Rising Interest Rates… What does it mean for M&A in 2016?

For the first time in nearly a decade, the Fed raised its target funds rate. This is not a surprise as the Fed has been signaling this action for months and the “zero” interest rate environment couldn’t last forever. Given easy credit has often been identified as a driving force for the premium values paid in M&A deals over the past couple of years, prospective M&A participants are asking “what does this mean for my process”. Two facts support that this will have little to no impact on M&A values in the near term:

• The rate hike was expected and helps to take some of the uncertainty out of the market
  While current rates do impact lending activity, the anticipation of a change in rates itself also has a material impact on pricing and activity. Since the rate hike has been expected for several months, albeit with uncertain timing, many lenders were already accounting for the increase. Other lenders that were not pricing in an expected rate increase were being more cautious in their approach given the uncertainty. This announcement brings clarity to lenders and removes some of the dreaded uncertainty in the market. Although the picture is more clouded today by the uncertainty around the Fed’s next move, the near term impact will likely be de minimis to M&A participants.
• The Rate increase was small – just .25%
  The quarter point increase in the target rate is tiny and brings the target range from 0% – 0.25% to 0.25% – 0.5%. By contrast, the last time the target rate was raised, in June of 2006, it was raised to 5.25% more than 10x higher than the top end of the new range (0.5%). Additionally, more important than the rate itself is the speed at which the rate increases. Since the Fed is looking to both avoid rate shock as well as calm any deflationary fears, the pace of rate increases will likely remain slow. Bottom line, rates are still incredibly low by historical standards and will continue to be for the foreseeable future.

While we do expect some of the large cap M&A deals to be impacted by an increase in rates, particularly those using junk debt (for example Dell’s $66 Billion acquisition of EMC), we expect no impact on deals around the growth companies we represent. Further, although the US economy may be strong enough for tighter monetary policy, growth is not yet robust and M&A still represents one of the key avenues for growth. A look back on previous periods of measured rate hikes shows that M&A is able to thrive as most buyers (especially strategic) remain active and even in a downside scenario, more sellers are driven to the table. In some instances the stronger US dollar has even led to a frothier market for firms with assets and operations abroad. Finally, the record levels of cash on Private Equity balance sheets provides a sufficient buffer to any short term hesitation around rising rates.