Q1’24: Understanding the Link: How Interest Rates Influence Mergers & Acquisitions by Financial Investors
Traditionally, financial investors like private equity funds and venture capital firms have played a big role in shaping the market dynamics of mergers and acquisitions (M&A) across many industries. If the acquisitions are funded by debt through a Leveraged Buyout, however, the acquisition valuation is sensitive to the interest rate environment as current rates drive the cost of capital that is necessary to finance the transaction. This isn’t to say that strategic and corporate acquirers are not impacted by the interest rate environment - they are. But strategic buyers generally have multifaceted rationale for acquiring another company based on its existing or future products, perceived economies of scale, or navigation of their competitive landscape that extends beyond the acquisition’s pure financial return.
As Rates Rise, M&A Activity Drops
Not surprisingly, as interest rates have risen precipitously since 2022, there has been a significant decline in the M&A activity among financial investors. Expectations for declining rates have shifted as the Federal Reserve plans to maintain higher rates longer due to persistently high inflation.
Source: IMMA: Institute for Mergers, Acquisitions, and Alliances, St. Louis FED Economic Data
We can see, with the exception of the market freeze during Covid lockdowns, that when interest rates were extremely low, M&A activity by financial investors increased rapidly and stayed elevated at between $400-$630 billion in quarterly acquisition volume. Since then, deal volume decreased to less than half that amount and was only $180 billion for the first quarter of 2024.
For companies hoping to be acquired in the near future, there is reason to be optimistic. EY-Parthenon predicts a gradual recovery in private-equity backed M&A through the second-half of 2024. Companies that have low-leverage, strong cash flow generation and robust EBITDA growth will be particularly attractive acquisition candidates.
Understanding the macroeconomic environment and making strategic investment and operational decisions today will prepare your company to take advantage of accelerating acquisition activity when interest rates and the cost of capital begins to decrease. The team at Keene Advisors offers deep strategic and financial analysis and planning to optimize your team’s performance and prepare for future inflection points. Contact us today for a complimentary consultation and we can discuss how to tailor solutions to meet your company’s needs.
Disclaimer: This commentary is intended for general informational purposes only. Keene Advisors does not render or offer to render personalized financial, investment, tax, legal or accounting advice through this report. The information provided herein is not directed at any investor or category of investors and is provided solely as general information. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action. Keene Advisors does not provide securities related services or recommendations to retail investors. Nothing in this report should be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product.