Tax uncertainty ‘hurting’ deal volume

Concerns over the US fiscal cliff – a combination of automatic tax increases and government spending cuts set to begin in 2013 if the US government doesn’t pass a deficit reduction agreement – are having a negative impact on US merger and acquisition activity, according to a panel of industry experts.

“It’s absolutely hurting volume,” said Jim Woolery, co-head of North America M&A at JP Morgan. “There’s no real incentive for a chief executive at this point to take a risk. They want to know what the rules are and I think that’s the dynamic that we’re in. I think the cliff could be a catalyst for deal making, particularly in the US, but we’ve got to get it done.”

Woolery was speaking at The Deal’s Economy 2013 conference in New York last week.

In the US mid-market, buyout activity has remained on par with 2011 through mid-November. Private equity general partners agreed 71 deals valued between $50 million and $500 million between 1 January and 15 November, worth a combined $12.7 billion, according to Dealogic, compared to 73 deals worth $13.4 billion during the same period last year.

Despite the uncertainty surrounding a US government deficit deal – and whether a solution might involve both cuts to entitlement spending and increases in US tax rates – some panelists were optimistic that an agreement would be reached before the end of the year deadline.

“It won’t all be entitlements, no way, but I think that Republicans would agree to essentially what is an effectively higher [tax] rate through a combination of limiting deductions for wealthy individuals with some kind of increase in rates,” said Ken Mehlman, global head of public affairs at Kohlberg Kravis Roberts. “You can see a deal that has those contours beginning to take shape.”

Still, Richard Jeanneret, Americas vice chair of transaction advisory services at Ernst & Young, said the fiscal cliff was not the most important issue facing deal volume.

“I think the real cliff is Europe. If Europe can get some stability, I think that there is such pent up demand, there are such good fundamentals, that M&A could come out rocking,” he said, adding that a resolution to the fiscal cliff could lead to “a modest uptick here [in the US]”.

However, resolving the fiscal cliff could still result in long-term uncertainty, according to Woolery.

“It’s much more likely that the government in this case is going to solve the issues that are shorter term, as opposed to the longer term five-year, six-year or seven-year [issues],” he said. “There is obviously a bit of a ‘kick the can’ mentality for longer-term issues. It’s probably more likely that we’re going to see a deal that deals with the big issues in the short term but doesn’t deal with long-term investment issues.”

Still, Ernst & Young’s Jeanneret highlighted the US government’s history of resolving crises, conceding that they typically come at the last second.

“Whenever we’ve got a huge problem, if you look back at our history, we’re wonderful at dealing with it, but always at the last minute. Whether the fiscal cliff is the true crisis or not, we’re sure getting closer to jumping off that cliff, and so I’m more optimistic,” he said. “You have the potential for an uptick in M&A activity. I do think though, that it will likely be modest until we have real stability in Europe.”

KKR’s Mehlman said that one silver lining related to the uncertain environment comes in the form of investment opportunities.

“Times like this are actually very good times to invest,” he said. “When the seas are rough we find it’s a very good time to invest, and obviously we’re in a very volatile time right now.”