EMC’s Spring Valuation Series – 3. How are market conditions effecting business valuations?

Natasha Askaroff | April 23, 2018

In this third instalment of our Spring valuation series, we discuss the current marketplace and consider how important government policy and macroeconomics are to business. Links to the two previous articles can be found below.

As corporate finance advisors, one of the questions we are most frequently asked is about the current state of the marketplace.

A post-Brexit Britain is starting to take shape. However, there is still a huge amount to be negotiated which naturally breeds market uncertainty. One of the widely expected outcomes of this uncertainty is economic slow-down in the short-term. Historically the M&A market correlates closely with the overall economy as acquirers become more risk averse and valuations fall due to decreased confidence in future business performance. Despite this, the second anniversary of the referendum is nearly upon us and the UK M&A market has proven to be robust. Deal values are at record levels and although deal volumes are down, it is by a much smaller margin than many forecasted.

Over the last 18 months, one of the sweeteners for UK vendors has been the exchange rate fluctuation. It has well-known consequences for importers and exporters trading abroad, but there has been an added bonus for UK targets and their overseas acquirers. The softening of the Pound meant that UK targets become cheaper. In essence, your Euros or Dollars bought more Pounds. This meant that deals were agreed between overseas buyers and UK sellers where previously the value expectations between both parties would not have been aligned. The movement in exchange rate also meant that overseas acquisitions for UK-based buyers were more expensive, so for those wanting to buy, a target based within the UK was comparably much better value. Over the last month we have seen this position softening as rates have rebounded.

Interest rates are a hot topic with talk of a potential rate rise in May and another in the Autumn. When interest rates were moved to 0.5% in 2009, the aim was to encourage spending and borrowing. From an M&A point of view this has been influential in the deal volumes over the last decade. Corporates and Investment Houses have been sitting on cash reserves (generating low returns in the bank) while any short of cash were able to borrow at competitive rates. At a time when organic growth has been hard to come by, strategic acquisitions have helped many to maintain growth.

While any rate rises will be gradual, we expect them to have a rippling effect on the marketplace. A concern for owner-managed SMEs looking to exit would be that the number of businesses interested in M&A could reduce, given that it would be more expensive to leverage transactions, and trigger an expectation that organic growth should be more achievable. Higher interest rates inevitably result in lower values.

Of course, the alternative (and more optimistic) view might be that increased personal savings will lead to an increase in the finance available to Private Equity. But it is hard to imagine that this would compensate for the reduction in trade buyers for owners at the SME level who are looking to exit.

In a cash rich, low interest economy there should be an increase in a business’s valuation due to the reduced risk of ongoing business performance. There should be strong appetite for acquisitions and the ones that complete should, hypothetically, be completed at a better price. However, in practice, one of the drivers in transaction value can be competition. With buyers aware that fewer people are interested in exploring M&A, they may feel that they can get a bargain so it is vital to ensure that you have more than one horse in the race.

If you have any queries or need advice, EMC’s valuation team are available to discuss with you on a strictly confidential basis. Call us on 01273 945984 or email michael.gibbs@emcltd.co.uk

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