Mergers & Acquisitions: Assess interest rates, recessionary fears

Q. How will rising interest rates affect the M&A market for HME businesses? 

A. As the Federal Reserve has raised interest rates to help combat inflation, private equity sponsors who utilize debt to finance a portion of their acquisitions have been faced with higher borrowing costs. Debt providers typically price loans off a certain benchmark rate (e.g., LIBOR, federal funds rate, etc.), and as those benchmark rates have risen, the cost of debt to finance acquisitions has increased alongside them. Historically, when interest rates rise and the cost of debt increases, valuation multiples compress. 

That said, the bulk of HME M&A volume takes place in the lower-middle-market (less than $500M), which is less dependent on debt financing, lessening the impact of interest rate increases relative to other sectors. Further, strategic acquirers and private equity-backed platforms that are less reliant on debt markets to finance acquisitions are well-positioned to continue aggressively pursuing M&A opportunities. By using balance sheet cash and existing credit facilities to fund inorganic growth, these groups can effectively insulate themselves from rising borrowing costs to deliver attractive valuations to sellers.  

There is also the impact of a potential recession to consider. The investor community generally views HME as a well-positioned sector to withstand a recession, given the demand for services and equipment provided to patients is inelastic in nature. This creates resistance to fluctuations in the broader economy, which is attractive to investors looking to deploy capital in an uncertain market environment. This dynamic could result in modest upward pressure on valuations.  

Recessions also tend to drive increased M&A activity at the lower end of the market, as smaller organizations that may not have the ability to withstand a temporary market downturn seek exit opportunities. This creates a window for well-capitalized and opportunistic companies to acquire these groups to deepen product offerings and expand market presence. 

Kevin Palamara is managing director at Provident Healthcare Partners. Reach him at kpalamara@providenthp.com.