When dry powder meets interest rate rises

The real wildcards, exposing dealmakers to potential risks, are unrelated to Fed rate rises, write Paul Aversano and David Evans of Alvarez & Marsal.

The Federal Reserve may hike interest rates twice more this year, after raising them a quarter-point in March. The evidence for this comes from the minutes of the Open Market Committee, released in early April.

It would be tempting to interpret these increases as the end of the latest era of cheap money – something that helped spur global M&A activity to record heights last year, which was a momentous year for deals and dealmakers. Three rate rises would surely stymie dealflow and put the brakes on a bumper 2017.

And yet M&A and private equity professionals, who have been making the most of cheap debt to fund deal activity, are taking the Fed news in their stride.

The reasons for this sangfroid are several.

After hoarding capital to weather the economic downturn after 2008, many corporations and private equity funds now have far too much on their books. Flush with cash – a situation compounded by easily available and cheap leverage – they are under enormous pressure from investors to deploy this dry powder to drive above market returns.

This is especially true of industries such as technology and healthcare. Private equity funds specialising in these sectors will be anxious to ensure their portfolio companies are on the right side of trends towards consolidation and increased regulation.

The result is that even non-core assets become increasingly attractive – and competitive – targets. Many global private equity investors are keener than ever to identify potential targets early on in the deal process, and get due diligence work done ahead of the curve.

Added to this, the dollar remains stronger than many other global currencies, providing a continued incentive for dealmakers to engage in cross-border deal activity.

The real wildcards in play – the factors exposing dealmakers to potential risks, and dealmaking to a potential cooling period – are unrelated to Fed rate rises.

The strength of the dollar may be pushing dealmakers towards cross-border deals, but political populism has created headwinds for these transactions. International mergers and takeovers afford media-savvy politicians the opportunity impose capital controls or block acquisitions on regulatory grounds.

For now, these risks do not appear to be dampening the appetite of dealmakers – favourable market conditions beyond the interest rate environment, combined with pressure on corporations and the private equity market to transact, are likely to keep market professionals busy until at least the end of the year.

It remains to be seen whether this activity will exceed the giddy heights of 2016. After all, a raft of national elections across Europe and beyond represents just one of many known unknowns in the coming months – but we can be confident that the Fed’s rate rises will do little to dent market enthusiasm.

Paul Aversano and David Evans are managing directors in Alvarez & Marsal’s transaction advisory service.