CEOs Positioning their Companies for the Long Haul

October 13, 2023 – How do you prepare for a recession that never quite arrives? More than halfway through 2023, economists and market watchers in the United States are starting to take seriously the possibility of a domestic “soft landing” buoyed by labor market resilience, moderating inflation and gently slowing final demand growth, according to EY. But corporate leaders do not have the luxury of assuming a best-case scenario. EY’s survey of 320 U.S. CEOs finds top leaders are fortifying their organizations for the long haul — assuming an environment of achievable but more moderate growth than we saw in the immediate wake of the pandemic.

“As it is, C-suites are already operating amid higher costs of capital, a constrained deal market and persistent market volatility after an averted spring banking crisis,” the EY report said. “Add to those factors the rapid development of artificial intelligence technologies — and ongoing debate over what form generative AI will take, and how to leverage it constructively — and CEOs are understandably cautious about transformational initiatives. If we were to summarize US corporate sentiment based on these latest survey results, we might say companies are creating their own weather: seeking out tailwinds, bracing for an ever-changing climate and setting up for growth when blue skies return.”

At first glance, EY’s respondents seem pessimistic about the macroeconomic outlook. Nearly all U.S. CEOs (97 percent) are planning for a potential economic downturn in their primary market of operation. However, greater percentages are now expecting a milder decline compared with the January 2023 survey: The share of those expecting a “moderate and temporary” US downturn has nearly quadrupled since our January survey, going from 10 percent to 37 percent; the share calling for a “severe and persistent” drop has plunged from 22 percent to three percent.

Moreover, nearly half of respondents are more positive about their organization’s financial performance than they were six months earlier, and another one-fifth say their sentiment has held steady. Among companies with revenue of $5 billion and above, a majority (53 percent) say they are more optimistic.

Where this modest optimism turns into action is at the capital allocation level, where Ey found that U.S. CEOs appear to be pursuing a place-all-bets strategy. Over the next 12 months, companies say they will primarily either invest in organic growth (30 percent) or maintain cash reserves (29 percent) — but the pursuit of mergers and acquisitions is not far behind (22 percent). “Given the higher cost of capital after a string of aggressive rate increases by the US Federal Reserve, such hedging reflects not only prudence but balance-sheet reality; even with that caveat, inorganic growth is clearly not off the table,” the EY report said.

M&A Intentions

Focusing specifically on M&A, 64 percent of U.S. CEOs plan to pursue a deal in the next 12 months, essentially flat from our January survey. As was the case early in the year, joint venture (JV) or strategic alliance intentions are higher at 71 percent; and divestment plans are notably strong at 45 percent.

The EY report says that the theme appears to be long-term planning — when in doubt, a deal can wait. “CEOs have long regarded divestitures as a strategic tool, and carve-outs and spin-offs are freeing up capital for other corporate purposes down the road,” the study said. “Similarly, JVs can serve as the on-ramp to a deal. Strategic alliances put a potential acquirer first in line for M&A when the moment is right, even if costs, competition and regulation are not immediately favorable.”

The Hot M&A Market for Executive Search Expected to Continue
Significantly more U.S. chief executives plan to pursue deals compared with their global chief counterparts, according to the newly-released U.S. CEO Outlook survey from EY. A full 63 percent reported they will pursue an M&A deal in the next 12 months, much higher than the 46 percent of CEOs globally who plan to pursue M&A. This fairly robust U.S. number may in part reflect a recent easing in asset valuations as well as pent-up demand.

Private equity firms, which have slowed their deal pace in recent months, are even more likely to pursue an acquisition, with 69 percent of private equity portfolio company CEOs saying they would pursue M&A. Across U.S. sectors, a majority of CEOs in financial services, consumer products and retail, advanced manufacturing and mobility (AM&M), and technology, media, and telecoms (TMT) plan to pursue M&A. Interestingly, joint ventures are very high on the U.S. CEO agenda: 73 percent plan to pursue JVs or strategic alliances, arguably the more recession-proof options.

A telling response came when EY asked CEOs about their approach to portfolio transformation, encompassing acquisitions, divestitures and spin-offs. One-fifth (21 percent) said they were accelerating their level of transformational change overall; even when combined with respondents maintaining current levels of transformation (28 percent), less than half of U.S. CEOs are actively looking to transform their portfolios. Of the 49 percent of respondents accelerating or maintaining current levels of portfolio transformation, the main source of financing transformation will come from performance improvement (56 percent). “This further indicates a changed environment — CEOs have shifted from growth at any cost to investments that must show a clear path to profitability or value creation,” the EY report said.

Related: Leveraging AI for Executive Search Success

These responses align with EY’s own observations of the M&A marketplace. “C-suite executives considering deals are intensely focused on buttoning down diligence, especially in a cost-cutting environment,” the EY report said. “Consolidative deals are on the rise more than strategic growth or transformative deals, and in all cases more time is spent on the business case. The rapid timelines we saw in 2021 and early 2022 are a distant memory; higher capital cost inherently leads to greater prudence.”

AI is Still Being Defined

The EY report also found that 80 percent of U.S. respondents say they have either integrated AI into their products and services or plan to within the next year. “But the potential benefits of AI are in the eye of the beholder,” the report said. “Executives are not only parsing the distinctions between generative AI and machine learning, but also weighing how AI can be usefully employed in a corporate development context.”

When asked if they were employing AI in the transaction diligence process, 30 percent of U.S. CEOs said they already were, but a greater percentage (37 percent) said they were only in the initial stages, and the balance either were not yet using AI or had no plans to do so. EY explains that the use of machine learning as part of the due diligence process of dealmaking is already well established; beyond that, C-suites are clearly still trying to wrap their arms around these new tools.

“If anything, more traditional business strategy principles based on value, capital structure and corporate strategy are winning the day,” the EY report said. “Even if the U.S. avoids a major recession — and at this writing, the outcome remains open to debate — interest rates are not likely to moderate for quite some time, and companies are working with their advisors to build a balanced capital agenda, with dry powder available to acquire when the time is right. In other words, a wave of accelerated transformation has given way to one of corporate consolidation. This year, and for some time to come, all-weather gear is the preferred outfit for smooth sailing.”

Search Veteran Weighs In

Ken Vancini is the founder and CEO of Innova Connect. He brings over 25 years of experience in the executive search field. Innova’s services encompass Chat GPT & AI Advisory, community roundtables, and general business advisory services. Mr. Vancini recently told Hunt Scanlon that the CEOs he speaks with fall into one of three groups.

“Early adopters are hiring and investing resources to stay ahead of the curve,” he said. “Early adopters are usually larger firms, but not always. These firms are using off-the-shelf products like chat GPT and hiring experts to integrate AI into the firm’s technology platforms.”

“The second is experimental firms,” he said. “This is the most significant number of firms. They usually have a few people on the team with technical abilities who have raised their hands to experiment with different AI tools.”

“The third is wait and see firms,” Mr. Vancini  said. “With a slowdown in business in 2023, these firms focus on what has worked in the past and are not interested in investing time and resources into unproven technology.”

Mr. Vancini also said: “At this point, it isn’t easy to pinpoint specific ROI benefits for the CEOs.   On a high level, benefits fall into one of four categories: Process improvement; new business generation; employee satisfaction; and cost savings.”

Related: AI’s Impact on Growth Strategies in a Shifting M&A Landscape

Contributed by Scott A. Scanlon, Editor-in-Chief; and Dale M. Zupsansky, Managing Editor – Hunt Scanlon Media