Managing through volatility: 2022 CFO Dive outlook

The pandemic is far from over, but for CFOs 2022 is shaping up to be the year of inflation.

Even though the coronavirus remains a concern — especially given the high transmissibility of the omicron variant — executives have had 18 months to get their remote and on-site work processes right. That will help them deal with any potential setbacks as the pandemic moves into its second year.

At the same time, executives confront the novel challenge of managing high inflation after decades of low price increases. 

It’s impossible to know whether prices will push into the nightmare territory executives faced in the 1980s, when mortgage interest rates soared to 18%. But few issues that CFOs can expect to deal with in 2022, from pricing goods and services to setting wages and salaries to managing taxes, will be addressed without the specter of inflation hanging over them. 

Against this backdrop, here’s a look at the top five CFO trends expected in 2022.

Inflation

In December 2020, Federal Reserve governors and district bank presidents predicted that their preferred measure of inflation — the core personal consumption expenditures price index (PCE) — would rise 1.8% during 2021.

It was not the Fed’s finest moment in forecasting. The Labor Department reported last month that core PCE in November hit 4.7% compared with 12 months before.

The Fed’s miss, and other signs of surging inflation, pose some hard questions for CFOs at the start of 2022:

• How much should they increase prices and pass on to consumers the 9.6% gain in the producer price index during the 12 months through November, the biggest gain since the data series began in 2010?
• How much should they raise wages, taking into account the need to attract and retain employees who faced a 6.8% jump in the consumer price index (CPI) during the 12 months through November — the largest jump in 39 years?

The way CFOs answer these questions will shape profit growth in the new year.

All eyes will be on the central bank. Fed Chair Jerome Powell dropped the label “transitory” last month when describing inflation during testimony to the Senate Banking Committee, noting that price gains could remain high through next summer.

The Fed on Dec. 15, falling in line with prior signaling by Powell, sped up its tapering of monthly bond purchases, putting such quantitative easing on track to end in March, or three months earlier than the Fed had planned.

Faster tightening suggests that the central bank may move as early as June to slow inflation by raising the benchmark interest rate from a record, near-zero low, according to Moody’s Analytics.

Fed policymakers in the next few months may feel the heat from even greater price gains, particularly in “core” CPI, which excludes food and energy prices, according to Ian Shepherdson, chief economist at Pantheon Macroeconomics. Core CPI may rise to as high as 7% in February or March, he said.

“Media coverage tends to focus on the headline rate, but a near-two-percentage point jump in the core rate over the next few months will not pass unnoticed,” he said.

CFOs especially would notice such a surge in prices and may do well to brace themselves — and adjust their 2022 scenario planning — for such a possibility

War for talent

CFOs at the start of the pandemic needed to focus on employee safety.

Now, amid a pandemic-induced labor shortage, CFOs need to focus on employee retention as well.

Attracting and retaining employees — otherwise known as the “war for talent” — vaulted to the No. 2 ranking of business risks for 2022 and the next decade from No. 8 a year ago, according to a global survey of 1,453 C-suite executives and board members by Protiviti and North Carolina State University. (Leading the list of risks for 2022 is the impact on business from pandemic-related government policy).

Workers perusing job listings can be choosy. During October, 7.4 million workers were unemployed while job openings rose to 11 million from 10.6 million in September, the Labor Department said in December.

The quits rate, or the number of workers who left their jobs as a percent of total employment, rose from 2.3% in January to 3% in November, the highest level in data going back to 2000, the Labor Department said. The quits rate hit 3% in September as well.

Many workers are switching employers to boost their wages and buffer against the 6.8% gain in the CPI during the 12 months through November.

CFOs have responded to workers’ newfound leverage on compensation, and to pay increases by their rival companies. Hourly private sector wages rose 4.8% in November from 12 months before, the Labor Department said.

Looking ahead, CFOs have budgeted 3.9% wage increases for 2022 — the biggest jump since 2008, according to a survey by the Conference Board.

