by Paul Donnelly
Premium equity valuations and rising interest rates stress our markets on a fundamental basis that high consumer confidence and low unemployment in the U.S. ultimately cannot outrun. A brutal start to this year for markets only got worse in June. The S&P 500 closed out the first half of the year down nearly 21%—the steepest first-half loss seen in more than five decades, leaving the benchmark index firmly in bear market territory.
At the time of this drafting, the Fed Funds Rate has increased from .08% in February to 1.21% in June, resulting in higher corporate debt costs. Meanwhile the inflation rate is at 9.1% for the latest 12 months ending June of this year. The big “R” word is now in full play. Although, there is a wide debate gap as to the intensity and length of the pending recession. As history often does repeat itself, the equity markets do not need a recession as an excuse to correct. However, corrections often fuel fear and caution.
So what does this mean in terms of the M&A markets? Let's take a closer look.
Recession Buyers’ Flight to Quality
Deal activity does tend to decrease during times of economic turbulence. Credit becomes harder to secure and declining stock market values do spill over onto private company valuations. Many buyers take the “flight to quality” route, buying companies or assets that are perceived to be best-in-class with mission critical value propositions and operating leverage that provides opportunities to capture market share gains from weaker competitors.
Recession Buyers Often Reap Long-term Rewards
While turbulence brings challenges, it also creates opportunities. Companies that are in a solid financial position can profit from downturns by seeking opportunistic acquisitions. Firms seeking to grow via the right deal will often find no better time to strike a bargain than during a recession.
However, these buyers must be disciplined to overcome short-term fears and capitalize on long-term rewards. Fewer buyers and tighter credit create an atmosphere of urgency that pushes targets to sell. Tough economic conditions can also allow strategic buyers to pick up troubled companies at a substantial discount. With strategic precision and a farsighted view, buyers can accelerate their market position and strengthen their financial profile even when broader economic conditions lag.
Best-of-Breed Recession Sellers Can Still Reap Premium Valuations
During a real or fear-based recession, companies that are excelling based on their current and projected revenue and EBITDA growth will continue to be met by buyers with enthusiasm and valuation premiums. Strategic buyers with big balance sheets can camouflage their own headwinds or real earnings challenges by announcing strong performing strategic acquisitions. Private equity, with an excess supply of capital, tends to put self-imposed pressure on itself to continue investing or risk returning capital to their investors. Private equity has learned that buying best-of-breed companies at premium prices still works during a 7 to 10-year fund cycle, no matter the market conditions.
Pressured Recession Sellers Can Seek a Merger of Peers
Companies that are being challenged during a recession or companies that are facing bank covenant pressure and lack a strong balance sheet or a deep pocket equity partner, are often compelled to consider a merger with a peer company. A synergistic peer company can ultimately provide a healthier, more competitively restructured business often with greater scale and better operating leverage to survive - and prosper – despite an economic recession.
Deal Experience Through Economic Cycles
Paul Donnelly and the Coil Partners team have executed over 130 transactions through all stages of market and economic volatility. We specialize in delivering corporate finance advisory and investment banking services to emerging growth and middle market firms. Thanks to our extensive industry experience, we have the expertise to close the most complex of deals. Over the years, Paul and the Coil Partners team have completed over $4.5 billion in transaction values.
