The hunt for value is on as era of ‘easy money’ ends
By Philippe Craninx,
Chair, Moore Global Corporate Finance
Economic responses to the Covid pandemic created favourable conditions for corporate deal-making, with cheap money and low inflation driving demand and valuations higher.
Those stimulus packages are beginning to wind down in the face of soaring inflation and a recognition by political leaders that the books have to be rebalanced. The reverberations will be felt by those of us in corporate finance for some time.
For companies on the acquisition trail, the ‘easy money’ they have become used to could soon become much harder to access – while owners looking to sell could see the value placed on their life’s work drop by up to 25%.
Rising interest rates could also see investors divert cash previously earmarked for private equity to other asset classes. There was a big market sell-off immediately after the January meeting of the US Federal Reserve, when chair Jay Powell signalled there could be a tougher interest rate environment than markets had envisaged.
Elsewhere, the UK seems to be following a similar path to the Americans while China is in a period of introspection and figuring out what to do next as instabilities in its biggest industries threaten to derail growth.
In contrast, the talk in Europe is of post-Covid growth strategies rather than inflation and interest rates. One third of the €1.8 trillion investments from the NextGenerationEU Recovery Plan, and the EU’s seven-year budget will finance the European Green Deal – this will be a game-changer.
The combination of a more benign interest rate environment and huge sums available to develop the technologies of the future will give even more impetus to the European start-up, IPO and mergers and acquisitions markets.
A new momentum is already clear to see. European fundraising efforts by private equity in the first half of 2021 generate €52 billion of new money to invest, according to Investing in Europe. Some 365 funds completed a fundraising round during the period, the highest ever and 5% ahead of the first half of 2020.
The desire to put that money to work is revealed in another statistic from the same study. In the first half of last year €57.3 billion was invested in European companies – the highest ever half-year total.
This enthusiasm reflected across the world and the average size of deals grew bigger as investors became bolder. The S&P Global Market Intelligence reported the average transaction value of deals at the end of September was $86.5 million against $67 million for the whole of 2020.
For sellers, all this money and growing appetite for bigger deals impacted positively on prices they could achieve. Earnings multiples jumped from 9.2x EBITDA at the end of 2020 to a high of 11.6x EBITDA in the middle of 2021 – a sure sign of pent-up demand.
Earnings multiples dipped towards the end of the year, most likely on the back of inflation and interest rate concerns among investors. It may be that some players pulled back as they reviewed their portfolios: after all, it only takes a few upward nudges of interest rates to make government bonds look an attractive long-term investment again for balancing risk.
Every euro or dollar taken out of the corporate finance market reduces the scope for deal-making and I would not be surprised to see a flight to quality in 2022.
In that scenario, there will a shift in appetite from growth companies to value companies. Growth businesses offer exponentially high rewards when – if – they mature but they also require much more capital. And that capital is likely to be more expensive for the foreseeable future.
In a period of high inflation, it will be the turn of stable established businesses with strong market positions in their sector to shine.
For sellers, the key to a successful transaction is actually no different than it was in 2020 or any other year.
As well as generating stable cashflow and providing sustainable, predictable yields it is important that the business is easy to understand. There has been a real trend in the last five years to simplify corporate structures and operating models.
For those looking to acquire, the important factors are to remain focused on the robustness of the target’s business model and sustainability in various macro-economic environments.
For example, Covid had a huge impact on hospitality and airlines but it was negligible on probably 85% of businesses. The inflation central banks agonise about (rightly) can be a huge drag on some sectors, while others brush it off without a worry.
As deal makers we must accept we are now watching the window of opportunity created by so-called free money close quite quickly. However other windows are bursting open, driven by Europe’s Green Deal and wider concerns about sustainability and environmental considerations.