Make A List, But Don’t Go Shopping Yet

Mergers and acquisition volume in 2021 was the highest on record. But acquisitions may not be the smart thing for business leaders in today’s economic environment. At some point in the future, though, having a shopping list already prepared will be wise.

The huge dollar volume of deals completed in 2021 reflected not only more deals, but higher dollar value per deal and in the aggregate. Recent economics have pushed asset values up across the board: stocks, bonds, real estate and private equity. The key factor is interest rates, though the strong economy helped out a great deal. Rising inflation may also have boosted the values of some assets.

Interest rates are rising around the world. In the United States, the Federal Reserve has started raising short-term rates, with plenty more increases to come. Some other major countries are also raising short-term interest rates. Long-term interest rates around the world are rising as global demand for credit increases faster than global supply of savings. With well-integrated capital markets, every major economy is tied to the worldwide trend. But each individual country has some room for variation from the global average. U.S. long-term interest rates have gone up more than most countries’ rates, reflecting our higher-than-average inflation rates. Also, the Fed in the pandemic aggressively purchased Treasury Bonds and mortgage-backed securities, but now they have stopped and will soon sell off a good chunk of their holdings. Interest rates across all maturities are headed up.

With higher interest rates will come slower economic growth, though with a time lag. Monetary policy takes about a year to impact employment, for example. (That’s a gross simplification but a ballpark figure.)

So in a year or two, interest rates will be higher and economic growth will be slower, with inflation starting to head down.

How does a business leader interested in growth play this cycle? Some years back the McKinsey consulting firm published an article, Learning to Love Recessions, reporting that the best-performing companies pursued acquisitions at different times than lower-performing firms. Most companies bought as the economy was growing and optimism was high. That was often when interest rates had been low. In contrast, the top companies in their global survey used the good times to strengthen their finances. Then, when a recession or slowdown came, they bought at low valuations.

This contrarian approach has been used not only by large corporations but by small business owners, including an Irish beauty salon owner. When the economy turns down, though, most business people turn gloomy. John Maynard Keynes wrote that “animal spirits” were a major factor in investment decisions because the actual calculation of value in the future is so uncertain.

Businesses are mostly in good times in early 2022. Profits have been strong, cash balances are high and borrowing costs are still very low. This is when the McKinsey report argues for building up a company’s financial condition. That means paying down debt and accumulating cash.

In a couple of years, economic growth will slow because of the high interest rates. General appetite for acquisitions will fade. Valuations of companies and their assets will drop both from weaker top-line expectations and a higher discount rate applied to future profits. In other words, acquisitions will be cheap.

Companies looking to grow will find good prices. But will they be ready? Writing a shopping list ahead of time will speed up decision-making at a time when speed may be very valuable.

An M&A shopping list can be specific or general. A CEO might think, “I’d like to buy Amalgamated Widget when I can.” The list can also include general criteria: mid-market hotels in Kansas, a spa franchisor, a steel fabricator serving logistics companies.

Having this list allows cheap activity to prepare for an acquisition. Specific companies can be followed, either through filings of publicly traded companies or business intelligence efforts. The CEO might get to know the CEO of a few possible target companies.

For less specific shopping list items, someone in the company should be tasked with learning more about which companies match the desired criteria. Investment banks or business brokers can also be consulted.

The shopping list can extend beyond companies to real estate and used equipment.

Being a successful business leader is partly about moving forward, and partly about biding one’s time. The move-forward CEO often has a personality that doesn’t wait too well. A good number-two person or advisor can help with that.

It’s not time for most companies to go shopping, but it never hurts to have a shopping list.