Grant Thornton surveyed 551 human resources leaders and found that companies plan merit increases in salary averaging 5%.

“A majority of survey respondents believe that the war for talent will last more than a year, and it appears that cash will be a major incentive of choice,” according to Tim Glowa, a principal at Grant Thornton focused on human capital services.

Usage-based pricing

For the past decade or so, subscriptions have been the go-to pricing model for software-as-a-service (SaaS) companies, but that’s changing as companies transition to a usage-based pricing model. The reason for the switch is economic: by letting customers pay based on what they use, companies stand to generate more revenue from heavy users while encouraging those who use less to stay on by lowering what they pay.

“There is an appetite for usage-based pricing, and we expect this to continue to accelerate in the coming months,” says Kyle Poyar, operating partner at OpenView, a venture capital firm.

Some 45% of SaaS companies include some form of usage pricing now, up from 34% last year, a 32% increase, an OpenView survey shows.

Chitra Balasubramanian, CFO of tech company CircleCI, oversaw extensive modeling by her finance team in preparation for her company’s move from subscription to usage pricing. The result has been good, she said. The company’s customers like the linkage between how much they use and how much they pay.

“The subscription in the earlier model was a little bit more like shelfware,” she said. “You’re paying for it, whether you use it or not.”

Corporate inversions

There was concern earlier in the year over the Biden Administration’s proposal to raise the corporate tax rate from 21% to 28%, taking it partly back to the 35% rate it was before the 2017 tax cut. One of the concerns was that a higher rate could spur corporate inversions — a tactic of companies to lower their taxes by arranging to be acquired by a partner in a low-tax country like Ireland.

Although talk of corporate inversions subsided once Congress left the corporate tax hike out of the administration’s Build Back Better bill, the risk that companies might look for a foreign buyer is still there, in part because of proposed lower deductions on global intangible low-taxed income (GILTI). House-passed legislation would raise taxes by reducing the GILTI deduction from 50% to 28.5%, resulting in an effective GILTI tax rate, once the 21% corporate rate is factored in, of 15%, up from 10.5% today. 

That leaves the inversion risk still there. “Any increase to the GILTI rate would impact the ability for American-headquartered companies to compete with their foreign competitors who are not subject to a similar tax in their home jurisdictions,” according to a Center Forward analysis. “It would likely have the unintended consequence of reducing employment in the U.S. by returning to the days of corporate inversions.”

Clawbacks

The Securities and Exchange Commission earlier this year dusted off a 2015 policy requiring companies that make restatements to their financial reports to claw back any performance-based executive compensation that resulted from incorrect numbers. Prior to bringing back the policy, the SEC only required clawbacks when restatements were the result of misconduct.

The SEC move comes at a time when companies are getting serious about clawbacks. More than 2,000 of some 5,500 publicly listed companies in the U.S have clawback provisions in their governing documents. That’s up from about 1,300 three years ago and fewer than 1,000 in 2015. 

Given this climate, more clawbacks are expected in the years ahead — or at least fewer material restatements. 

“To the extent there are companies on the margins that want to push the envelope, this proposal would likely be an incentive for them to not issue a restatement when they otherwise might have,” Susan Schroeder, a partner with the law firm Wilmer Cutler, told The Wall Street Journal.

Or they might issue restatements but they’re more likely to be below the threshold for triggering an SEC review. Either way, the new climate will have CFOs thinking about restatements and clawbacks much more than they would have just a year or so ago. 

The global market for mergers and acquisition, while hotter in 2021 than any year this century, is showing signs of flaring even more in 2022.

A rebound in economic growth, low interest rates and abundant investment capital will push up total deal valuations in the U.S. this year beyond the $2.9 trillion from January until mid-November, corporate dealmakers said in a KPMG survey. Three out of five U.S. CEOs plan M&A this year, EY found in a survey last month of 336 chief executives.

