In our last blog post, we examined the prospects of the startup ecosystem following the elections on February 8th. Since then, perhaps the most noteworthy news to emerge from the ecosystem involves Turkish fintech powerhouse Papara’s acquiring SadaPay, a prominent fintech company in Pakistan. Although the details of the acquisition have yet to be revealed, reports indicate that the all-stock deal is valued somewhere between $30 million and $50 million.
The deal represents the first significant M&A activity for 2024 following a relatively quiet year in 2023. Global M&A activity experienced a decline last year, with a 14% decrease in deal volume and a 41% drop in deal value.
Similarly, there were a total of 8 notable M&A transactions in Pakistan in 2023 involving both local and international entities, marking a 20% decrease compared to 2022. Among the significant M&A deals in 2023 were Abhi’s acquisition of 2.7 million shares in the logistics company BlueEx and Opay’s acquisition of the EMI license of Finja.
Reasons for Subdued M&A Activity
Globally, following the substantial dealmaking activity of 2021 and early 2022, both private equity and venture capital sectors have experienced significant declines in deal activity. Factors contributing to this downtrend include rising interest rates, a dearth of financing, and widespread economic uncertainties. Additionally, existing investments have been subject to sharp devaluations, resulting in down rounds for VC-backed companies.
The domestic market has reflected these trends, with interest rates reaching an all-time high of 22%. Inflation, which stood at approximately 30% in 2023, has significantly impacted the economy. Moreover, the sharp devaluation of the rupee, combined with the foreign exchange liquidity crisis, has undermined investor confidence.
Source: Ismail Iqbal Securities
Listed equity valuations mirror this broader trend, trading at a discount despite substantial earnings, primarily attributed to the prevalent macroeconomic uncertainty.
Drivers of M&A Activity
The current fundraising environment is challenging, and for numerous startups, it appears that the end of the road is approaching as they deplete their cash reserves with slim prospects for additional injections.
As seed-stage startups in Pakistan often secure funding through SAFEs, those transitioning to priced rounds will encounter heightened scrutiny and extended lead times before funds are disbursed. This raises the question of how far the current reserves of these businesses can sustain them.
At this juncture, businesses with relatively sustainable models or those on the verge of achieving sustainability may find acquisition to be a viable option.
From an acquirer’s perspective, current valuations are still appealing, as the trend of down rounds persists. This situation allows acquirers to purchase startups at reasonable or discounted prices. Moreover, once the anticipated broader macro correction happens, valuations are likely to experience a rebound.
While many look outward to identify potential acquirers, domestic conglomerates are also promising candidates for a potential shopping spree in the local startup market. In light of robust corporate profitability in 2023, entities in specific sectors such as banking, energy, and consumer goods have surplus liquidity at their disposal. A number of these entities already have existing investments within the ecosystem.
Alternatively, some in the corporate sector may be unwilling to assume the significant risks associated with startups. In such instances, a “dip-toe” strategy may be more appropriate, where initial investments involve acquiring a smaller stake that can be gradually increased over time, eventually leading to an acquisition.
For instance, Bank Alfalah has made a notable foray into the venture capital ecosystem by agreeing to acquire a 7.2% equity stake valued at PKR 140 million (USD 0.5 million) in the startup QistBazaar.
QistBazaar is a licensed Buy Now Pay Later (BNPL) non-bank financial company (NBFC) regulated by the Securities and Exchange Commission of Pakistan (SECP).
Such transactions enable startups to extend their runway by securing additional funding, while also providing investing companies with the opportunity to assess the prospects of the startup before making a significant financial commitment.
Looking Beyond
Consolidation through M&A activities is indicative of a maturing and vibrant ecosystem. The resulting synergies and access to capital can greatly propel the growth aspirations of local startups. Additionally, the increase in M&A activity can also benefit foreign players seeking entry into the Pakistani market.
Local acquirers have the chance to venture into new sectors or gain access to cutting-edge technology stacks through the acquisition of startups. This is especially relevant in the FinTech sector, where the market is saturated with both legacy players and emerging startups.
While the M&A deal activity is anticipated to persist throughout the year, the central theme will revolve around the sustainability of a business. Potential acquisition targets must demonstrate a viable path to profitability backed by positive unit economics.