Interest rates have an impact on a variety of factors — not just in M&A, but in business in general. That's causing businesses to develop strategies to minimize the impact of those rising rates to avoid a liquidity crunch.
John Erkert, CFO of IPEG Industrial Group | Piovan North America LLC, says pricing has been one focus for his company. They have raised prices four times in the past few years, partly in response to inflation, but their vendors also have been raising their prices, so they're trying to stay ahead of that curve and avoid margin compression. Though they did experience some margin compression last year, at the beginning of this year they were experiencing some margin expansion. So, he says, there is a lag to some of these price increases.
"Companies try to really pay attention to that with their operating cash flows during this kind of environment," Erkert said during the Pittsburgh Smart Business Dealmakers Conference. "Of course, using tax planning and some structuring that we use within the Piovan Group is important in this type of environment, with the uncertainty as well."
Managing working capital is important in any environment. But with the supply chain issues of the past couple of years, inventory has gone up for many companies. So, trying to manage inventory cash flows and payable cash flows and customer advances is prudent.
The flip side of the interest rate swap environment is the potential to use the movement of the dollar compared to other currencies.
With the acquisition of IPEG by Piovan, a European company, the acquirer was able to secure a loan in Euros at a very low fixed interest rate. They then pushed a good portion of that Euro loan down to Piovan North America, taking some of the proceeds in Euros and getting them into dollars to pay the sellers of IPEG. By paying the Euro loan back to the parent company, they're able to buy Euros at $1.10 or even $1. So, both on the way down on the European side and on the way back up for the U.S side, the repayment in dollars, he says, has led to some incredible rate gains this year.
"I wouldn't call it hedging, but to some extent, it's just been good timing and good luck," he says.
From an M&A perspective, in this environment, he says he's still seeing a strong flow of potential deals, though there has been some work on the structures.
"We're not seeing seller financing being a part of it, per se, but earnouts are still on the table," Erkert says. "And that's, to some extent, a form of seller financing, if you will. If it's a fairly certain earnout, you're just really delaying the payment of the purchase price."
But as far as multiples, they're still as high as they've been over the last few years.
"So, even though the interest rate environment is changing, we're not seeing that reflected in what sellers are looking for these days yet," he says.
The multiples being paid for companies is in part a matter of expectations, and the current expectations of the multiples, he says, have to come down.
"I don't think it's based on economics purely, or the weighted average cost of capital," Erkert says. "Of course, a weighted average cost of capital for us is impacting intangible valuations and impairment tests and things like that, with the interest rate environment going up. But as far as seeing it in deal multiples, of course, I agree there's arbitrage going in with somebody who has a multiple of 11 can buy somebody who has a multiple of nine and be very happy. So, I think that type of thing is going to continue, but I don't know if that's really driving it or if it's just a matter of seller expectations are still quite high."