Forrest Tefft, head of corporate finance at Northwest Bank, has been in the investment banking business for more than four decades. He’s seen his share of unusual financial times, but nothing quite like what we’ve recently witnessed. Last year saw record deal activity and valuations, and Tefft says two main factors played a role in that.
“There was record liquidity within all the capital providers from private equity firms to commercial banks,” Tefft says. “In fact, the latter of which had exceedingly low loan-to-deposit ratios, averaging 80 percent or less, plus capital to deploy and shareholders who wished it to be deployed. Then the second factor is there were very few alternatives, and those alternatives — in terms of deploying capital — had low returns quickly for cash and short-term investments.”
The result of low alternative returns led to investment in hard assets across the board. That, he says, could be seen in the valuations of firms being acquired as well as with homes, and new and used cars.
“There's a great emphasis on acquiring hard assets,” Tefft says.
In addition to those acquisitions, businesses are rethinking their growth strategies as a result of geopolitical unrest in Ukraine and supply chain issues.
“There's a greater emphasis on vertical integration as companies look to gain more control over their operational resiliency,” Tefft says. “Furthermore, an analysis of the underlying supply chain is playing a larger role in the due diligence process. A weak supply chain would create significant financial risk for the acquirer, lowering valuation.”
Globalization used to be the common buzzword in M&A. Today, Tefft says, that has changed to “near sourcing,” where companies prefer to have their supplies come from stable countries that won’t be dependent upon lengthy overseas shipping. He used Volkswagen as an example.
“They’re going to deemphasize, at least on the supply side, globalization and emphasize near sourcing,” Tefft says. “No doubt that decision was influenced by the fact that they had several key suppliers of component parts of their products that are located in the Ukraine and Russia.”
In evaluating a possible acquisition, Tefft says there are still the traditional considerations of market share, proprietary product, management strength, customer relationships, predictable and recurring cash flow, and growth within that sector.
“However, I think there are simply new and more considerations that impact valuations,” Tefft says. “One would be geopolitical risk, and outright avoidance of autocratic countries such as Russia and China. A second would be supply chain and transportation bottlenecks. Adequate staffing is clearly an issue. However, my own experience would suggest that there is an overriding trend that is to buy American.”
To the latter point, he says within the bank’s client base, both clients and the firms that they wish to acquire or merge with, there’s a trend towards buying American.
As mentioned, buying hard assets and high evaluations have been common, but Tefft doesn’t believe that is sustainable.
“What will be interesting to witness is if there’s an outright correction like there was in late 2008 and (2009) and into (2010), which impacted housing valuations and, of course, equity valuations as well,” Tefft says. “There’s still a great deal of liquidity in the marketplace and if there is a correction, I think it will be a relatively mild one. But we’re going to go through a relatively bumpy road here the next 18 months.”
Tefft spoke on the Smart Business Dealmakers Podcast about how M&A has changed through the pandemic and a challenging geopolitical climate. Hit play to catch the full conversation.
