Q1 2020 Capital Markets Update: What You Need to Know
During the first quarter of 2020, the US economy experienced a dramatic downturn as a result of COVID-19. Due to shelter in place orders, many employees have not been able to show up for work and some companies have shut down, laid off employees, or halted production. The decline in production has pushed demand and GDP downward. The economic growth rate fell from 2.1% in Q4 2019 to an estimated -4.8% in Q1 2020, while unemployment rose from 3.5% at the end of 2019 to 4.4% in March. Further, many companies began to feel the pressure of fixed interest payments as revenues fell, and defaults on corporate debt started to rise. As a result, the capital markets have experienced the shockwaves of economic distress.
According to recent estimates, economists expect the economy to contract another 30% in Q2, with the possibility of unemployment reaching as high as 15-20%
But the worst may still be yet to come.
According to recent estimates, economists expect the economy to contract another 30% in Q2, with the possibility of unemployment reaching as high as 15–20%. Clearly, the pandemic is causing a significant negative demand shock, which means that as the market is falling, people are focusing more on saving their money rather than consuming. Within this context, the capital markets have started to see a significant decrease in appetite for IPOs or mergers and acquisitions that could continue for the remainder of the year.
2020 was off to a promising start for companies looking to enter the public markets. During the first two months, IPO activity continued to ride the momentum from Q4 2019, experiencing a rise in IPO proceeds of 39% compared to Q1 2019. The largest proceeds came from the health care company PPD, Inc., which raised $1.9 billion. The healthcare sector led the charge in Q1 for IPOs, representing 48% of IPO proceeds for the quarter. Healthcare companies also dominated deal volume, accounting for roughly 50% of IPOs. However, most of these IPOs took place in the initial stages of COVID-19.
In March, as people began staying at home and businesses began to cut operations in response to the crisis, equity markets began to tailspin. As a result, many IPO candidates began to face funding and liquidity challenges.
In March, as people began staying at home and businesses began to cut operations in response to the crisis, equity markets began to tailspin. As a result, many IPO candidates began to face funding and liquidity challenges. Out of the 37 IPOs for the quarter, only 5 were listed in March of 2020. Comparatively, this is a decrease from 14 companies that were listed in March of the previous year. The swift rise in market uncertainty has made it difficult to foresee how the market could value a company on any given day. Consequently, the appetite for IPOs has dwindled. This trend may continue until after the presidential election in Q4 2020.
The pandemic resulted in an unprecedented amount of disruption to a deal market that has seen a record amount of activity over the past decade. M&A activity for the United States dropped by nearly 50% from Q1 2019 and roughly 19% from February 2020 to March 2020. Investors have become increasingly cautious regarding M&A due to the uncertainty surrounding COVID-19. The number of deals worth $100 million or more decreased to 96 deals in March of 2020, a sharp decline from February, which saw 168 deals of the same magnitude.
Despite volatile market conditions, some companies still found paths to execute transactions. Although COVID-19 largely put M&A activity on pause, it provided opportunities for some aggressive stakeholders. Insurance broker Aon, and rival Willis Towers Watson agreed to a $30 billion all-stock takeover by Aon. Additionally, Morgan Stanley entered into an agreement to acquire financial services company E*TRADE in an all stack transaction valued at $13 billion.
However, experts expect more of a decrease in M&A activity moving forward. For example, in late March 2020, Xerox, withdrew its hostile $34 billion takeover bid of HP. Three factors are driving activity downward: logistics, the difficulty of valuing assets in a volatile environment, and capital availability. Restrictions on travel for management meetings hinder progress on transactions. Additionally, rampant market fluctuations and liquidity limitations result in challenges to accurately price and pay for deals. Further, in mid-March, the Department of Justice asked companies to add 30 days to their M&A timing agreements. With the growing pressures, the question of if and when companies will feel comfortable striking deals remains a matter of speculation.
Capital is the fundamental building block of our corporate economic environment. While the current pandemic does not change this fact, the nature and timing will likely alter. Sponsors, management teams, and stakeholders can control their preparedness for when the capital market window opens back up by managing liquidity and understanding their near-term position, optimizing available credit, and improving working capital. Companies can take advantage of this time to realign their strategy by determining which initiatives will be most critical to increasing profitability and reducing cost.