PE and Rising Interest Rates
Our clients often ask us about “topics du jour” and their impact on their specific businesses, our industry, or both. With the pandemic, it was all about working remote, the return to the office, and now, working hybrid. Ditto for events, a high-profile topic we’ve been benchmarking and researching. Ditto also the Great Resignation and research on best practices for responding to it, or better yet, being proactive.
So, it was no surprise when we started getting a spate of inquiries on higher interest rates and their impact on valuations and PE investment. As it turns out, Outsell just participated in a panel at our partner JEGI CLARITY’s event this past week, getting an up-to-the-minute view on the answers to these questions. I asked our lead consulting partner Andy Jacobson — an Outsell Leadership Council co-chair and an experienced industry CEO and PE investor who covers these topics for us — what he heard and what his take was on the questions we are getting, which include the following:
- What’s happening to PE investment with rising interest rates?
- Has the current situation changed supply dynamics or investor dynamics at all?
- Is it impacting valuations?
- What about strategic versus PE or PE supply?
Andy told me that the topic of the impact of rising interest rates on PE investment came up at the event last week. The general thrust was that rising rates themselves are not yet having a big impact, but there were several key considerations, which he shared:
- There is so much competitive debt out there. If banks pull back, there are lots of non-bank lenders, unitranche players, and mezzanine to step in where needed.
- The huge overhang in PE capital combined with plentiful debt capital has led to a situation where PE has been over-equitizing for a few years and being picky about what debt they want to add to the balance sheet. This means that there’s a long way to go before leverage is an issue — basically, PE still has plenty of flexibility and room to maneuver even if rates rise.
- The general consensus seemed to be that PE continues to have an edge over strategics because they have the capital to outbid strategics and the speed to move more quickly in most cases (we heard from both strategics and PE firms at the conference). Some strategics have the infrastructure for quick, decisive M&A activity and can successfully compete.
- Even if the Fed raises rates 400–500 basis points — they’ve raised 75 bp so far — that will only get us in the 5% range that we were in during the big expansion in 2005–2008 (when the economy grew a lot, even in the face of those rising rates) and during the late 90s boom (5–6%). It is far removed from what we saw in the 1970s and 1980s. How far the Fed can raise rates and avoid a recession remains to be seen, but many who were participants in financial markets in prior cycles (PE and lenders) aren’t yet getting worked up. Rates have impacted the stock market, particularly tech stocks. Equity market volatility remains high — as evidenced by the big swings in the last few days — and it seems like anything could happen.
- Lower public equity values are likely to spread to private market valuations, which could provide a little relief from the sky-high valuations we’ve seen. That means PE firms could hold onto assets longer and actually step up acquisitions. Some PE speakers at the conference joked that they weren’t too bothered by lower valuations and that the only ones who consistently benefited from higher and higher valuations were investment bankers! On the investor side, there could be a redeployment away from equities and alternative strategies. PE firms certainly need to think about what impact this will have on LP perceptions and expectations, but it might be too early to gauge this.
- Some companies say that they will delay going to market as they see valuations declining. Others are rushing to market sooner to beat potential future drops or higher rates. There still seem to be plenty of deals in the pipeline.
- Summary thought: By historical standards, valuations are still high, and interest rates are still low. However, volatility — given inflation, supply chain challenges, geopolitical risk, interest rates, and shifting stock and bond markets — is the watch word.
If you’re a CEO or board member operating in the data, information, and analytics economy, we have your back. When you have questions, give us a call — that’s why we’re here. Knowing that one CEO had the questions above, we decided to publish a response more broadly because we figured the odds were that others were wondering the same.
What else is on your mind? For OLC members, Andy is hosting our quarterly M&A Trends Topical Forum on May 25, covering the Company, Contact & Personal Information, B2B Media & Business Information, Marketing Intelligence, and Legal & Regulatory Solutions sectors. Register today! Not an Outsell member yet? Contact us about joining Outsell to get advice from experts like Andy at our M&A forums as well as a host of other membership benefits.