As has been well documented, the effects of COVID-19 are and will continue to be global, indiscriminate, and merciless. Thus far, governments have closed their borders, restricted the movements of residents, and unprecedented fiscal policies have been implemented. However, while the past and present can be told with certainty, the same cannot be said for the future.
At this point in time, both the short-term and the long-term are rife with uncertainty. No one truly knows what the macro effects of COVID-19 will be. This article outlines the ways that COVID-19 is currently affecting the M&A sector and also provides insight on the potential future outlook for the market.
M&A and COVID-19
M&A is a high intensity, fast-paced industry. The risks involved in operating in this sector are significant, and the potential return to market participants is commensurate. Timing is key in M&A as there is potential for the micro and macro landscapes to change drastically within a relatively short period of time. For example, we are aware of several deals that were weeks from closing mid-March, with no obvious reason why they wouldn’t complete. Within days, these deals had been put on hold indefinitely.
Given the reactive nature of the M&A sector and the recent major changes to the global economic climate, it is important for current and future market participants to understand how the industry has been and will be affected. There are several underlying factors that directly influence the M&A market, including investor confidence, general business health, and economic and political conditions. These factors can be considered within two naturally critical aspects of the market – demand and supply.
This refers to the capital that is available to be invested and is directly linked to investor confidence. Where investors are confident about the future, they will be more willing to part with their liquid assets. Conversely, a lack of investor confidence will reduce the pool of investable capital, as cash will gain value as the price of investments fall (relatively speaking). COVID-19 has naturally deflated investor confidence, and as a consequence the supply of capital has reduced. Several previously live deals are now indefinitely ‘on hold’, and some investment managers are in ‘portfolio mode’, meaning they are focusing on limiting value erosion of existing investments. Having said this, other investors do realise that this market presents opportunities and have advised that they remain open to considering new investments.
Fortunately, UK investors have generally been storing up capital in recent times, primarily due to the uncertainty surrounding Brexit and the election. This means that the market is in a relatively strong position to navigate through this uncertain period and may mean that recovery time will be reduced. However, the overall supply of investable funds is still currently depleted, and this is having a correlated effect on the activity in the M&A market.
This refers to the amount of investment opportunities in the market and is affected by business owners’ willingness to divest their control interests. Often the most valuable time that shareholders can sell an enterprise is when their business is in the best health as this will encourage a strong valuation. The well-known effects of COVID-19 means that many businesses are not currently in optimal health, resulting in owners holding off or delaying entering M&A processes. However, companies have finite capital reserves, and therefore an increasing number will require funding as the effects of COVID-19 persist. Whilst there may currently be a limited supply of investment opportunities across the board, this will increase as business owners take measures to ensure the sustainability of their companies. This will lead to an uplift in accelerated and potentially distressed M&A activity, but the number of deals completing may remain limited by demand. Economic uncertainty combined with increasing supply and limited demand will in theory lead to a general reduction in valuation. This should eventually encourage more investors to re-enter the market.
Opportunities for the M&A Sector
Having said the above, it is important to keep in mind that the current climate still harbours opportunities in the M&A sector, including but not limited to:
- Parties with sufficient liquid assets will have the opportunity to acquire businesses at a relative discount;
- Accelerated M&A engagements will increase as businesses continue to suffer from the crisis;
- Value expectations on the sell side should become more realistic, improving the chances of successful transactions and enhancing process efficiency;
- The market has the ability to bounce back strongly within a short amount of time, given the general reserves held by investors. This is a great time for business owners to get their companies ready for a future sale process, and M&A professionals can assist with this; and
- The Future Fund recently announced by the UK government is in essence a match funding initiative. Businesses will be able to receive a convertible loan from the government where they have an equivalent capital commitment from the private market. This should help to drive activity in the debt and equity capital markets.
It is difficult to predict what the future holds for the M&A sector. In the aftermath of both the Dot Com and the Subprime Mortgage crises, heightened cautiousness was exhibited by investors which led to increased scrutiny involved with executing investment processes. Recent research indicates that 40% to 50% of M&A advisors in the UK expect that new assignments in the next three months will be reduced by 50% or more. The market has also seen a change in the attitude of financiers, with some putting deals on hold, others being more cautious, and a small amount dismissing new opportunities all together.
Taking a longer-term view, well documented historic macroeconomic cycles may provide insight into what the future could hold. These cycles often exhibit specific stages, that include periods such as growth, peak, decline, and crash. Recent cycles have lasted for approximately 10 to 12 years each as indicated by the decline / crash phases – 1987 stock market crash, 2000 Dot Com crash, 2008 Subprime Mortgage crisis, and now the 2020 COVID-19 crisis. If history is anything to go by, it could reasonably be expected that the next six months to a year will be a decline / crash phase, followed by three to four years of regrowth, followed by three to four years of acceleration, and finally a peak phase. Though the initial phase can be rather grim for the M&A market, the other phases are generally more amiable, with sophisticated investors re-entering the market in the regrowth phase and other market participants joining the party as confidence grows and uncertainty reduces. It is likely that the M&A market will eventually return to a rational equilibrium state, however, the main unknown factor is time. As famed economist John Keynes once said, “the market can remain irrational longer than you can remain solvent”.Back to top