Aug 29, 2022 - Economy

Dealmakers wince at Jay Powell's "economic pain"

Photo illustration of Fed Chairman Jerome Powell casting a shadow on a stock chart

Photo illustration: Sarah Grillo/Axios. Photo: Brendan Smialowski-Pool/Getty Images

Fed chair Jay Powell on Friday warned of coming economic pain, causing dealmakers to wince.

The big picture: Conventional wisdom is that sellers retreat in rising rate environments, as valuations contract. Particularly after such a long bull market in which growth trumped fundamentals.

  • Lenders also are on their heels, having already been swamped with committed financing before Powell shoved them underwater.
  • And we've clearly seen a slowdown, with U.S. M&A volume down 39% year-to-date and U.S. private equity volume off 25% (per Refinitiv).
  • "I think private equity activity of 2018-2021 was the weird period, not the moment we're in now," one top PE exec tells Axios. "This is a more healthy environment, where money has real cost."

Plot holes: Private equity investors who spoke with Axios tend to agree with the conventional wisdom. Several, however, provided a lengthy list of caveats.

  • Some was "we've seen this movie before" stuff. For example, how private markets tend to lag public markets or how some sellers will proceed with auctions due to fears of future prices being even lower than current ones.
  • But most was about how 2022 is a new narrative, because of how deal markets have evolved since the last time rates rose (or were even quasi-high).

The most significant change is that private capital markets have moved from the cottage to the compound, with dry powder now measured in trillions.

  • "People want to do deals because so much money has been raised," one veteran investor explained. "No one's expecting a financial crisis, so people feel they can model around speed bumps. That may cut into IRRs five or 10 years from now, since multiple expansion has helped people do really well over the past few years, but it keeps the funds and fees flowing."

This goes beyond supply and demand. The nature of deals have changed, with the industry diversifying beyond vanilla LBOs in sectors like industrials and toward higher growth areas like tech and healthcare.

  • The upshot is that some PE firms already are comfortable with minority stakes (including PIPEs) that may not need as much lender involvement, or buying from other sponsors via transactions in which debt can be rolled over. Or with simply over-equitizing deals and hoping to refinance later.
  • Many firms also are dominated by investors who came of age after the financial crisis, let alone actual inflationary periods.

The bottom line: Deal activity is slowing, but still will move faster than history books would suggest.

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