Impact of the virus on the number and conclusion of M&A deals
Since the novel coronavirus (COVID-19) pandemic keeps up its omnipresence in the global news, the M&A market is now plummeting after several years of booming M&A activity. Indeed, this unprecedented crisis caused severe ravages in the stock market and hence drastically impacted corporate share prices worldwide. This plunge is reflected by the collapse of deal activity amounting to $12.5bn during the last week of March, which was the lowest weekly total since the financial crisis of 2008. The opening period of 2020 amounting to $698bn was the lowest since 2016, with a decrease of 28% compared to the previous year.
This sharp decrease is mainly explained by the decline of the US M&A activities and by a downfall in the number of deals with a value higher than $10bn, according to Refinitiv data.
Only a few acquisitions and divestitures are being concluded; however, they are mainly from the same industry and are all-cash basis deals: for instance, in the previous month have been announced the $7.1 billion acquisition of Credit Karma by Intuit and the €17.2 billion deal divestiture of the elevator division of Thyssenkrupp, bought by a private equity consortium.
The effects of the coronavirus outbreak towards the Investment Banking and Private Equity firms’ businesses
Currently, M&A activities are not the priority of corporations, since executives are mostly worried about the security of their employees and customers. The primary mission of the executives is to save their own company rather than looking to acquire others. This trend influences IB and Private Equity firms. According to Dietrich Becker, the head of the European advisory of Perella Weinberg Partners, each company is mainly focusing on its liquidity, credit profile and ratings due to this revenue slowdown context. On the other hand, most private equity firms are paying particular attention to the management of their portfolio companies rather than looking for any potential build-ups. We anticipate that most of the business, including private equity firms, are doing whatever it takes for their portfolio companies to deal with the impact caused by the pandemic. For instance, we expect firms to draw down on any available sources of funding such as credit lines in order to strengthen reserves of cash to face the future uncertainties. Those uncertainties will force companies to focus on their short-term vision which will lead them to prioritize the stability of their supply chain, their customers as well as their workforce.
How the uncertainty has been faced by corporations
Some deals have been postponed due to the uncertainty over the business models and valuation purposes, according to David King, the co-head of technology M&A at Bank of America. The uncertainty over the business models urges buyers to demand a more holistic and thorough analysis of the precariousness areas. Hence, the due diligence teams may increase in size and involve more external experts and consultants – specifically in geographic areas where travel has been restricted to reduce the risk of uncertainty. During the due diligence process, sellers should also encompass information in the data room concerning the impact of the COVID-19 outbreak towards the company. This will be essential to price the deals within this unpredictable environment. Financial projections and their underlying assumptions such as the forecasted revenues and cost synergies, EPS accretion/dilution analyses should be updated and corrected to reflect the magnitude of the COVID-19 impact in a reliable way. For the moment, negotiations are threatened since sellers require buyers to value their share price close to their 52-week highs. To mitigate the lack of confidence in the forecasted earnings, buyers will take the opportunity to resort to the earnout mechanism in which a part of the acquisition price is paid upfront, and the rest is paid based on the performance of the company following the acquisition. However, this measure could generate disputes over closed deals. Regarding the business due diligence, site visits may be postponed or canceled, and in-person meetings are becoming “virtual” which might slow down the deal process. Regulatory consents from government or legal bodies have become more strenuous to receive due to the coronavirus restrictions. This effect will also influence the timing of the deals. For instance, the Federal Trade Commission and the US Department of Justice seek extra time to review the pending merger offers properly. Auctions processes may also be delayed due to the situation and ongoing deals may be deferred to wait for the fiscal ending quarters. Moreover, other deals such as cross-border deals are under pressure and many have already been cancelled.
Industries impacted by the coronavirus
Certain industries are expected to be impacted more intensively than others on their M&A deal activity. Namely, hospitality, airline, auto industry, oil and gas, entertainment (movies, gambling, sports) are the industries that have been impacted the most by the coronavirus outbreak. The companies belonging to those industries will hardly manage to obtain their preferred financing terms for upcoming transactions due to the risk they are exposed to. They may undertake detailed examination regarding the amount of debt involved in the deal, the financial projections, coverage ratios and financial maintenance covenants. Lenders will require less amount of leverage in the deal especially in large deals that involved several layers of senior and subordinated debt in order to avoid any bankruptcy risk and will demand a higher amount of equity, which could limit the returns of certain companies, specifically in the private equity sector where leverage is used as a mechanism to maximize returns and hence to reach an internal rate of return (IRR) on their investment to satisfy their institutional investors. However, the technology industry is less affected by this new virus: for instance, the telemedicine, medical cleaning technology, and software-based applications may experience increased opportunities during this period. Regarding the healthcare industry, the deal-making may slightly slowdown in 2020 due to the pressure caused by the coronavirus on the internal resources of this industry.
How can the coronavirus be compared with the 2008 financial crisis?
It is notable to mention that this current crisis is different from the financial crisis of 2008 since dealmakers expect the M&A activity to recover swiftly and speed up quicker than the 2008 crisis once the pandemic is over. Indeed, this crisis is an external shock to the market compared to the financial crisis, which was a crisis that affected the US financial institutions deeply internally and hence it was harder to recover. For example, economists anticipated a V-shaped recession for the COVID-19 compared to the U-shaped downturn during the 2008 financial crisis. Therefore, the impact of the COVID-19 may be stronger but shorter, compared to the world’s economic crisis.
For the following months, we can expects many consequences, some of which are listed below:
- the social distancing will be reduced,
- the consumers will regain confidence,
- companies will reopen in the short-term (1-3 months),
- the workforce will get back to work,
- liquidity issues of corporations and households will abate,
- corporate revenues will bounce back,
- supply chains will open again,
- capital markets will settle down and hence will give room to restoring M&A deal activity.
However, we may raise an interesting question: Could investors take advantage of the crisis by buying out distressed companies that are undervalued?
Author: Charles Zeitoun