Portugal’s M&A market has been blessed by a scorching hot summer for deal flow this year amid the rebound from the pandemic, the search for returns, and a flood of cheap money. This was particularly true for the country’s mid-market and the infrastructure sector, as foreign investors were attracted by Portugal’s competitive pricing environment and foreign direct investment regulations. But the sun can’t shine forever, and some of the participants in Leaders League’s Thought Leader Roundtable in Lisbon raised concerns about a slowdown in deal flow as we head into Christmas and the beginning of next year.

“I think we had a very hot season,” said Mariana Norton, partner at Cuatrecasas and the host of the Lisbon event. Deal flow began to pick up in April and May as the public health situation in the country improved and society started returning to normal, a pace that continued even through August and September, she said. “It’s amazing how resilient M&A has been.”

Much of the deal volume has been driven by the infrastructure sector, according to Cláudia da Cruz Almeida, partner at VdA. “Infrastructure has been amazing,” she said. One particularly interesting trend she said she’d noticed in the sector was that the line between private equity and infrastructure investment has begun to disappear. “You see classic infrastructure investors like pension funds taking a very broad view of infrastructure.”

Joana Torres Ereio, partner at Uría Menendez, agreed that infrastructure has been one of the biggest sectors for M&A in the country. “Whenever there’s a good asset, we see a lot of interest from pension funds,” she said. “In terms of sectors, we’re working on the same ones: energy, infrastructure, agro-business,” and other sectors that have proven resilient during the pandemic. Meanwhile, new sectors are also starting to attract attention. “With hydrogen, we are seeing new players coming to Portugal.”

The Portuguese mid-market (i.e. deals valued at €50-100m) has also been enjoying its time in the sun, according to Duarte Schmidt, partner at PLMJ and co-head of the firm’s M&A practice. Deals in that size range “have been happening at a very good pace. We see a lot of them,” he said. These deals are being driven by a variety of types of buyers, he added. “We’ve seen a lot of activity in the mid-market, real estate, and hotels. The prices are not as interesting as in 2018 or 2019, but there are investors who think that pricing will pick up. I think that is a reasonable assumption.”

Gustavo Oliveira, partner at SRS Advogados, agreed. “We’re seeing few large transactions, but a lot of mid-market transactions focused on sectors such as tech-related companies.” Many of the buyers are coming from abroad, he added. “International tech companies that are consolidating or private equity and venture capital funds, that’s where we’ve seen most of the activity this year.” Going forward, most of the volume will be in “IT and digital economy, retail and logistics, mobility, and energy-related” companies, he said.

Private equity funds have been a major source of deal flow, according to the panel, thanks to the recent success of the sector. “For the first time in Portugal’s history, you’re seeing Portuguese private equity making money, which is allowing them to raise new funds and increase the volume they generate,” Schmidt said. “For the first time in my life, I’m seeing managers not knowing if they’re going to put an investment in one fund or another.”

Another issue that has been driving deal volume this year is the low cost of funding. “Interest rates are quite attractive,” Almeida said. “Money is cheap. There are no options other than investing to get a good return.”

The EU’s investment program to help the continent rebound from the pandemic should only magnify this trend going forward, according to Torres Ereio. “The resilience programs will bring more liquidity to the market.” Pension funds are also increasingly looking to industrial companies, assets that they hadn’t been interested in previously, she said.

Companies that have proven resistant to the pandemic have been especially attractive to acquirers, Oliveira said, with the crisis having an asymmetrical effect on the market. “It boosts fast-growing companies, IT, software, mobility, and logistics.” Those companies are the ones that have been growing the fastest and attracting international investors, he said.

On the other side of the coin, the pandemic has had a negative impact on sectors such as hospitality, leisure, and industrial companies that are suffering from the supply chain crisis, he said. “There are a number of distressed assets coming from that side. There’s still low interest rates (and apparently unlikely to increase) and increasing liquidity and dry powder to invest, as well as availability of substantial EU funds to invest in certain sectors” 

International acquirers have been another source of strength for Portuguese M&A, according to Schmidt. “We see strategic foreign investors come in and acquire companies that makes sense for consolidation purposes,” he explained. Some of this is being driven by competition for assets in other countries, particularly the rest of Europe, according to da Cruz. “They have a lot of competition, so they expand to other, more exotic geographies. This started three years ago.”

Foreign buyers have always been a source of strength for Portuguese M&A, according to Sofia Carreiro, partner at Sérvulo. “Since Portugal joined the EU, the M&A market has been driven by international transactions,” she said, with the country’s credit rating largely dictating inflows into the country. The government’s sovereign rating was recently upgraded to Baa2 by Moody’s in September and is rated BBB by S&P and Fitch. “Portugal’s sovereign investment grade rating supports the capital investment of major foreign investors,” she added. “Hopefully it will have a positive impact.”

Large multinationals have also provided fuel for the Portuguese market, Oliveira said, as they have been attracted by the country’s talent and business ecosystem. The country’s foreign investment framework has also been a major plus, Schmidt said. “We are a very open country. There are no restrictions on foreign investment. We are as open as you get.” Foreign buyers are also attracted by the fact that Portugal is a low-cost EU country with a good ratio of qualified professionals for the cost. “Some companies divested and migrated to China and other markets and then came back because even with the lower costs, the quality was lower,” he added.