Dealmaking “has heated up to a fever pitch and it feels like it’s going to keep going for the foreseeable future,” Mustafa Hadi, managing director at Berkeley Research Group (BRG), said in an interview.

CFOs can outmaneuver rival companies and negotiate promising deals by following best practices that range from aligning M&A with business strategy and keeping transactions simple, to ensuring a good cultural fit and beginning integration of the acquired company early, deals experts said.

Several forces will likely drive M&A this year.

Sharper CFO attention to environmental, social and governance (ESG) priorities will spur dealmaking, including divestments, as companies seek to reduce their carbon emissions or embark on innovative efforts to curb climate risk, according to Duncan Smithson, senior director for mergers and acquisitions at Willis Towers Watson.

One out of every four U.S. CEOs plan deals this year aimed at improving their sustainability footprint and strengthening their ESG capabilities, EY said.
 

The pandemic set in motion forces that will probably fuel M&A well into this year, Smithson said in an interview. Lockdowns and the tightest labor market in decades have compelled companies to seek acquisitions that will add critical capabilities.

The trend toward hybrid work has increased the speed and scale of digital transformation and intensified competition for specialists in technologies such as cybersecurity and software engineering, Smithson said.

Companies will likely acquire firms that increase their self-sufficiency and reduce the risk of disruption from supply chain bottlenecks, social unrest, cyber attacks and harsh weather, he said.

COVID-19 undercut revenue for thousands of companies in hospitality, entertainment, bricks-and-mortar retail and other customer-facing sectors, creating opportunities for dealmakers to snap up the distressed businesses.

“Coming out of the pandemic, one of the things that’s really important for us is growing very fast and scaling really fast,” according to John Meloun, CFO at Xponential Fitness, a publicly traded boutique fitness company with 10 brands operating 2,100 studios in 10 countries.

“A lot of fitness providers have gone away, so there’s a lot of white space that you can quickly grab by getting studios opened faster,” Meloun said in an interview.

Headwinds to deals

To be sure, several factors could slow dealmaking this year, including inflation, geopolitical tensions, a pullback in central bank stimulus, transaction complexity for high-quality assets and tougher regulation of technology and other sectors, CFOs and M&A experts said.

Prospective buyers may stay on the sidelines as companies targeted for acquisition in technology, energy, financial services, healthcare and other hot sectors demand higher purchase prices, according to CFOs and M&A experts.

“Valuations are just through the roof,” according to Adriana Carpenter, CFO at Emburse, a provider of software for managing expenses and accounts payable. “You’ve got a lot of investor cash going after too few assets.”

At the same time, many CFOs feel pressure to seize on easy money and complete acquisitions before credit gets too tight, Carpenter said in an interview. They need “to be careful not to be caught up in a buying war.”

CFOs and M&A experts say dealmakers should keep eight principles in mind when pursuing transactions this year, including:

1. Align M&A with business strategy

Companies that pursue acquisitions without first syncing their plans with their business strategy embark on a rocky path, according to the CFOs and deal experts. An acquisition may appear attractive in isolation, but not cohere in a way that advances company objectives.

“At the end of the day, we have one thing in mind, and that’s our end customer,”  according to Brian Fitzgerald, CFO at World Insurance Associates, an insurance broker that bought 42 firms in 2020 and 50 last year.

“When we’re out looking for potential targets, it’s always with the mindset of ‘what talent, what resources and what tools do these potential targets offer that we can then use to introduce to our customers and clients?’” he said.

Completing a “holistic” acquisition, Emburse last year purchased Roadmap, a mobile travel platform, to promote sustainability, expand its tech stack and geographical reach and further its mission to “humanize work,” Carpenter said.

Roadmap enables companies to centralize travel bookings and provide employees with features including flight updates, safety reminders, tips about destinations and carbon emission data. Employers can also track spending trends to better calibrate travel policies.

“It was a super successful acquisition,” Carpenter said.

