The extent to which inflationary fears are impacting dealmaking is still hard to measure, but about a month into an uptick in prices, some patterns are starting to emerge: buyers are targeting “inflation-proof” sectors, portfolio companies strategically hedge interest rate exposure, and private equity dealmakers continue to monitor the market for signs of persistent price inflation. VSS Capital Partners’ Patrick Turner talks us through potential impacts.
Driven by high food and energy costs, consumer prices increased 5.4 percent in June from a year earlier, the biggest monthly gain since August 2008, right before the financial crisis, according to U.S. Labor Department data. Excluding food and energy, inflation increased 4.5 percent, the largest move since September 1991.
“We’re not producing [products], we’re providing services,” said Turner, explaining the limit of an uptick in input prices on his firm’s portfolio. “So where inflation comes in with that is really about personnel; we don’t have issues with products themselves.”
That wage inflation has yet to manifest in VSS’ business services milieu, insulating the firm from potential fallout. It’s a view echoed by 3i’s co-head of North American private equity Andrew Olinick in an interview last month. Back then, Olinick noted that 3i’s business services-tilted portfolio was in a position to pass along price increases to consumers, though the firm was also increasing due diligence efforts to analyze exposure to inflationary pressures from new targets.
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. In June, the personal consumption expenditure index rose less than expectations. The market may well have room to test resilience levels given deal pipelines hitting new thresholds.
Add to the mix soaring deal valuations, and buyers potentially walk a narrow line between growing and fighting to maintain margins.
“Will values come down?” Turner queries, “I do see so many competing firms in the upper middle market, higher market, so when we find deals in that space they’re still paying those high prices. And so, multiples have been really high compared to historical norms, so is that sustainable? Or is that an aberration? And do you come back to a norm of 12-15x? That’d be the question.”
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.
