Interest rates and the impact on M&A
If you are running your own business and looking to exit through a trade sale, or other mechanism in the near future, clearly the present climate is uncertain. Economic indicators have started to falter post Brexit and the Bank of England has acted by lowering interest rates to a historic low of 0.25% today - the first time this has happened since 2009.
So what impact might this have on Mergers and Acquisitions?
Before answering this question, it is important to understand the drivers and barriers of M&A.
The key negative factors of acquiring a UK business at present are the obvious political uncertainty, currency risks and limited growth prospects in the medium term. This is in addition to general investment principles that must be assessed, such as:
- Regulatory issues
- Integration / cultural issues
- Risk aversion from management / shareholders
- Reputational risk
On the positive side, big businesses are holding huge amounts of cash and capital expenditure is still considerably below pre-2008 levels, so there is plenty of firepower for acquisitions in the UK, particularly in sectors where there is significant disruption taking place to traditional business models.
The mergers and acquisitions market is generally driven by the cost of money and the relative attractiveness to the acquirer, so today's announcement is unlikely to dent the appetite for acquisitions at home based on financing reasons. With rates near zero, an increase, even several, will still leave interest rates near historically low levels.
Management teams are under pressure to create growth and acquisitions are generally positive for the following reasons:
- Add skills / talent / technology
- Staying ahead of competition
- Accelerating growth
- Diversification / vertical integration
- Financing / balance sheet pressures
- Creating value for shareholders
- Internalising outsourced functions
What about the UK's relative attractiveness?
Immediately afterward today's announcement, Sterling dropped against the Dollar and Euro, reflecting the relative weakness of the UK economy at present. This means Sterling is now down 20% against the Dollar and the Euro over the last 12 months. This makes UK companies much more appealing to a foreign buyer.
The speed of rate hikes in the US can be as important to M&A activity as the level of interest rates, since a rapid change could cause a shock to the financial system. That’s clearly not in anyone's interest.
We have to expect that the Fed will move slowly in tightening money policy, particularly since employment gains remain incremental and overseas export markets are in turmoil. In contrast, the U.S. is enjoying gradual economic growth, an environment that can accommodate a slow rise in interest rates. As the U.S. economy expands, so too does corporate confidence, which is critical to determining whether executives are willing to make acquisitions. I would therefore expect many US companies to be looking abroad for acquisitions and particularly the UK.
It is an attractive time to issue debt, however, with the high levels of cash potential acquirers have on hand, the less need there is to borrow to complete a deal, so there is no lack of money to fund acquisitions abroad. Indeed, strategic buyers have been using stock and cash to complete acquisitions, instead of debt. This reduces the importance of interest rate levels on the deal market.
China’s growth is still enviable, as it's economy shifts to services and away from manufacturing, although reflective of their position as the 2nd largest economy in the world. This is in contrast to European economies, which have been unable to pull out of the continental malaise.
With low interest rates and a flat yield curve, comes the expectation of lower growth environment overall. These factors should combine to keep M&A as a key driver of corporate growth as businesses fight to stay competitive.
For foreign buyers, rising rates in the United States will likely continue pushing the dollar higher, making acquisitions of U.S. companies more expensive.
For now, it would seem that UK businesses should be focusing on keeping themselves ready for when that day comes and maximising growth where possible, as M&A is looking like a key driver of longer term growth.