2. Build a comprehensive M&A team

Companies that want to prevail in M&A against intense competition and handle the intricacy of many transactions today need to invest substantially in dealmaking resources and expertise, the CFOs and dealmaking experts said.

“We’ve genuinely reached an inflection point in terms of the complexity and challenge of getting a deal done successfully,” Smithson said. “The companies that are doing this well have invested heavily in building out their own M&A capabilities.”

An M&A team should span the full range of company functions, from product engineering, marketing and sales to tax, accounting and human resources, the CFOs and M&A experts said.

Leadership is essential — from due diligence to integration of the target company —  to avert omissions and misunderstandings, Carpenter said. “What I’ve seen a lot is people talking but nobody’s hearing, and they’re not saying the most important things.”

3. Keep it simple

Transactions can bog down and fail because of unnecessary complexity, the CFOs and M&A experts said.

An overly intricate deal opens the way for disagreement and “drives frustration on both sides of the fence,” Meloun said. “You can negotiate forever and just end up paying a bunch of lawyers.”

Xponential Fitness usually avoids the complications of buying companies that need sign off from a large pool of investors, he said.

“When there’s one or two founders, you can sit at a table on a Saturday, knock through a bunch of terms and everybody feels good about it,” Meloun said. “But when there are 15 people and private equity invested, it gets to a level of complexity that’s frustrating.”

4. Beware of a ‘big bang’

Companies across a broad range of industries can yield the greatest dealmaking returns for shareholders by systematically and regularly acquiring companies rather than by making a “big bang” acquisition or by growing “organically” without M&A, according to McKinsey.

“Carefully choreographing a series of deals around a specific business case or M&A theme — rather than relying on episodic “big bang” transactions — is far more likely than other approaches to lead to stronger performance and less risk,” McKinsey said. “Companies that regularly and systemically pursue moderate-size M&A opportunities deliver better shareholder returns than companies that do not.”

Companies that follow “programmatic” M&A enjoy a 65% chance of outperforming their peers, whereas those that buy a company with a market capitalization that is greater than or equal to 30% of their own market capitalization have just an even chance of success, McKinsey said.

“You have to be more mindful of big acquisitions because you’re deploying a lot of capital and resources immediately, whereas with smaller ones you can moderate your growth and resource commitments,” Meloun said.

5. Solve problems right away

CFOs at acquiring companies eager to complete a deal may decide to postpone addressing problems at a target company that appear to be small and easily solvable after the transaction, including on ESG topics. That’s a mistake, the CFOs and M&A experts said.

“You don’t really understand what the problem is until you try to resolve it during due diligence,” Carpenter said. “You might think that it’s small, but it could explode in your face.”

6. Define early ways to grow revenue

Many M&As flounder when the buyer overestimates its ability to spur revenue growth at the newly acquired company, the CFOs and M&A experts said.

“One of the worst things that I’ve seen is people think that they can turn around revenue lines when actually all they’re really good at is turning around cost loads,” BRG Director Kevin Hagon said.

“As a CFO, you can identify synergies, duplications and you genuinely can save money,” Hagon said in an interview. Boosting revenue is much more difficult, hinging on complex factors such as competitive strength, product development and market fundamentals.

World Insurance avoids considering the purchase of a broker that shows any signs of weak growth in its book of business, Fitzgerald said.

“Most people may be optimistic and think, ‘That’s fine, I can make it grow right away,’” he said. “Others may say, ‘That’s a telltale sign that leadership perhaps is at a point in their careers where they’re not looking to continue the grind — they’re just sitting on their laurels.’”

“You get to the point where you see some of these things and you’re able to walk away very early,” he said. “You don’t even get involved much in due diligence.”

7. Ensure a good cultural fit

Even the most robust profit growth won’t save a merger of two clashing company cultures, the CFOs and M&A experts said.

“What derails most M&A is not paying attention to the cultures of both the target and acquiring company,” Fitzgerald said. “If a company culture is not there, things will start to go sideways.

