Dealtalk: D.C. Debt Cliffhanger Gives M&A Pros Pause

NEW YORK, July 28 (Reuters) – Some U.S. companies and private equity firms are hitting the pause button on deals as the U.S. debt ceiling debate turns into a cliffhanger.

A U.S. credit downgrade or default if lawmakers don’t reach a deal on a deficit reduction plan would raise the cost of financing transactions and deliver a body blow to an already fragile economic recovery, investment bankers said this week.

The volatility in U.S. stock markets also is making stock deals difficult to cement, they said.
With the deadline for a debt ceiling deal less than a week away, these bankers said some CEOs and boards feel it’s better to wait for more clarity before proceeding.

“It’s definitely having a chilling impact on people’s ability to get deals done right now,” said one top investment banker who declined to be named. “If we can get the ceiling lifted off our heads, so to speak, it’s possible you see a re-acceleration of activity.”

“For any company that’s thinking about using stock as a component of the consideration in a deal, that’s definitely making it very difficult right now,” the banker said.

The U.S. Treasury has said it will run out of authority to borrow money on Aug. 2, and at some point after that date, will run out of cash to pay its bills.

Even if a deal is reached to lift the $14.3 trillion debt ceiling, a budget plan that flinches from hefty cuts in the deficit may result in a downgrade of the top-notch U.S. credit rating, which would push up U.S. and global borrowing costs.

Global stock markets have fallen sharply on fears that Republicans and Democrats will fail to break the stalemate as the debate drags on.

The chances of a default are remote, but a downgrade alone could cause a widespread slowdown in U.S. deals, said Morningstar analyst R.J. Hottovy.

Hottovy noted that leveraged buyouts and large cash deals would become more difficult to complete if interest rates rise.

Smaller strategic acquisitions would likely proceed in that scenario, he said, because “a lot of the would-be acquirers are sitting on huge cash balances and, frankly, have been looking for ways to put that capital to use.”

The mergers and acquisitions market had largely shrugged off these fears in the early days of the debate. July has been the third most active month of the year with more than $107 billion in U.S. deals announced so far, up nearly 74 percent year over year.

Just last week, Express Scripts Inc agreed to buy rival Medco Health Solutions Inc for $29.1 billion, in the largest ever deal in the healthcare services industry.

Mergers and acquisitions volume is up 72 percent to $680 billion so far this year.

“From a corporate perspective, the real question is what type of risk the current events create for the economics of a potential transaction,” said Gary Posternack, head of M&A for the Americas at Barclays Capital. “Those economics can be impacted to the extent that disruptions on a macro level affect the availability or the cost of financing.”

“So far, we have not seen meaningful impairment on either of those fronts,” Posternack said.
Greenhill & Co Chief Executive Scott Bok said he also had not seen any impact so far and expected the fears to pass.

“I tend to believe that some reasonable but last-minute compromise will be reached, so I don’t expect any impact on M&A activity,” Bok said.

But other bankers privately said the uncertainty means few deals may be sealed before the looming deadline.

“Everyone is busy working on deals, but there’s unlikely to be much coming to completion in the next few days until there’s more clarity,” said a consumer products investment banker, who was not authorized to speak on the record.

While most dealmakers believe the possibility of a default is remote, they are concerned because the consequences would be dire.

“It could be 2008 all over again if it goes the wrong way,” said the consumer products investment banker, referring to the financial crisis and subsequent recession.

One private equity executive said a default may even undo deals that have been struck already. During the financial crisis a number of deals grew contentious as banks were unwilling to finance transactions agreed to during better times.

M&A may indeed become the least of companies’ problems if a U.S. default happens. “If there’s going to be Armageddon you don’t worry about a hangnail,” he said.

(By Michael Erman; additional reporting by Paritosh Bansal and Megan Davies in New York and Jessica Hall in Philadelphia; editing by Carol Bishopric)