Impact of macroeconomic factors on M&A
Raghu Marwah & Parul Goel
by Raghu Marwah and Parul Goel
Mergers and acquisitions (M&A) have a major effect on the world economy as a whole. As a significant tool, M&A helps organisations expand into new markets, diversify business activities, and achieve cost synergies through economies of scale. A whole host of macroeconomic variables, including interest rates, inflation, market sentiment, and economic growth, are critical in influencing M&A activity.
Interest rates
Interest is the monetary charge for the privilege of borrowing money, typically expressed as an annual percentage rate. (Source: Investopedia)
In case of low interest rates, borrowing becomes cheaper, and it becomes feasible for companies to finance transactions through leveraged buyouts. Higher interest rates discourage companies from engaging in such transactions, as the valuation goes for a toss (becomes of little to no value) because the discount rate used for valuing the company is affected by prevailing interest rates. In such scenarios, companies start opting for a different capital structure consisting of more equity than debt. Companies with strong reserves and surplus tend to pursue acquisition in such a scenario.
Inflation
Inflation is the rate of increase in prices over a given period of time. (Source: International Monetary Fund)
As inflation rises, businesses' input, labour and operating costs rise as well. Profit margins may decline as a result, which may lower the valuation of prospective targets and make them less desirable acquisitions. Different industries respond to inflation differently. Because they can pass costs on to customers, utilities and consumer staples, for instance, might do better than discretionary industries.
Market sentiment
Market sentiment refers to overall perception of investors towards a market.
Valuations can rise as a result of positive sentiment, which also motivates businesses to make aggressive acquisitions in order to expand their operations. Conversely, negative sentiment can lead to decreased values and increased risk aversion, which hinders M&A activity and makes funding more difficult. Furthermore, regulatory agencies may scrutinise planned mergers more closely during pessimistic times, making clearance procedures more difficult.
Economic growth
Economic growth refers to an increase in the size of a country's economy over a period of time. The size of an economy is typically measured by the total production of goods and services in the economy, which is called GDP. (Source: Reserve Bank of Australia)
Times of economic growth are usually when businesses enjoy good profitability ratios, increasing market confidence to pursue deals in a bid to gain market share and to profit under prevailing market conditions.
Strong economic growth drives higher valuations of acquisition targets and facilitates access to capital. However, during times of economic recession, stability and cost-cutting concerns tend to dominate.
In essence, M&A activity is highly cyclical, often peaking during periods of economic expansion and lower interest rates, and slowing during downturns. Macroeconomic factors create a foundational backdrop that companies must navigate, making them crucial considerations in M&A strategy and timing.
Raghu Marwah, a qualified Chartered Accountant with a Bachelor of Arts (Economics), joined the RNM team after having gained experience at one of the Big 4 firms. He specialises in advising and rendering consultancy services to clients in relation to structuring strategic investments, offshore structuring, cross-border holdings, M&A, and valuations. Contact Raghu.
Parul Goel, a graduate with a Bachelor of Commerce (Honours) from Delhi University and having completed two levels of the CFA program, is an analyst at RNM Capital Advisors. She works with startups and family offices in various areas like strategic investments, valuations, M&A, and cross-border transactions. Contact Parul.
Established in 2009, RNM Capital Advisors (RNM) is a mid-market focused boutique investment banking firm. RNM provides advisory services to its clients across sectors and geographies in the area of mergers & acquisitions, joint ventures/collaborations, fund mobilisation, restructuring & turnaround, valuations, due diligence, India entry, family office, alternative investments and other allied corporate finance matters.
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