COVID-19 and the M&A Market

COVID-19 has had massive economic impact, providing a simultaneous demand and supply side shock to the world economy. These effects have been well documented (including in our previous columns).

Rather than focus on reasons for economic collapse, from the M&A perspective, the main reason for the dramatic decline is the massive uncertainty created by COVID-19. Yogi Berra’s comment that “Forecasting is difficult, especially the future”, has never been truer.

Let’s analyze this uncertainty around M&A. Even if COVID-19 were to miraculously disappear tomorrow, there would still be enormous uncertainly surrounding the economic effects of the virus: would it be a fast “V”-shaped recovery, a slow “U”-shaped recovery, or an “L”-shaped stagnation?

How fast will unemployment recover? What stresses will be there on the banking system? How many countries will go into default? Will the globalization process continue forward or reverse? What will happen to supply chains?

There will likely be entirely unforeseeable domino effects. We are only scratching the surface here in terms of the massive uncertainty, even under a scenario of COVID-19 stopping immediately.

But we know the pandemic will continue for many more months to come. It is only now beginning to hit high-density low-income emerging economies like Brazil, Indonesia, India, etc. New hotspots are emerging in developed countries. There is the possibility of re-infection, mutations, etc., uncertainty as to when a vaccine will emerge, and how effective it will be against COVID-19, as well as possible mutations.

An M&A transaction requires a buyer and a seller. Sellers always tend to look at the value of their company optimistically, buyers take a much more cautious approach. With all this uncertainty, the expectations gap between buyer and seller is perhaps wider than ever before.

Most would-be sellers have no intention of accepting distress-type valuation, and would rather wait for markets to recover, while in most cases buyers would insist on valuations approaching distressed levels. Hence the main reason for the dramatic decline in M&A.

There are at least two other major reasons for the virtual cessation of M&A activity. First, lack of liquidity. Most potential acquirers are themselves facing reduced cash flow, and need to keep powder dry to provision for the uncertainty. Second, bank financing has become much more challenging to arrange. Issuance of new bank debt, particularly for SME’s and in Central Europe, is also greatly diminished.

When Might There be a Recovery?

We believe full recovery will not come any time soon, certainly not in the next six-12 months, as it will require a considerable reduction in the aforementioned uncertainties; domino effects will need to work themselves through the system, and the risk from COVID-19 itself will need to at least becoming manageable.

Despite a number of governments talking about removing lockdowns, the risk of reinfection or mutation is still great, and confidence in most governments is low.

Where Might There be a Partial Recovery?

There are quite a few pools of capital available for acquisitions; namely private equity firms, and a number of large corporations, particularly in the high technology area.

According to the Global Private Equity Report 2020 by Bain Research, private equity dry powder, or uncalled capital, hit a record high of USD 2.5 trillion in December 2019 across all fund types, and USD 830 billion for buyouts alone. There may also be interest from Chinese investors to invest into Europe and Africa, in manufacturing, automotive and natural resources (see “Cross-border M&A Activity Expected to Pick Up” by chinadaily.com).

So where is this money likely to go?

1 Distressed assets: Typically, it usually takes a number of months for the “penny to fall”, for owners of distressed enterprises to realize that there is perhaps no way out, other than a distress sale, or for banks to foreclose and then begin disposing of assets. The number of assets and companies sold under distress begins with a trickle, and will end up a flood.

2 Winners from COVID-19: There may be more of these than the reader may realize; just to list a few potential winners:

    a  The most obvious winner may be Amazon, which has announced plans to hire some 175,000 employees since the start of COVID-19. Amazon is not alone. There is a massive shift from physical retail stores to online retailing;

    b Other internet-based technologies, from online education to telemedicine will benefit;

    c Certain pharmaceutical companies and health-related companies are also likely to do extremely well.

3 Technology: Google and other technology majors continue to announce deals even during the virus.

The M&A market may have collapsed, but it is far from dead. However, M&A activity will remain suppressed for the foreseeable future; in the meantime, there will be considerable corporate finance activity, as companies attempt to repair or improve their balance sheets, raising equity or obtaining more liquidity through debt, or refinancing debt on more favorable terms.

Les Nemethy is CEO of Euro-Phoenix (www.europhoenix.com), a Central European corporate finance firm, author of Business Exit Planning (www.businessexitplanningbook.com) and a former president of the American Chamber of Commerce in Hungary.