‘We are now living in a different world’ BLM report on how Covid-19 is affecting the M&A sector
The relentless progress of the corona virus is pummelling life and business in the UK in a way that hasn’t been seen since World War two. The health of the nation has been shifted to the center of importance, with UK businesses effectively put in lockdown to tackle the spread and save lives.
To find out how different sectors are being impacted and reacting to the spread of the disease, BLM is talking with sector leaders across retail, construction, tech and others.
For this article, we look at how mergers and acquisitions (M&A) activity is being affected.
Andrew Hodgson – KPMG
Jonathan Jay – Dealmakers Academy
Rob Crews – Momentum Corporate Finance
How is the Covid-19 crisis affecting M&A activity?
M&A activity has been significantly impacted by Covid-19 with the crisis causing economic uncertainty, restricting the availability of cash and creating logistical difficulties. All three of these factors are causing deals to fall over or go on pause.
But the principal deal killer is uncertainty. Without being able to take a reasonable view of the future it is difficult for purchasers to arrive at a deal value and therefore move forward. The uncertainty is not just affecting the target of the transaction – the purchasers are themselves often unsure of their own futures.
As expected, we saw a bounce in M&A activity at the start of the year as management teams became more confident, buoyed by the resolution of the General Election and as greater clarity emerged over Brexit.
Little did we know just how short lived this would be. We are now operating in a very different world. As disruption reached into all parts of the economy, deal activity well and truly hit the buffers, with a thump.
What are the M&A opportunities during this period?
Whilst it is difficult to proceed with a transaction, it is not impossible. Specifically, where a business is being bought for its long-term growth, has a fundamentally strong business model and is not in a sector directly impacted by Covid 19, then we are still seeing transactions progress.
Sectors in which we are still seeing deal activity include defence, cyber security, technology (both hardware and software) as well as food and drink manufacture.
Sectors which have been particularly badly impacted include leisure, travel, hospitality and (to the extent not on-line) retail.
Some deals are still moving and there are pockets of activity in selected sectors, but this is at significantly reduced levels. The current crisis has accelerated the trend towards these sectors, many of which are underpinning the economy right now, such as healthcare, logistics, renewable energy, online retail, financial services, insurance and IT.
While we saw interest in these areas long before we knew what the terms ‘furlough’ and ‘viral load’ meant, there’s a new agility in the economy and a stark difference has emerged between those businesses that are saleable at a strong multiple and those that are not.
Beyond these ‘hot sectors’, it is likely that distressed M&A will take the limelight over the coming months as working capital problems force sellers to entertain investors bearing rescue packages in return for equity.
It is likely that as companies are weaned off the considerable aid provided by the Government – particularly the Jobs Retention Scheme – we will see an uptick in businesses in distress. Many businesses will not be able to fund the ramp-up in working capital needed to re-start their business.
A downturn should not prevent you from expanding by buying another business – or three. Even when there is a lack of available finance, it is possible to structure deals so that no debt is required and, in many cases, the buyer doesn’t have to use personal capital either.
This is especially appealing to the business owner who wants to buy a business to add and additional income stream or to expand into another territory.
Buying a business without risking your own cash, may appear to be a pipe dream, but those deals are out there if you know where to look.’
What about the role of private equity firms in funding M&A deals?
Private equity firms are still keen to invest but are taking a very cautious approach due to the economic uncertainty and often a need to deploy more cash into their existing portfolio of investments.
In addition, private equity access to bank funding for new deals is also severely restricted, as the banks focus on supporting their existing customers and deploying capital under the various government support schemes.
Where there is a good underlying business and a realistic story of turnaround then banks will lend. When this becomes an equity risk however, then I don’t expect banks to lend. It’s at this point that shareholders will need to turn to equity investors or sell their business at a distressed point in the cycle – not a palatable proposition for most business owners.
A parallel in the public markets might be an uptick in ‘public to private’ deals as buyout houses and well-resourced corporates capitalise on depressed share prices.
What are the long-term opportunities when it comes to M&A
Whilst M&A activity is clearly reduced at present, we see the potential for a surge in deals in the second half of 2020. Assuming that Covid 19 is brought under control, then there will be opportunities for purchasers to pick up assets at attractive prices, following the current turmoil.
In addition, the availability of cash funding should improve – this crisis is different to 2008 in that the banking system is fundamentally robust and will hopefully pay a key part in the post Covid recovery.
Governments have taken swift and decisive action to ensure temporary economic damage does not turn into permanent scarring. This bodes well for the recovery. A modest increase in government debt to GDP % is a price well worth paying to avoid a vicious circle of company failures, rising unemployment and zero or negative growth.
The big question remains as to how sharp the recession will actually be and crucially how quickly will the world bounce back – particularly the USA and China. If these power houses of the global economy can get moving quickly then the prospects for deal activity in the second half of 2020 are good.
What advice would you give to business leader’s during this crisis?
From a corporate strategy perspective, it is best to think of the journey through the COVID-19 crisis in four phases – and helpfully, four (almost) Rs: Reaction, Resilience, Recovery and New Reality.
The Reaction stage is something that we’ve all been going through where organisations had to make tough rapid decisions to protect their staff and business. They deferred paying their tax, rent, rates, suppliers and staff. This behaviour can’t go on for long though.
Next, we’ve seen the Resilience stage as companies settle into support schemes and progress from initial conversations with lenders, advisers, HMRC and other stakeholders to agree compromises that buy the business enough time to plan and recover.
Only then can management teams indulge in considering how to create a business for the future. This Recovery phase should see leaders make positive steps towards that vision. That means preparing for how their sector will change and what it will demand of them. This is also when forecasting, and prudence, are critical.
All this leads to the final stage, the ‘New Reality’. Many sectors will have gone through extreme changes and businesses need to be fit for the new reality, not the one that existed pre-crisis.
The winners will be those that embrace change – whatever it might look like.
They’ll likely be the ones to drive a new wave of consolidation and investment, getting the M&A market back up and running. How long this will take remains to be seen, but best case is mid-2021. Worst case, it could be 2023 before the M&A markets return to its own New Reality.