Navigating the M&A Process in the New Reality
As COVID-19 continues to spread worldwide, companies and market participants are struggling to keep up with the increased risk and uncertainty posed by the virus. Social distancing, steady cash flows, reliable supply chains, and employee safety are of the utmost importance. While most businesses have shifted their priorities to ensure their own viability, some opportunistic companies and business owners have realized that uniquely profitable scenarios might arise from the current situation. While both opportunities, as well as risks, are evolving quickly, this article from Beacon Advisors
presents some key considerations that parties to M&A transactions may wish to consider.
Since 1980, recessionary periods have led to steep declines in aggregate global M&A deal size—typically, of around 50% during the first year. According to Forbes, M&A levels in the United States fell by more than 50% to $253 billion following the World Health Organization’s declaration on March 11th. The fall-off results from factors like supply chain disruptions but also difficulties with financing and a lower consumer confidence index. However, buyers with excess dry powder are still seeking to deploy capital in time with less competition and slightly higher negotiating power.
While past major disruptions like the financial crisis in 2008 resulted in a quick rebound in M&A activity, COVID-19 recovery largely depends on the ever-changing government and business decisions in response to the effects of the virus, along with the new policies. With interest rates at historically low levels, there is a significant amount of capital left to be deployed. Once a rebound is in full effect, we expect opportunities to flood the market.
New Fundamental Questions
Buyers and sellers are now rethinking fundamentals about valuation and pricing strategies. While historical financial data presented businesses with an accurate benchmark previously, can this information still reflect a company’s value given unprecedented disruptions in supply chains or unusual amounts of bad debt? Moreover, do the underlying assumptions in complex financial models still make sense? If not, which assumptions are able to capture the uncertainty to a full extent? Professional judgment has never been more important than during a viral outbreak like this one. Going forward, the success of M&A deals will depend on factors including:
- Greater use of scenario and sensitivity analysis for growth and discount rates
- Wider than normal valuation ranges
- More detailed disclosures regarding short-term volatility
- Innovative deal structures that spread risks across all parties
- Transparency and effective communication between buyers, sellers, and intermediaries
- Motivation of buyers and sellers to see deals through even as the process takes longer
When establishing the going-concern value of businesses, the following adjusted metrics may provide ideas on capturing the impact of COVID-19:
- Multiple cash flow scenarios – Taking a weighted average of multiple cash flow projections based on different scenarios (i.e. economic downturn or subsequent recovery).
- EBITDA COVID Adjustment – When recasting financials to arrive at a normalized EBITDA, a new line item that represents COVID-19-related losses could be added back as well. For example, loss in revenues, additional employee compensation, unusual bad debts, or inventory changes. This method assumes that these losses are temporarily caused by the virus and not as a result of normal operations.
- Forward multiples – A forward-looking multiple is derived from projected earnings over the next 12 months. After obtaining these projected earnings and adjusting for COVID-19-related losses, multiplying by an appropriate forward looking earnings multiple can provide a reasonable valuation guidance.
Delayed Deal Process
Preliminary discussions between parties, negotiation of LOI’s and purchase agreements, due diligence and transaction closing are expected to take longer, thereby delaying the traditional M&A process. This prolongation may be a result of:
- Social Distancing – Restrictions on physical meetings may extend the time it takes for buyers and sellers to push a transaction forward.
- Due Diligence – Extra time will be needed to perform due diligence for a company’s supply chain, working capital, insurance, or IT systems.
- Financial Information – COVID-19 could delay the delivery of key information, such as audited or interim financial statements.
- Limited Financing – Buyers requiring financing will encounter delays resulting from increased scrutiny from loan providers and less flexibility.
- Precaution – Buyers are going to be much more cautious, and internal justification to buy will need to be more compelling.
Buyers and sellers need to think through the different and not always obvious ways that COVID-19 could impact business performance and therefore transaction process and terms. The Beacon team, having successfully navigated M&A transactions during and post financial crisis of 2008-2009, is well equipped to provide clients with sound strategies to navigate the M&A market during these unprecedented conditions and realize maximum value.