Thoughts on M&A and COVID-19

During this period of uncertainty, we are being asked by business owners and clients how the pandemic may impact mergers and acquisitions (M&A) activity. While it’s still early days and we’re navigating a period with significant unknowns, it’s also not the first time markets have been shaken in modern history. We can apply valuable lessons learned and deal trends from previous downturns, continue discussions with various counterparties in the M&A industry, and glean insights from active transactions since COVID-19. As the markets continue to evolve, MNP Corporate Finance continues to remain active and has been working hard to stay on top of the changes in the M&A landscape.

We have already begun to see drastic changes in the M&A world caused by COVID-19. Overall, the deals environment has generally shifted into a holding pattern. However, diving deeper reveals active deals still closing on a status quo basis, short-term delays or extensions as opposed to terminations, re-negotiations, and everything in between. While no one can exactly predict the short-term and long-term impacts that COVID-19 may have on M&A transactions, the comments outlined below seek to look beyond the headlines and provide insights to clients looking for clarity during these uncertain times. Every deal is different, and dynamics are changing daily. If you are considering selling your business, are in the midst of a possible sale, or are tailoring your acquisition strategies, we would be happy to discuss your particular situation. Our goal is to continue to offer clients sound advice during these times.

Above all, we hope you stay safe and healthy.

Buyer and Market Sentiment

Our corporate finance partners are in constant contact with a variety of active buyers in the market, including industry strategic consolidators, private equity groups, and family offices. We are also seeing steady communications coming to us directly from the various private equity groups we interact with. Here are some common themes we’ve observed:

• In general, private equity groups continue to look at new opportunities, some are choosing to actively close deals during COVID-19, while others are choosing to defer closings. Most are still screening new opportunities to build their deal pipelines. The overall message is clear: buyers want to continue seeing deals from us and are trying to look beyond current disruptions;
• Buyers appear to be taking a more cautious and selective approach to new opportunities, focusing on deals that are core to their existing operations and fit their buying mandate. This may not, however, necessarily have a negative impact over an M&A process. In other words, finding the right buyer will supersede a shotgun approach of targeting higher quantities of buyers;
• Depending on industry exposure, some buyers are temporarily putting the brakes on acquisition opportunities and instead focusing on managing internal matters;
• COVID-19 hit us at a time where there was ample capital and liquidity available in the markets. Private equity groups in general have ample cash to deploy on new acquisitions, specifically those coming off recent capital raises. COVID-19 doesn’t change the overall acquisition mandate, rather parameters around it. Those in a healthy cash position will look to continue to deploy this cash on attractive acquisition opportunities;
• Demand will increase for opportunities in resilient or essential industries as a diversification strategy;
• Buyers and their due diligence advisors will need to get comfortable with COVID-19 EBITDA run-rate adjustments, evaluating and understanding proposed vendor adjustments will be critical in the future to meet vendor value expectations and remain competitive through a process;
• Specific to private equity groups (and to an extent, diversified conglomerate strategic buyers), the health and resilience of portfolio companies can dictate the current appetite for evaluating new acquisition opportunities. For this reason, private equity groups with resilient or essential portfolio companies may be much more active than others during this time. Meanwhile, those with portfolio companies with a more direct impact from COVID-19 may focus capital on internal matters. Finally, businesses with exposure to non-essential products and services may look to resilient industries as a diversification play, which could increase the demand for those businesses;
• Timelines are being stretched out on deals in general. This is inevitable given the numerous stakeholders in any M&A transaction and the pervasive impact COVID-19 has had;
• Lenders are currently focusing on helping their clients from an operations standpoint, while acquisition lending is of secondary focus to banks. This may impact a buyer’s ability to secure acquisition financing while we’re also seeing buyers being asked to inject more equity into deals compared to pre-COVID-19;
• We are seeing opportunities to assist clients who are looking to grow during this time and have been fielding numerous calls on clients looking for acquisition assistance in various capacities. There may be opportunistic buying opportunities available;
• Buyers will look back at the financial health and resilience of businesses during COVID-19 and their corresponding recoveries. The right business decision today, will add value tomorrow;
• Some buyers are choosing to re-negotiate deals that have not yet closed or are looking to take advantage of material adverse effect clauses on signed deals. On the latter, good legal advice is not wasted. The level of success that buyers will have with such measures remains to be seen;
• In all likelihood, valuations for certain industries will feel downward pressure. Buyers may also seek different structures that limit downside risk due to increased uncertainty. That being said, quality businesses still closing during this time may see little impact to valuation. However, deals being delayed simply aren’t closing, resulting in no movement of the needle on multiples. Vendors seeing beyond the short-term impacts of COVID-19 may be unwilling to adjust valuation expectations. Finally, we expect to see more deals subject to vendor financings and earn-outs;
• With some vendors choosing to delay sell-side mandates, buyers are faced with fewer opportunities. Therefore, buyers may be competing against more bidders for fundamentally sound businesses. The fundamentals of supply and demand along with the strength of financial markets pre-COVID-19 have not changed and may help balance out valuations, and;
• While interest rates are at or near all-time lows, debt continues to be cheap from an acquisition lending standpoint. In the longer-term, interest rates may rise as a tool to combat potential inflation, but this is yet to be seen. 

