WHAT'S CAUSING A TSUNAMI OF M&A ACTIVITY?
Most investment bankers, lawyers, accountants, and lenders I talk to are reporting record transaction activity. Likewise, investment firms, are saying they are inundated with deal opportunities. In fact, last month was a record month for most investment firms, in terms of the number of inbound deal opportunities. Why is that? Here are our thoughts on converging factors driving the abundance of M&A today.
1. Deal Overhang
Many deals were put on pause due to the pandemic and the uncertainty of the overall economy at the time, some of these deals re-surfaced, but many are just now becoming active again, months later.
2. Excess Dry Powder
Financial buyers had an abundance of capital ready to deploy. As the economy rebounds, the need to place this capital is now more pressing, having effectively lost a month and or years from acquisition hesitancy. Many strategic buyers also have cash earmarked for growth through acquisitions.
3. Covid Benefactors Selling into Strength
The economic changes due to Covid created difficulties for many businesses, but it also created incredible opportunities for others.
Companies in selected industries were major benefactors of the economic shift due to Covid. Offsetting this were the brick-and-mortar retail, restaurants, tourism, travel, and events industries that were significantly impacted.
Companies that benefitted from the economic shift are trying to sell into strength…
4. Potential Tax increases
The change in political administrations in the US, record government debt in the US and Canada is causing concern among business owners that taxes may increase before their eventual exit. For business owners considering selling in the next few years, the thought is, why wait a few years to sell if the after-tax proceeds are the same amount today, even if I grow my company?
5. Low Interest Rates
Interest rates are extremely low. Driving asset values such as real estate and operating businesses to increase. Interest rates for debt and mortgages are inversely related to purchase price. for landlords and shareholders, lower interest expenses allow for higher borrowing capacity (while maintaining proper interest coverage ratios from cash flow from operations). Greater borrowing capacity allows for higher purchase prices. The current low rates enable buyers to pay more and still manage their cash flow.
6. Inflation
Inflation is the inevitable outcome of printing money, which the Central Banks have done to unprecedented levels.
Government spending is ballooning in many countries, and while some of that has to do with combatting the pandemic, in other cases political agendas are coming into play, hijacking the relief process. Canadian budget deficits are expected to end the year at about 20 per cent of GDP, which will be the fourth-highest level in the world, according to a recent IMF report cited by Bloomberg.
Inflation tends to squeeze margins in the near-term as companies fight to increase prices at a rate that outpaces increases in their cost basis for raw materials and labor. Offsetting this margin squeeze, is that inflation also shrinks the value of the debt used to acquire a company, as the borrowed dollars used for the acquisition inflate away. In other words, an acquirer repays debt with inflated dollars (future dollars of lessor value). Couple this with the historically low interest rates available and you have an opportunity for interest rate arbitrage over time. In effect, if interest rates are below the rate of true inflation, it is free or very low-cost money, via leverage.
This is the opportunity for acquirers, if you cannot beat them (getting out bid by other acquirers), join them strategy, the game many acquirers are playing right now. Accumulate appreciating assets with the longest possible fixed-rate loan (to capture and lock-in current low interest rates) and repay the debt with dollars of lesser value in the future as inflation shrinks the effective value of debt, in a sense, this is a way to pseudo-print money… just like the central banks.
7. The Retirement Conundrum
To a baby boomer business owner, this is a huge and sticky quagmire. One of the serious issues we are now facing in our society is the ongoing impact of the baby boomer business owner retirement, the overall impact on our society will be huge, the reality is baby boomer business owners, as they retire and seek buyers for their companies, are overwhelming the market.
When the last of the boomer business owners turns 65 (in a few more years), there flooding the market with companies for sale during a weak economy and some may not be able to extract the value their friends bragged about only a few years earlier when they sold a business. With some optimism that the economy is starting to get better the value of the business may be rebounding, but they will all want to get out at the same time.
8. The Totality of Risks
Business Owners and leaders spend considerable effort identifying, considering, evaluating, and mitigating risks. thinking about products and services, the industry, rivals, technological disruptions, employees and management team, suppliers, customers, operations, marketing, sales, etc. All these areas and others contain risks factors.
The global pandemic underscored to many business owners that there exist systemic risks for which they have no control or insurance. Even if their company managed to navigate the new economy, or even thrive in it, owners are forced to consider what other systemic factors might be lurking for which there is no immediate remedy.
The pandemic caused many owners to reflect on the totality of risks they assume. It is difficult to watch some businesses, some entire industries, get wiped out to realize it could have been your business/industry just as easily. The idea that there are risks out there beyond control became more difficult to ignore or recover from as one ages.
Most notably, past, and present terrorist attacks, cybersecurity breaches, economic events at home or in foreign countries are examples of external factors for which few private businesses have prepared contingencies.
Sometimes, the response to the question, “What other risks am I assuming?” becomes… “it’s time to take some chips off the table.”
And that is what we are experiencing…
Seeking the Latest Insights?
Subscribe to our newsletters, register for upcoming events, download free content from our library of resources below.