Mergers and acquisitions are Wall Street's bread and butter. When companies combine, or one company buys another, it creates opportunities for investors and banks to make money by providing advice or finance for the transaction.
But M&A activity has dried up over the past year as dealmakers contended with rising interest rates and fear of a recession — investment banking powerhouses Goldman Sachs and Morgan Stanley both reported substantial drops in revenue and profit at the end of last year.
Things were beginning to look up again earlier this year as dealmaking appeared to be resuming, but market uncertainty around the self-imposed debt limit and the possibility of a US default has put the kibosh on a comeback.
Before the Bell spoke with Mitch Berlin, EY Americas vice chair, Strategy and Transactions to discuss the effect the debt ceiling drama is having on dealmaking:
This interview has been slightly edited for clarity.
Before the Bell: M&A activity was incredibly low in 2022 and banks suffered as a result. What changes did you see in early 2023 and what brought them on?
Berlin: The back half of 2022 saw a drop off in dealmaking as interest rates rose and valuations stayed elevated. M&A continued to be sluggish coming into 2023 as companies balanced persistent inflation and the high cost of capital against growth and employment, but we were seeing some uptick at the end of the first quarter with March deal value totaling more than January and February combined. Companies are now finding financing difficult due to tightening credit conditions from stress in the banking sector and an uncertain economic outlook, especially the risk from a debt default. Given the difficult financing from traditional sources we expect to see an uptick in private credit.
How does the possibility of default threaten to once again hurt M&A? How bad would it be for the market? Even if a deal is made in the 11th hour, will we see M&A suffer?
Uncertainty around the debt ceiling is threatening to stall any momentum in the M&A market. Building a thesis around deals is already quite difficult given the lack of predictability in the economy, and the growing threat of a default is already challenging the economics for any deals in the works and delaying timing for deals to finalize. If the debt ceiling is not raised within the next few weeks, dealmaking will largely be put on hold and it could set M&A dealmaking back to the lows of the early pandemic or worse.
What impact does this have on the broader economy? Why should Main Street care about what's happening on the upper floors of Goldman?
It's hard to predict all the ways a default on US debt would challenge our economy since we've never experienced one, but a failure to raise or suspend the statutory debt limit would trigger severe financial market turbulence that would be widespread and devastating. Main Street is already showing signs of distress with record credit card debt and declining savings, and, according to our EY economists' estimates, a default from not raising the debt limit would result not only in a hit to real GDP of around 5%, causing a self-inflicted recession this summer, but also cost the economy around 5 million jobs.
Is there a pipeline for M&A just waiting to open up when conditions get better? When could that be?
There continues to be a need to transact to transform in this challenging economy. Many companies have stronger balance sheets than they did pre-pandemic and are closely following any declines in target valuations to find strategic and transformative acquisitions, and private equity continues to explore opportunities and build a pipeline but won't pull the trigger until the valuations reconcile to the increased cost of capital. We're expecting a recession that is moderate yet still difficult in the second half of the year, but if we avoid a debt default and the Fed holds rates at current levels for the remainder of the year like we expect, we could see the M&A market start to really recover in Q4 and into early 2024.
Comments
Post a Comment