Remember when M&A professionals waxed poetic over horizontal and vertical mergers? The savviest bankers convinced CEOs and CFOs to expand upstream and downstream, take advantage of economies of scale, snuff out competitors. Now the life of the M&A banker is primarily comprised of brownnosing Private Equity fund managers. Persuading a company to make a strategic acquisition is far more labor intensive then pitching a private equity shop that is required to make an acquisition, lest the shop’s existence be deemed unjustifiable.
Thusly, an increasing share of headline grabbing acquisitions, and an increasing share of less well-known middle-market acquisitions are private equity backed deals. These transaction tack incremental leverage onto cash flowing companies to juice returns ahead of a flip. For avoidance of accusations of slander and rank cynicism, PE does provide important economic benefits such as providing liquidity to the private markets. Some funds may also introduce best practices in management. What cannot be denied is that the leverage assumed in Private Equity backed transactions places excess risk in the system which exacerbates the downside in bad economic times. Also, some of that precious liquidity evaporates when the credit cycle turns.
We Are Near the Endgame Now
As often mentioned on this site, interest rates are rising. Higher rates gum up the mathematics of the leveraged buyout. Witness Apollo’s recent comedown on the $20 billion dollar purchase of aluminum maker Arconic. This deal has some hair on it with legacy lawsuits dogging Arconic. However, the other stated reason for the hold-up is elevated interest rates.
We may be at the peak of lenient borrowing terms for merger and acquisition financing activity – not in history mind you, but in the current credit cycle. Lenders and Private Equity Buyers are still relatively chaste from the financial crises, so acquisition financing deal terms on the whole, while perhaps too lenient for bank credit officers, are not aggressively sloppy in terms of real economy statistics.
Nevertheless, should performance of private equity backed companies start to flag, credit terms will become more stringent. This is probably not something that will halt private equity buyers full stop, but it will slow the negotiation process for deal financing, and perhaps allow time for some less nimble competitors in the strategic buyer space to get their act together.
It’s Not Just Private Equity
Reduced competition for delectable acquisition targets is not merely attributable to actions of the private equity community. The conglomerate merger is also on the backfoot. General Eclectic (Sp error intentional) the largest casualty of buying without strategy is instructive. Buffet and Berkshire are still feeling good, but the demerger trend for industrial conglomerates is gaining relevance with United Technologies deciding that breaking up is easy to do. Once there was comfort in diversification, but now it appears diversification can be had for the price of a low-cost Exchange Traded Fund. Strategic focus is the new drumbeat coming from street analysts and eager to please, quarterly returns focused CXOs.
China Steps Back – For the Meantime
What about other competitors? You can count out China Inc., and it’s not just the trade wars in this case. If the Huawei incident isn’t chilling enough for cross-border capital flows, China stung itself by hanging its own champions out to dry. Dalian Wanda for example was over levered and apparently under-represented in the CCP. Half a decade into a power consolidation putsch disguised as an anti-corruption campaign, the most outbound and adventurous of Chinese companies are retrenching inward to protect the family silver. Suffice to say, lending for Chinese acquirers of U.S. assets has been hard to source.