Vendor Considerations

The pandemic will impact clients in the process of, or thinking of, selling their businesses. As every deal is different and is situation specific, the impact will depend on the industry of the client, the current stage of their sell-side process, and the counterparties and advisors involved in the deal. Under normal circumstances, the success of a well-designed M&A process is tied to the financial health and risk profile of a business, which especially holds true during COVID-19.

Vendors will need to carefully assess run-rate adjustments to EBITDA to normalize the impact of COVID-19. Properly demonstrating supply chain resilience, strong customer demand, and ability to rebound post-COVID-19 will be critical. The M&A advisor’s role in analyzing and isolating the non-recurring impacts of COVID-19 and integrating into the sell-side mandate will be important.

Industries with exposure to essential products and services are expected to be very busy during COVID-19. As essential services remain open, the demand for their products and services may increase. To the extent that 1) the supply chains supporting these businesses can continue to operate with limited disruptions, and 2) the health and safety of employees can be preserved with limited shutdowns, the following industries may see less of an impact as it relates to M&A:

• Food and Beverage, including producers of consumer packaged goods, food processors, food distributors and commodity processors / handlers, notably as it relates to staples;
• Transportation, warehousing and distribution – movement of goods is essential;
• Health care service, retail distribution, research or manufacturing businesses not impacted by work from home initiatives – however, health care supply chain preservation will be critical;
• Manufacturing companies supporting essential services – some may pivot towards medical supply manufacturing;
• Agriculture and agrifood based companies – food production must go on, and health and availability of skilled labour will be critical along with supply chains;
• Staple consumer products, notably those with robust e-commerce capabilities – the ability to by-pass physical retail will be key as social distancing and quarantine measures continue to be enforced;
• Infrastructure and civil construction companies – these companies may benefit from any future government stimulus spending following the pandemic to re-energize global economies; and
• IT, technology consulting, software or streaming-based companies. 

Retail and consumer goods

We are already witnessing physical retail and services being severely impacted due to social distancing measures and non-essential store closures. While the return to normal may result in pent up consumer demand, it may also result in a consumer shift down-market due to weaker consumer confidence. While this may be detrimental to luxury goods, it could result in a boom for staple goods. And while physical retail may be weakened in the short-term, companies with well established e-commerce capabilities with robust supply chains may see less of an impact. Further, all retail sectors should not be viewed the same. The pet industry, consumer electronics, outdoor leisure (camping, hunting, fishing, hiking), home cooking, home appliance, personal wellness, and staple consumer packaged goods are some sub-sectors of retail that may be resilient in the immediate and short-term. The supply chains that feed into these retail segments will follow suit, but resilience testing and supply chain restructuring may occur. Meanwhile, retail service sectors, as opposed to goods, such as dentistry, will see significant short-term impacts to businesses. However, the underlying demand and fundamentals for such services does not disappear due to COVID-19, and the question for business owners should be – will demand for the service go away, or simply build?

Deal Timing

As it relates to deal timing, it’s safe to say that deals are taking longer to close. Every step of a deal is generally taking longer than it did pre-COVID-19. At a high-level, we are seeing some of the following trends:

• Deals with financing conditions will be more impacted by delays;
• The earlier in a sell-side process, the higher the exposure to a deal delay or outright pause;
• Some buyers are extending closing periods until current COVID-19 social distancing measures ease and business returns to normal. This can be industry dependent;
• Due diligence processes are being slowed down given restrictions around travel. To the extent advisors are able to conduct due diligence virtually, this is ensuring deals can continue to progress;
• Deals already past due diligence or signed purchase agreements in place are generally closing with less exposure to delays;
• Paused processes are also being driven by certain buyers due to business uncertainty as well as various deal stakeholders. For example, consent may be more difficult to obtain from lenders, key customers, OEMs, landlords, franchisors, etc., and;
• Processes more susceptible to delays appear to be concentrated around deals that have not yet gone to market, or, face more uncertainty to their businesses.

With some vendors delaying deals today, they may quickly return to the market following COVID-19. Valuations may rebound with recoveries and normalizations, while business owners may not want to suffer another downturn. In either case, the COVID-19 recovery may be a catalyst for deals.

For further information, please contact Brett Franklin, CPA, CA, President, MNP Corporate Finance, at 204.336.6190 or [email protected]