The founder of a company may initially welcome giving the acquiring company responsibility for back-office operations such as accounting, finance, and human resources, he said. “Most of the sellers say, ‘Yeah, that’s great, take the administration away from me because I just want to go sell and deal with my customers.’”

But some sellers who have built a business over decades may resist any loss of autonomy, according to Fitzgerald and Meloun.

CFOs need to assert control while not quashing the dynamism of the purchased company, Fitzgerald said. “It’s a balancing act.” 

8. Begin integration early

An acquiring company should explore the nuts-and-bolts of integration as part of due diligence, rather than wait until the deal is done, the CFOs and M&A experts said.

“Delaying the steps for integration to later in the merger, when you have more time, just adds more complexity after the closing,” Carpenter said. “Employees should immediately come on to the new corporate entity.”

Worldwide Insurance, as part of its business model, performs due diligence with the intent of fully integrating a target company within 90 days, Fitzgerald said.

“The moment due diligence starts, we ask, ‘Is there anything we see that could affect our integration process?’” he said. “We offer integration the minute we exchange funds.”

Turbulence from the pandemic economy makes this a good time for CFOs at some companies to pursue dealmaking, the M&A experts said.

Xponential Fitness is expanding in a U.S. market in which roughly 20% of boutique fitness companies have failed since the outbreak of COVID-19, Meloun said.

The company, offering guided workouts ranging from yoga and dancing to rowing and boxing, opened 240 U.S. studios in 2020 and more than 230 last year. It bought a specialized fitness company in both 2020 and 2021.

Lockdowns during the past several months have cleared the fitness landscape, providing Xponential “an opportunity to start plugging our brands into retail centers fairly quickly, with more favorable leases compared with pre-pandemic,” Meloun said.

Dire warnings that a botched transition away from the London Interbank Offered Rate could lead to market turmoil have given way to a relatively quiet dawn of the post-LIBOR world. 

Banks effectively stopped making new LIBOR loans on Jan. 1 following regulators recommendations and financial executives needing to tap new debt have been able to do so with few apparent hiccups, sparking some optimism and comparisons to the seamless Y2K computer transition in 2000. But experts caution that any celebration is premature given the complicated operational, accounting and technology challenges financial executives must navigate to prepare for the final chapter of the LIBOR phase-out in 2023.

"The next year and a half is the time for institutions to make sure they're ready from an operational standpoint," Alexey Surkov, a Deloitte Risk & Financial Advisory partner, told CFO Dive. “Just like Y2K, it’s incumbent upon us to check and double check and triple check everything ... to make sure that when the switch is actually thrown in the middle of next year nothing happens.”

To be sure, the changes have reached a long-anticipated critical stage as banks are expected to transition to offering the Secured Overnight Financing Rate (SOFR), and the one-week and two-month U.S. dollar LIBOR were discontinued on Dec. 31. But the more popular U.S. dollar tenors such as the six-month will run until June 30, 2023. 

That's a massive technical shift for financial markets to adjust to as LIBOR, the scandal-plagued reference rate for trillions of dollars in mortgages, hedges, business loans and other contracts worldwide, has been a favored benchmark for loans since the 1980s. But mounting credibility concerns led regulators to begin calling for it to be discontinued after the 2008 financial meltdown.

“It’s a lot more tangible now,” Amanda Breslin, managing director of treasury advisory at Chatham Financial, said of the transition. "We’re at the place where banks are saying you absolutely can’t [get a LIBOR loan]. It’s a mindset shift for CFOs that this is real.”

Operational to-do list                                                                                                                       

After years of following the issue in the abstract, the focus of CFOs and treasurers over the next year and a half should be on the operational and infrastructure adjustments that the benchmark change necessitates, Surkov said.

