The uncertainty caused by Covid-19 has dented management’s appetite to make big strategic moves such as conducting large transformative deals.
Although much of the world is still under some form of lockdown due to Covid-19, M&A transactions have not come to a complete standstill. The first quarter of 2020 saw 3,685 transactions announced worth over $560bn. But deal activity has slowed considerably. According to Mergermarket.com, global M&A activity is down over 39% by value compared to the first quarter of 2019. Moreover, just eight transformative “megadeals” (transactions with an enterprise value above $10bn) were announced globally in Q1 2020, down from 11 in Q1 2019 and 14 in Q1 2018.
According to Dealogic, in 2020 the global M&A market experienced its slowest two months of the year since 2005, while the value of global dealmaking sank to a six-year low to March. There were just $119.2bn worth of deals announced in the first two months of the year, though these included notable deals such as the sale of ThyssenKrupp Elevator to a consortium of investors for $18.7bn, the $33.4bn Aon–Willis Towers Watson merger deal, and Worldline's acquisition of Ingenico Group for $10.6bn. More recently, Liberty Global acquired Telefónica in a £31bn deal in May.
The downturn in megadeals comes as no surprise.
The uncertainty caused by Covid-19 is due to three key factors: public market volatility and instability of share prices; a mixture of regional restrictions on travel and face-to-face meetings; and uncertainty surrounding the global economic outlook for the reminder of 2020 and well into 2021. Combined, these factors are reshaping the M&A landscape and are creating an array of challenges and opportunities for both buyers and sellers.
For acquirers, the increased availability of assets and distressed companies has created a “buyer’s market”, especially for buyers who have cash and/or still have access to debt funding. Some buyers are likely to avoid cross-border deals due to country and regional protectionism to prevent takeovers of local distressed companies. Recently the EU, Australia and India among others have moved to implement regulatory obstacles to takeovers of local distressed companies by foreign buyers.
With face-to-face meetings off-limits and factory and office visits cancelled, it has become difficult for buyers to conduct due diligence on target companies. However, buyers are taking innovative approaches to due diligence by using drones and GoPro video visits. For firms which still have access to debt financing, exceptionally low interest rates have created even cheaper financing to fund deals. Because of the low asset prices, acquirers will ignore organisational fit with potential targets.
Sellers desperate to generate cash are putting more core and non-core assets up for sale. Companies that have innovated to successfully address Covid-19 by altering their operating models or firms which offer products and services that have increasing consumer demand are attractive acquisition targets, and they will be highly valued by acquirers.
If they do not already have them in place, distressed companies whose valuations have dropped significantly are implementing poison pills to prevent hostile takeovers. Because they are desperate to sell, sellers will ignore organisational fit with potential buyers.
So-called “zombie deals” are transactions caught in between signing and closing. In order to save their cash and/or not take on additional debt to fund a transaction, buyers are looking to walk away from deals agreed to prior to the onset of Covid-19 by invoking the Material Adverse Change (MAC) clauses found in most transaction agreements.
Volatility in the financial markets combined with heightened economic uncertainty is complicating negotiations on valuations, and there will be an increase in MAC clause litigation from sellers trying to prevent buyers from backing out of deals.
More and accelerated industry consolidation will occur, for company and industry survival (e.g. retail, restaurants, and entertainment). Because of the slowdown in deal volume, M&A service providers such as banks, lawyers and consultants are repurposing their transaction staff to, at least temporarily, work in their restructuring units to help clients refinance and restructure debt, renegotiate supplier contracts, and achieve operating efficiencies.
In the longer-term, as the pandemic subsides, various firms will have accumulated stockpiles of cash creating pent up demand for deal-making and launching the start of another significant “M&A wave”.
Flexibility – Conducting deals via video only, service providers repurposing staff to other service lines until transaction volumes pick up.
Creativity – Site visits via drones, buyers and sellers trying to assess 'cultural fit' with no in-person meetings.
Adding risk on top of risk – Based on the poor track record of deals often not achieving projected returns, M&A are inherently risky activities (especially for buyers). So, risk is being added when deciding to move forward (which some buyers are) without ever meeting the partner company in person.
Lawyers will be busy – With several buyers trying to walk away from deals struck before Covid-19, there will be an increase of litigation to test the material adverse change clauses of those deals.
Given the fluidity of the public health and economic impacts caused by Covid-19, combined with the variability of regional responses and policies to the pandemic, buyers, sellers and M&A service providers will have to be flexible and creative in their transaction tactics for the foreseeable future.
But any experienced dealmaker will tell you that these traits are not new, they have always been essential for success in the deal world.