Experts Advise a Strong Economy Plus Rising Interest Rates Indicate a Time to Plan, Not Panic
HOUSTON, Oct. 9, 2018 /PRNewswire/ -- The expanding economy, low interest rates, and availability of capital have led to a dynamic business environment, robust M&A activity in Houston, and strong optimism among the middle market. Planning for an inevitable change in the market cycle dominated the discussion at "The Current State of Capital Markets" breakfast forum hosted Sept. 26 by BoyarMiller, a Houston-based business and litigation law firm.
"Our panelists expressed cautious optimism while sharing their insights about the capital markets," said Chris Hanslik, BoyarMiller chairman. "Here in Houston our business environment and M&A activity are going strong. Our panelists advised us that we need to plan and prepare for an expected market adjustment, although they stressed we should not panic."
The panelists included: Mark Montgomery, Houston Market CEO of BBVA Compass; Ali Nasser, CEO of AltruVista; and Scott Winship, Managing Director of GulfStar Group.
Strong Economic Environment
"We are in a late-stage economic cycle, which means we've gone through an expansion fueled by low interest rates, and reached four percent GDP growth," said Nasser. "Speculation about what happens next is on the minds of business owners. Economists expect we may see a recession in 18 to 24 months as the Fed increases interest rates. One thing about economists is they may have the right data, yet they often have the wrong timing."
BBVA Compass's Montgomery said that the national economy is strong, and Houston is on the verge of outpacing the economic growth of other Texas cities after lagging behind.
"We should see five percent GDP for the third quarter in Houston since oil prices have come back up," he said. "Regarding a possible recession, our economists suggest that it may be mid to late 2020 for a recession to kick in, but we don't have a crystal ball."
Winship agreed, stating that GulfStar is cautiously optimistic regarding the economy through 2020. "It is a very dynamic market environment right now and an excellent time for business sellers," he said. "Business owners just need to take into account the risks and unknowns, such as the impact of an increase in interest rates, that factor into the return profile for both strategic acquirers and private equity firms."
Planning for Change
The Federal Reserve announced in September that it is raising short-term interest rates by a quarter-percentage point, to a range between two and 2.25 percent, and that it will raise them again this year and through 2019 to align with a strong economy.
Nasser revealed three areas of focus for business owners to prepare for in an environment in which interest rates will increase and the economy could face recession.
"First, stress test your business. Determine what will happen if some of your customers or clients had financial difficulty or went away," he said. "Then, look at how a one to two percent increase in debt service will affect your financials. Lastly, liquidity is important. You have to have the appropriate capital in your company so you are not stretched. Prepare for the worst, but continue to participate in growth."
Winship said there is a definite correlation between a rise in interest rates, business valuations, and potential M&A activity. He predicts that with a "creeping interest rate environment" there would still be a lot of M&A activity in 2019 and 2020.
M&A Activity and Advice
According to Winship, robust M&A activity has historically occurred on a six-year cycle and the current cycle of activity has lasted eight years.
"Lending has been easy and cheap with terms and conditions that have been accommodative to borrowers and private equity firms," said Winship. "There is a lot of money out there that has to get to work and it is being deployed at high valuations in many cases."
Montgomery confirmed that loan demand in Houston continues to increase and middle-market businesses are receptive to deals. "Loan volumes are higher than in 2016 and 2017 and that stands to reason with businesses needing more capital to continue their growth."
Whether a deal involves a strategic buyer or a private equity firm, the panel agreed that preparation is critical to a successful outcome.
"Every buyer is looking at a transaction through the lens of risk and that is defined by the ups and downs on a P&L, operational configuration, quality of the management team, and depth of reporting," said Winship. "Before starting the process, make certain your financial house is in order and you can illustrate how you manage challenges. A lot of upfront work can significantly influence the value of the business."
Moving Forward
While current market valuations are high, Winship said it is different from a stock market bubble that stems from an unwarranted surge in asset prices. When traced backward, a bubble occurs from a departure in discipline and he assured there is nothing concerning to indicate a market bubble.
Nasser closed the discussion with reassuring advice to business owners. "We know there is a recession coming because it occurs typically every five to seven years. It is not a time to panic," he said. "It's like winter and we don't panic when winter comes along. Prepare and make sure you have a strategic plan to handle whatever is coming. It may be the best time to take advantage of opportunity."
For more information about BoyarMiller, visit www.boyarmiller.com.
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BoyarMiller is a mid-size Houston-based law firm that advances client business goals by bringing new possibilities into focus with confidence and clarity to achieve extraordinary outcomes. Since 1990, we have been providing practical and smart business solutions. Our firm is comprised of two practice groups – business law and litigation – and we serve multinational companies, middle-market businesses and entrepreneurs in need of collaborative and strategic representation. See www.boyarmiller.com for more information.
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