As the pandemic eases into its next stage and more businesses hope to get back to normal, inflation is an increasingly important consideration, especially for companies considering M&A. Classic monetary policy suggests that rising inflation can be best managed by increasing interest rates. This makes saving more attractive than spending, which can potentially slow a hot manufacturing M&A market with rising prices. Debt financing will likely become more expensive, making higher multiples more difficult to achieve. But does classic monetary policy apply in today’s market? Here’s what we’re seeing in the manufacturing M&A space.
We have some indication that the traditional model deserves skepticism. This current upswing is not cyclical. The shock of the pandemic put brakes on the global economy, and there’s reason to believe that current inflation is not inflation at all, but reflation that brings us back to a prior state.
Another reason for optimism is the type of inflation we’re seeing. The pandemic massively disrupted supply chains, and many of the issues we are witnessing is associated with those disruptions rather than a real increase in systemic prices. The lumber shortage is one such example. While everyone was talking about a lumber shortage a few months ago, it seems now to have mostly resolved. Cars are another example; a pandemic renders mass transportation problematic, feeding a boom in car purchases. As demand retracts, so too does the inflation it triggered.
Additionally, the Fed has mad clear it is not as determined to prevent inflation as it has historically been. This may be due to a sense that the natural inflation rate was unnaturally suppressed in prior years. It could also be because fewer dollars are tied up in fixed investments, inflation poses less of an overall risk to high savers and retirees.
Perhaps most critically, it is likely that finance markets can absorb a significant share of rate pressure before financing M&A grows sufficiently expensive to affect the market. Most M&A financing nowadays comes not from traditional banks, but from hedge funds, family offices, sovereign wealth funds, and other non-bank lenders. They may be able to continue lending at historically low rights, absorbing lower margins than we have witnessed in previous inflation cycles.
For now, it is frankly uncertain what the extent of inflationary pressures will be on M&A, nor whether the Fed will take action, how such action might affect markets, or even what level of pressure inflation is truly exerting on the manufacturing market. This gives manufacturers significant reason for hope: while things are tight, they may not be as bad as they seem. Hope means opportunity, and in an otherwise booming M&A market, investing in M&A may still be a wise strategy.