But despite these positives, Carreiro pointed out that Portugal remains a relatively small player in European M&A. "Portugal’s M&A market underperforms the European M&A market in terms of the weight of M&A deals in Portugal and the country's weight in Europe's GDP" And while the number of deals may have increased this year, there are being done at lower prices. “In the third quarter, Portugal registered a 25% increase in the number of M&A transactions but a 38% decrease in value [excluding the acquisition of a majority stake in Brisa].”

And things are expected to cool down as winter frosts arrive, the roundtable agreed. “What I’ve been feeling in the last couple of weeks is a cool-down in investment decisions that were supposed to occur before year-end,” Norton said. “This year there is obviously M&A activity, but some of the deals we were expecting by year-end may start a bit later. Deals that were supposed to be fully in place are being a bit slow and will start a bit later than expected.”

Ricardo Andrade Amaro, partner at Morais Leitão, agreed. “I tend to believe we’re going to have a slower Christmas than usual. The beginning of 2022 will probably see deals picking up again.”

Torres Ereio said her firm is also seeing a bit of a slowdown. “These have been two very unusual years. Now we’re experiencing the slowdown we didn’t have in 2020 or 2021.” One of the reasons for this is that it is still unclear whether the pandemic is truly over, with some investors waiting to see what happens during the winter. “I think investors are worried,” Carreiro added. “I don’t hate Christmas, but it’s not the best time for us.” Nevertheless, she said she is still seeing deals being done in the mid-market.

One of the biggest concerns for the roundtable was political uncertainty and instability heading into the start of 2022. After the proposed budget by the minority Socialist government was rejected by the Assembly, President Marcelo Rebelo de Sousa dissolved the government and announced snap elections scheduled for 30 January. “The uncertainty around interest rates and the government is negatively impacting Portugal’s M&A market,” Carreiro said. Norton agreed, adding that “Portugal is in a delicate political situation.”

However, the uncertainty surrounding the snap elections need not be an insurmountable obstacle to deal flow. “The elections will have a major impact on M&A,” da Cruz acknowledged. “There are questions of instability. But there is a lot of money and pressure to invest, and competition in the Portuguese market means we’ll continue to be attractive.” While the huge pipeline of small deals that had been a significant part of the deal flow this year will likely be on hold until after the elections, da Cruz said, it’s unclear what that means for the M&A market overall. “Let’s see what the future holds.” Nevertheless, da Cruz said she was “very optimistic” about the future of M&A in Portugal. “Tourism and hospitality will continue to be hot, real estate too.”

That was a sentiment echoed by Oliveira. “We feel very optimistic for the coming years, even though things are slowing down at the end of the year,” he said. There are still deals in the mid-market scheduled for beginning of next year. “We are quite optimistic on these sectors and everything that is tech-related. The size of the market is not a problem.”

Torres Ereio agreed. “We’re still optimistic, despite regulatory and tax instability.”

“I think overall the key issue is that Portugal is a peaceful country,” Norton said. “Even though there will be a change in government, this won’t be traumatic, but may cause investors to hold off and take a wait-and-see attitude. I think for the next year we have a very good pipeline.”

As for how the country could help grow its M&A sector, the roundtable had a variety of recommendations. For Oliveira, the most important issue was stability. “Stability (political, tax and legislative) is key. Especially for foreign investors.” If foreign investors sense that instability is increasing, a deal that was off to a good start can suddenly become a no-go. Specifically, the government can help by not creating any unnecessary obstacles, he said. “Either tax or labor measures,” he specified, along with taking any measures aimed at making investment more flexible. “Obviously, this is difficult given the political framework and the traditional difficulty in agreeing on long term stable policies, as is traditional in Portugal,” he said. Nevertheless, “There have been good measures taken in the last few years to favor the startup space, which is an advantage for Portugal. We have good examples of startups, some unicorns, and we have a lot of startups with hundred-million-euro valuations.”

Norton agreed that the country had taken positive steps to support M&A: “We had a couple measures that worked very well in venture capital,” she said, that created benefits for certain funds and investments. “This is something hopefully we should get more of for the private equity sector.” One area in which the government can help is tax incentives and benefits, she said. “In M&A, I think we also need affirmative action.” That includes “tax and regulatory incentives for recurring investments in private equity funds.” Creating such tax incentives would provide the country with recurring funding to invest and capitalize companies, she said.

For Andrade, the biggest issue holding back deal volume is political interference. “We’re a small country with a very small number of high-profile M&A deals and we tend to see some degree of political interference with campaigning around most of them. International players aren’t accustomed to that and don’t like it. That’s a serious obstacle to M&A deals and to attract foreign investment to the country…we still have a path to go to become a true and free market economy.”

One thing companies can do is to work with Portuguese citizens who have emigrated, da Cruz said. “The flip side of having a big brain drain is that we have a significant diaspora in the infrastructure and private equity world. I’m not convinced we’ve fully exploited that.” Many key people in infrastructure and private equity around the world are Portuguese, and are incentivized to pay attention to the country, she explained.

Finally, making changes to the country’s bankruptcy laws could have a big impact on the sector, Carreiro said. “Eighty percent of companies are shut down because of liquidity (or over-indebtedness) problems and not because of their capacity to generate cash. Reworking the bankruptcy code is key for the dynamics of business bailouts and job protection.” Improving the insolvency procedures would also help minimize job destruction, allowing bankrupt companies to continue to operate under new ownership instead of having to eliminate its entire workforce, she said.