining popularity and new players are entering the market. This is set to change, however, as regulators are beginning to force these organisations to strengthen control and their compliance functions to obtain a license-holding. Naturally, this would limit the number of new entrants in this space, making licence-holding companies extremely attractive and driving appetite for M&A or consolidation.
Gen AI can exponentially boost a company’s productivity and allow greener enterprises to disrupt big industries. Businesses already innovating in this space will become more valuable and there will no doubt be fierce competition to acquire them.
Overall, one can anticipate a flurry of M&A activity in Q3 and Q4. While not all driven by preference, companies positioned with both the financial resources and a thorough strategy will be able to capitalise on the current dubious market to make transformational deals that may contribute to their long-term success.