Rising interest rates and higher prices are affecting the valuation of companies. Inflation in the eurozone might have fallen slightly from its peak of 10.6% in October 2022, but companies are still feeling the pain.
After all, today’s inflation figures reflect the rate of change from a year ago, when prices had already started to rise in reaction to Russia’s invasion of Ukraine and the lingering effects of the pandemic. Supply chain disruptions, labour shortages, strong demand, high energy prices and government stimulus have all contributed to the rise in inflation.
Central banks around the world have responded by hiking interest rates, which may work to slow down the rise of prices, but also causes pain on businesses and individual borrowers. This has encouraged fears of a slowdown in economic growth.
It’s no surprise that company valuations have weakened in this environment, especially for businesses with negative earnings. While corporate equity is often considered inflation-proof in the long run, that’s only true for companies that survive the short-term effects. In practice, investors place a lower value on corporate cash flows when prices are rising, creating significant stress for many businesses.
This has created a buyer’s market in the M&A space, which can be seen in Dealsuite data that shows investors are paying lower EBITDA multiples. This is especially true for smaller companies.
Economists have dedicated entire careers to understanding why this happens, but the general process is clear. Inflation’s biggest threat to shareholder value lies in the inability of most companies to pass on cost increases to their customers. When businesses can no longer absorb these rising costs, cash flow is inevitably affected, resulting in lower valuations.
All things being equal, companies need to produce higher cash flows just to maintain their valuation.
Finding a better deal
There are ways for sellers to reduce this effect in M&A deals. Despite low market valuations, companies can find better deals by casting a wider net in their search for buyers — and the easiest way to do this is by seeking out cross-border opportunities.
M&A professionals who place sell-side mandates on Dealsuite gain access to a much bigger pool of potential buyers, far beyond what might be available in the home market or within a network of contacts.
A recent study by SPS found that most private equity firms only see 15% to 30% of relevant deals, and this drops to a coverage rate of just 9% for deals in the $10m to $250m range. The most common approach to avoiding M&A FOMO is still focused on building relationships and networks.
With Dealsuite, M&A advisers can improve these odds by tapping into a network of like-minded professionals who are motivated to close deals.
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