In the 1930s, John Maynard Keynes famously identified what he called “animal spirits” as a major driver of increased consumer activity, entrepreneurial risk-taking and investment — and the resulting economic prosperity.
In today’s world these animal spirits are heavily influenced by what we call “visibility,” or the ability to forecast the future. A lack of visibility leads to dampened animal spirits – and reduced consumer spending, business investment, and hiring.
Impact on M&A
When it comes to selling your company, the animal spirits of buyers are especially sensitive to visibility,or the ability to forecast future economic conditions and your company’s performance. Less visibility means more risk for the buyer, a lower valuation for your company, and fewer successful deals.
The consensus is the lack of visibility is one of the major reasons for lower than expected mid-market M&A activity over the past two years. According to Marshall Sonenshine, Chairman Sonenshine Partners, LLC, there is a lack of conviction about the future performance of companies in the present uncertain environment. “You need to be able to project corporate earnings in order to do deals, and right now there is still low visibility.”
Tobias Levkovich, Chief U.S. Equity Strategist at Citigroup Inc., agrees after talking with a number of M&A bankers and hearing the same thing. He adds that even though the cost of capital is low there just isn’t that much confidence in the future.
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Cost of Money
Along with animal spirits the cost of money for making deals is another very important M&A driver. In response to a Bloomberg interviewer’s question, Sonenshine explained that buyers are normally more aggressive when anticipating higher interest rates. But in 2013 everyone understands that rates are being held down because of Fed policy in the face of continuing economic uncertainty. Sonenshine says this is another form of the same visibility challenge in predicting future company performance has been slowing M&A transactions.
This irregularity in buyer behavior highlights an unintended consequence of the Fed’s program of quantitative easing. A recent Financial Times report provides an excellent article on how artificially low interest rates and the Fed’s expected tightening have hurt M&A activity over the past several years.
One reason for this dampening effect is that cheap money is driving valuations up now,but buyers know this will no longer be true when the Fed tightens and the cost of capital increases for the next buyer. FT quotes a banker saying, “When private equity firms consider potential deals, one of the first considerations is where the 10-year rate is and where it will be in five years’ time when it is time to let go of companies bought now.” This combined with poor visibility an uncertain political and economic environment, has prevented M&A activity from returning to pre-2008 levels until now.
Positive Signs for 2014
There are several reasons to hope that this situation may well improve in 2014. The first is that in spite of increased payroll taxes, ACA, the government shutdown, and sluggish international growth – the U.S. economy seems to be continuing its modest growth. Most economists believe that 2014 GDP growth will be in the range of 1.5 to 1.75, with some predicting even higher growth based on the most recent employment figures.
Some analysts also believe M&A activity will improve based on the continued rise of stocks, and the fact that corporate and private equity coffers are full. Another reason to expect improvement, revenues aren’t growing for most companies in the new normal, while operational improvements have been made, leaving acquisitions as the best way to grow earnings.
Assuming we don’t experience another government shut down, and with a little help from the Euro zone,there is reason to hope that the strength of the economy will overcome present fears over Fed policy.At that point, according to Mark Bradley, co-founder of boutique investment firm DBO Partners in San Francisco, “buyers and sellers will have more of a shared view of the future (read visibility) and the markets will become more stable.”
Robert Albertson, Director of Investment Strategy of Sandler O’Neil & Partners believes M&A is brighter spot in capital markets right now because there are more realistic discussions between buyers and sellers. And, there are other signs that animal spirits are on the rebound. According to Goldman Sachs M&A there is evidence that CEO’s are shifting to more Strategic Investments. They believe that what is needed to generate significant M&A activity in 2014 is a period of reasonable political and economic stability.
Let’s hope that stability comes about and the September SIA Staffing Industry Forecast of an increase in U.S. staffing industry growth of 5 percent for 2014 turns out to be on the low side.
All of which will happily lead to better visibility, a further boost in animal spirits- and more buyers to your door in 2014.
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