Inflation lingers as a potential risk to the robust rebound in M&A sending deal multiples and dealmakers alike to new heights. As private equity investors look to safeguard their portfolios, Mergers & Acquisitions sits down with 3i’s co-head of North American private equity Andrew Olinick to discuss the risks and opportunities presented by a potential rise in prices. One insight: due diligence is increasingly important to mitigate risk.
“There’s various degrees of companies impacted by it. Some companies are naturally hedged, able to pass through price increases and are in a bucket that’s pretty safe from inflation,” Olinick says. “On the other end of the spectrum, we don’t have many of these companies in our portfolio, but we are mindful of inflation as we conduct due diligence on potential new investments.”
Heightened scrutiny of acquisition targets’ ability to pass through costs could impact deal flow. Private equity has historically pulled back on multiples paid for assets during high inflation environments, potentially creating a wider bid-ask gap between buyers and sellers.
A gut check on the magnitude of the issue is in order. Market makers continue to debate whether an uptick in the consumer price index will be transitory or persistent, and whether the Federal Reserve will be able to tame a sticky rise in prices. The market may well have room to test resilience levels given deal pipelines hitting new thresholds.
“We’re watching closely to see how much is temporary and how much is permanent?” says Olinick, who also leads 3i’s global business and technology services team. “Lasting inflation won’t immediately stop all deal flow–it’ll cause firms to readjust and see how well companies can pass along costs. Some spaces like healthcare and business services are protected from inflation; those might see more interest.”
Those sectors have already attracted strong private equity interest. Fundraisings have hit record levels, with healthcare-focused funds now routinely oversubscribed.
“Interest rate inflation is something we’re watching as well that can have an immediate impact if rates were to go up quite a bit,” Olinick says. “There continues to be a lot of money in the leveraged loan market but we’re proactively going through our portfolio companies and preemptively hedging them against any shift in the rate curve.”
The impact could take time to manifest, though, given tailwinds that have created a sellers market at least two years in the making. The effect of higher borrowing costs could take time to manifest, and be partially mitigated through earnouts that have already become more common.
– Brandon Zero