"You have to make sure you agree with counter-parties on new rates and new spreads and frequency, in some cases, of payments and all of that creates a body of work from an operational infrastructure perspective that is not yet fully completed by the industry," he said. "So that is a big to-do on the to-do list of CFOs and treasurers." 

Firms may also need to change their databases or take steps to make sure computer systems will recognize the replacement rate that legacy LIBOR contracts are tied to. 

Financial executives will also have to get up to speed on new debt quoting conventions and learn the new ways to value and measure the debt.

"Switching to SOFR involves a learning curve," Surkov said. "The calculations of the rates could get quite complex and a little bit messy and it does require CFOs, treasurers and others to get comfortable with the new mathematics." 

Ideally CFOs should take an inventory of any legacy LIBOR-exposure to check to see if the loan has so-called fallback provisions, Breslin said.

While fallback language in debt contracts vary, the clauses typically spell out the replacement index that the debt would default to and establish triggers that can prompt an index change ahead of the 2023 LIBOR sunset.

Companies that hold derivatives ideally want both a loan and its hedge tied to the same index or the debt might no longer be perfectly hedged and it might call certain accounting assertions into question, she said.  

Then, too, accounting implications also loom. Once a loan is reset to a new index, the shift could also trigger certain accounting treatments that the Financial Accounting Standards Board appears to be on track to extend relief on through 2024. The proposal should be out for review by the end of the second quarter and finalized by the end of the year, a source familiar said. 

Accepting SOFR

Corporate treasurers and financial institutions initially delayed switching to SOFR, in part because it did not reflect credit risk as LIBOR does. But the outlook for the adoption of SOFR brightened on July 29 when the benchmark’s forward-looking term structure gained an endorsement from the Alternative Reference Rates Committee (ARRC), a panel of banks, insurers and asset managers convened by the New York Federal Reserve.

The switch has since picked up momentum. Wells Fargo CFO Michael Santomassimo, speaking on the company's Jan. 14 earnings call, said the bank effectively stopped offering new LIBOR-based loan products in the fourth quarter, according to a transcript. He estimated the bank has done about, or just under, 4,500 new wholesale SOFR-based facilities and that it now has tens of thousands of SOFR-linked ARMs on its books. "And so I think it's starting to take hold," he said.  

Building on some big early SOFR corporate borrowers last year like Ford and GSEs, an increasing number of CFOs and financial executives are now cautiously beginning to take out SOFR debt. 

Sherri Moyen, CFO of SEO software company Conductor, expected to close a $35 million credit facility with Silicon Valley Bank last week. Moyen is pleased with the SOFR rate she got; it has generally been lower than LIBOR, but she plans to keep an eye on how it moves. “We will closely monitor both current rates, ” Moyen said in an email. 

Others are taking more of a wait-and-see approach. Omar Choucair, CFO of financial software company Trintech, has a credit line but is likely to let it stand as is for now. “The benefit to waiting is to see more historical trend data on SOFR," he said.    

In many cases, financial executives are just beginning to wrestle with the mechanics of the new debt. For instance, at a securitization industry conference this month, there was talk that a lack of consensus over how to initially price deals without LIBOR could slow issuance of commercial mortgage backed securities this year. 

Investors were pushing for fixed-rate deals' initial pricings to be tied to treasuries while many lenders wanted to use a so-called SWAP rate over SOFR, similar to the convention used with LIBOR SWAP since the 1990s, according to Darrell Wheeler, a CMBS researcher at Moody's Analytics. Swaps are defined as derivative contracts that exchange fixed interest payments for floating rate payments. 

But the deals are now sailing through the market at a relatively healthy pace with the SOFR SWAP reference so far prevailing, he said. 

"We may yet see some deals price the other way but so far it looks like issuers and investors are figuring it out," he said.

Among the first commercial mortgage backed-security transactions that have priced to date this year was a fixed-rate $670 million commercial mortgage-backed security backed by a Chicago office tower and a floating rate $2.02 billion commercial real etstate collateralized loan obligation.