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The COVID-19 pandemic has disrupted and challenged businesses in every sector. Against this backdrop, pursuing M&A may seem counterintuitive; however, this moment may present corporates with opportunities for strategic M&A that weren’t previously available.
The Changing M&A Landscape
As companies continue to assess the impacts of the pandemic, the dynamics of the M&A landscape have changed. For instance, there has been a noticeable slowdown in M&A activity. In March, Xerox abandoned its $35 billion bid for HP, while Boeing passed on a $4 billion deal to acquire part of a commercial jet business. And April marked the first time since 2004 that no deal larger than $1 billion was announced.
Michael Ho, Ph.D., Managing Director, Co-Head of Fifth Third’s Buyside M&A Advisory, says this slowdown can be attributed to several factors. “Certainly the travel and meeting restrictions present a challenge to the myriad logistics issues in an M&A transaction,” he says. “The pandemic has also impacted the operational and financial performance of both buyers and sellers, who may still be trying to understand the impact—both short-term and long-term—to their business model and strategies.”
For Ho, this latter point is critical, as an acquisition may be one way companies look to bridge gaps exposed by the current crisis. “The pandemic has caused permanent changes in the way industries, companies and consumers operate and behave,” Ho says. “Gaps in key competencies now exist that must be filled to remain competitive in the ‘new normal.'”
Jim Parrino, Ph.D., Managing Director, Co-Head of Fifth Third’s Buyside M&A Advisory, notes that while many businesses are still determining how they’ll navigate the immediate crisis, some corporates are beginning to position themselves for future deals. “In this environment, being proactive and doing heavy planning is going to pay off, as it has in previous downturns,” says Parrino. “So those [companies] that have acquisition as part of their [larger] strategy are gearing up and figuring out where to put their ‘dry powder.’”
Tizu Menelik, SVP, Group Head of Fifth Third’s Diversified Industries and International Corporate Banking, adds, “Those companies that are interested in acquisitions believe this is an opportune time, and the expectation is that once COVID-19 restrictions are lifted, the corporates are going to be very active."
Taking Advantage of the M&A Window
The pandemic has also prompted companies to reexamine how they approach M&A. On the buy side, some corporates are using the relative quiet of this moment to prepare for future M&A activity by building up their internal M&A capabilities, analyzing and reevaluating their investment thesis, and clarifying their process for evaluating targets.
Ho states, “Savvy corporate acquirers are taking the time to sharpen their M&A skills. For example, they’re further refining their screening process, taking a clear view of the potential targets, of their own business, of their competency gaps, revisiting existing targets to see how they’ll change during and after the pandemic, as well as how that might change the mindset of targets they previously had on their list for acquisition.”
On the sell side, there may be greater appetite in some quarters to sell in the current environment. “For example, there might be some family-owned companies that have been really impacted—both financially and emotionally – by the pandemic, that might be more open now more than ever to considering an ownership transfer of some sort,” says Ho.
Which companies are best positioned to capitalize on this M&A moment? “Strategic corporate buyers—those with strong balance sheets—can use it as a competitive weapon in this environment,” Parrino says. “The combination of private equity groups (PEGs) pausing to focus on their portfolio companies and limited debt capacity for new deals is creating strong opportunities for corporate strategic buyers.”
For companies that have had their supply chains disrupted, seen overnight changes in consumer behavior, and have been forced to furlough or lay-off workers, using acquisitions to gain much-needed resources and competencies may be one way to turn the uncertainties of this moment to their advantage.
Executing M&A During a Crisis
Companies looking to acquire in this environment may find some aspects of dealmaking more challenging in the past.
“From a pure process perspective, a lot of M&A work— accounting, finance, operational assessment, etc.—can still be done remotely,” says Parrino. “Negotiations can still go on.” However, he notes that certain facets of dealmaking may be more challenging in these circumstances. “Some of the cultural aspects—particularly if the buyer is dependent on the management team of the selling organization—may be difficult,” he says. “Buyers get uncomfortable making these types of decisions if they can’t be in a room with people and look them in the eye.”
The disruptions caused by the pandemic can also lead to delays in deal timing. Says Ho, “M&A negotiations may take longer; travel restrictions mean due diligence may take longer; even obtaining regulatory approvals may take longer.”
Such delays are already beginning to play out, with recent reporting that the Department of Justice (DOJ) has requested that companies involved in mergers and acquisitions add 30 days to their deal timelines.
In addition to timeline delays, there is considerable uncertainty about how to approach the valuation of targets. “Interpreting financial performance in the current environment is a challenge,” adds Ho. “The industry, competitors and the target are likely experiencing extraordinary financial results (either positive or negative). It’s challenging to determine how much of that is temporary and how much represents a permanent regime shift—that could impact not just valuation, but also risk allocation and deal structure.”
Menelik agrees that making any predictions in the current environment is difficult since the available data is limited. “We’ve only had two quarters of [financial] COVID impact,” she says. “Determining what any target company is going to look like at the end of the year is going to be a challenge. How resilient is their business model? How bulletproof is it? Can they ring-fence COVID's impact and structure around it? It’ll be a challenge to get answers to these questions.”
“The real question,” says Ho, “will not be ‘what will the target company look like in 2020,' but what will it look like in 2020 and beyond.”
M&A Beyond the Current Moment
No business has been untouched by the pandemic. Menelik notes, "COVID has impacted every industry, and every company and a number of industries are looking for an opportunity to pivot, to transform themselves and determine how they move forward.”
So what will M&A look like in the post-crisis world?
“If history is any guideline, I would anticipate it’s going to be very active on the M&A front," says Parrino. “If you look at the last few downturns, we historically had very active acquisition markets as the economy recovers, so I would expect a similar environment in this recovery.”
Indeed, research suggests that companies that acquired during the economic downturn of 2008/2009 experienced a 22% increase in total shareholder return in the subsequent three years, compared with companies that did not execute acquisitions.
Additionally, Menelik notes that some corporates and PEGs are sitting on significant cash at the moment that will eventually need to be deployed. Particularly for PEGs, “the consensus is that they may have missed the boat after the 2008 downturn in terms of deploying their cash,” she says. “They won’t want a repeat of that, so the expectation is that the cash will need to be deployed soon.”
Beyond the current COVID-driven crisis, companies across industries will continue to face the buy-vs.-build dilemma.
“Because it takes so long to build skills and infrastructure internally, and because the pace of change has accelerated so much in all industries, the buy-vs.-build calculus has—in many areas—really started to tilt toward the ‘buy’ side,” remarks Ho. “The market expectations of growth for our clients are so high, they can’t afford the long runway [needed] to develop a lot of these competencies internally, so they have to look at acquiring them in order to continue to be relevant, two, three, four and five years out.”
Says Menelik, “COVID-19 has accelerated a reevaluation; many of our clients are looking at their business models and trying to determine how you move forward with operating under new safety guidelines. Technology is going to be the avenue that helps to bridge gaps.”
For companies choosing to move forward with M&A in the current environment, Ho says the key will be “having a well-thought-out, robust strategic plan and a proactive implementation program. The pandemic disruption necessitates a re-examination of the pre-pandemic growth strategy and acquisition program, in light of the pandemic’s impact on industry structure, competitive dynamics, critical success factors, operational optimization (e.g., supply chain), end market demographic shifts, and other factors.”