Navigating M&A During Macro Uncertainty
COVID-19 has created an unprecedented amount of general macroeconomic uncertainty, which is particularly evident in the sharp downturn in M&A activity. With companies across the globe seeking to preserve liquidity, safeguard employee welfare and ensure business continuity, our recently robust market has unexpectedly turned inward, forcing a hard examination of deals under consideration or already in progress. However, opportunities still exist for companies that have the market patience to understand and address the macro and industry-specific impacts of this new environment.
The unprecedented shutdown of broad sectors of the economy for an extended period of time will undoubtedly have uncertain medium- and long-term ramifications, clouding attempts to forecast deal activity for Q3 and Q4.
Deal Cycle and Industry Impact
Sustained volatility in capital and commodity markets, as well as fiscal and monetary policy, introduce further instability to the long-term deal outlook. The unprecedented shutdown of broad sectors of the economy for an extended period of time will undoubtedly have uncertain medium- and long-term ramifications, clouding attempts to forecast deal activity for Q3 and Q4. As a result, companies are pulling up their proverbial drawbridges, affecting every stage of the deal cycle:
- Focus on balance sheet health is prompting conservation of capital and caution in the deployment of liquidity, despite considerable dry powder.
- Lack of confidence in valuations presents a challenge to push transactions to completion in a timely fashion.
- Prospective buyers are prioritizing employee welfare, business continuity, and operational flexibility, reducing appetite for inorganic growth.
- As with other industries (e.g. real estate), the difficulty of completing diligence activities in person has crimped the deal pipeline.
Forward-looking guidance for most companies is unpredictable and prone to rapid revision, complicating the timing on strategic acquisitions.
Beyond general uncertainty, certain industries’ prospects—and therefore suitability for M&A activity—have been particularly affected:
- Aerospace: Aerospace has seen a wave of consolidation since 9/11 but massive equity downgrades in the past two months have dampened deal appetite.
- Energy: After more than a decade of expansion, energy M&A activity began slowing in late 2019; investors see a mature industry with slowing productivity, which should be generating returns rather than pursuing growth, and have tightened the financial screws accordingly.
- Hospitality: Hospitality is particularly exposed to stay-at-home mandates; megadeals like Marriott/SPG may be a thing of the past and alternative investments that performed well in 2008 may not enjoy the same outsized returns.
- Technology: Although technology has remained relatively strong, a high percentage of the industry’s debt is in collateralized loan obligations, the downgrading of which may cool strategic acquisitions.
- Real Estate: Retail’s decline due to debt service and e-commerce preceded the COVID-19 pandemic, but the real estate needs of other sectors (corporate entities, higher education) have contracted sharply, and may continue to do so with companies extending work from home benefits beyond the current health crisis.
Though opportunities remain, prospective buyers need to account for the specific obstacles of certain industries.
In addition to the unique crisis-driven market conditions in certain sectors, the same enduring challenges to initiate, close and execute transactions must still be addressed. These may include reduced internal personnel, target technology constraints, and conducting due diligence remotely. To address these and other hurdles in this macro environment, companies may consider alternative approaches.
Amending traditional investment strategy goes without saying, but that can take many forms, from shifting toward pursuing businesses with a healthy cash position to focusing exclusively on targets that diversify a business’ market offerings. Additionally, given the difficulty of diligence in this environment, companies may consider a “comfort range” within which valuation may fluctuate during the deal cycle, rather than a hard target. Finally, rapidly changing macro conditions will require a dynamic execution plan; securing organizational buy-in up front, augmenting internal staff with a larger third-party deal team, and prioritizing business continuity planning within the 100-day plan will reduce disruption to the target business during integration.
Even in stable macro conditions, between 70 and 90% of mergers and acquisitions fail to fully deliver on the investment thesis/synergies; with the current situation, developing a well-planned and executed integration plan is even more critical.
Despite these challenges, there are several indicators that are cause for cautious optimism for the second half of 2020. Pent-up demand and massive accumulations of undeployed capital will increase activity as we emerge from the crisis; this will depend upon the timing and sequencing of reopening the global economy, but as of the end of 2019, private equity firms alone had more than $1.4 trillion in dry powder. Additionally, with greater numbers of distressed companies and depressed valuations, there will be ample opportunity for value investors, gradually increasing transaction volume. And although demand for strategic acquisitions may ebb, much of that activity may be replaced with divestitures, secondary seed rounds, and other investment vehicles
While these are difficult and uncertain times, deal flow will return and opportunities for value investment remain. Having a clear understanding of COVID-19’s unprecedented roadblocks—and the right mitigation strategies to counter them—will be vital for companies seeking to unlock value potential through inorganic growth.