Global M&A had another strong showing in 2019. The deal volume and value recorded was even more impressive given the uncertainty which has haunted the global economy over the last few years. The looming threat of a global recession, stock market pullbacks, increasing trade disputes, heightened national security and competition concerns, sluggish economic growth and political uncertainty had an impact, yet dealmaking remained robust. The $27bn purchase of Refinitiv by the London Stock Exchange, the $74bn merger between Bristol-Myers Squibb and Celgene, and Salesforce’s $15.7bn acquisition of Tableau were all notable mega deals which helped drive corporate dealmaking to its fourth strongest year on record in 2019, according to Refinitiv.
Last year’s activity raised expectations for 2020. In October 2019, EY’s ‘Global Capital Confidence Barometer’ noted that 52 percent of respondents were planning to actively pursue M&A in 2020. According to Refinitiv’s Deal Makers Sentiment Survey 2020, 47 percent of deal makers anticipated a rise in M&A volume, with an average predicted growth rate of 4.7 percent.
Yet despite these optimistic outlooks, more subdued forecasts proved correct in the first quarter of the year. Citing ongoing global economic uncertainty and the risk of recession, Baker & McKenzie suggested that global M&A volume would drop 25 percent in 2020, with value declining $2.8 trillion to $2.1 trillion.
As 2020 unfolded, the global M&A market experienced its slowest first two months of a year since 2005, according to Dealogic, though some notable deals were announced. Thyssenkrupp AG agreed to sell its elevator unit for $18.7bn to a consortium including Advent, Cinven and Germany’s RAG foundation. Also, in early March, Thermo Fisher Scientific Inc agreed to acquire German genetic testing company Qiagen NV for $11.5bn.
Despite these and other deals, the value of global dealmaking sank to a six-year low to 1 March. There were just $119.2bn worth of deals announced in the first two months of the year, a 49 percent fall compared with the same period last year, according to Refinitiv.
One of the key factors shaping activity has been the rapid spread of the novel coronavirus or COVID-19. While it is difficult to forecast exactly how the coronavirus will impact M&A in the long-term, its short- to medium-term impact will be significant.
In a March letter to startup founders and chief executives, venture capital firm Sequoia Capital called the virus the ‘black swan event of 2020’ and urged firms to “brace…for turbulence and have a prepared mindset for the scenarios that may play out”. Stock markets crashed in early March amid fears of a global recession. M&A deals are already being delayed or cancelled as firms try to wait out the worst of the downturn.
“Many transactions have been put on hold,” says Martin Schwarzer, partner and co-head of mergers & acquisitions at PwC. “We will see a severe drop of announced M&A volume. As in previous crises, cash is king again.”
Deals that do proceed may take longer to complete. Localised outbreaks, travel restrictions and quarantine procedures will slow due diligence processes which can already take upwards of six months. According to Gartner, the average time to close a deal has already risen more than 30 percent over the past decade. Advisers are being forced to adapt. “Given the significant measures implemented to slow the spread of the coronavirus the due diligence process has become all remote, with in-person management presentations, site visits and other meetings being conducted by telephone or videoconferencing,” says Mr Schwarzer. “As in previous economic crises, M&A activity is likely to become more selective. Investors have to conduct up-to-the-minute due diligence on target companies. The most recent month may be more important than evaluating trends over the past three years.”
Despite the challenges presented by the outbreak, acquirers must redouble their efforts surrounding due diligence. These uncertain times require companies to conduct thoughtful, comprehensive due diligence. Issues such as the impact of the outbreak on a company’s workforce, ability to function remotely, supply chain, capital expenditures, financial condition, ability to service debt and other fixed obligations, business continuity plans and emergency response protocols, actual and potential liability exposure not yet captured by financial forecasts, cyber security, privacy and other human resource (HR) issues must be considered.
Return of the MAC
The outbreak may also trigger a spike in material adverse change (MAC) clauses. MAC clauses were already more prevalent last year, in part due to ongoing geopolitical and macroeconomic uncertainty. According to Nixon Peabody, of the 200 deals it reviewed in 2019, 98 percent contained MAC clauses, up from 87 percent in 2018.
While MAC clauses can be difficult to invoke, they often enjoy a resurgence at times of crisis. It is unclear whether the coronavirus will satisfy a generic MAC clause, but there could be attempts to demonstrate that the outbreak had a negative long-term effect on financial performance. It is likely that more buyers and sellers will consider inserting MAC clauses into their agreements in the coming months. Buyers may also seek to reallocate some of the risk of a transaction back to sellers by seeking special indemnity provisions.
Distressed M&A activity is expected to increase. Many PE firms have built up big distressed debt funds and will be looking to pick up assets cheaply. Companies that struggle due to the coronavirus could be rich pickings for would-be acquirers. “Some PE funds that can do all equity are already telling the market that they are open for new investments,” explains Mr Schwarzer. “Due to the high market volatility we might even see unsolicited takeover activity.”
PE has record levels of dry powder available, which will have an impact on dealmaking activity in 2020. According to EY, PE firms are holding approximately $2.4 trillion, while US corporations have access to about $2.2 trillion in cash. “There are vast amounts of capital that need to be deployed. This, coupled with the fact that there are fewer companies that are looking to the public markets as a source for liquidity or an exit, will mean that there are plenty of opportunities for private equity sponsors to spend,” says Frank Arnone, a partner and co-head of private equity at Cassels. “PE funds will continue to look further afield in order to find suitable acquisition targets and cross-border activity should reflect this. We also expect to see an increase in ‘going private’ transactions as PE funds use their capital to help companies unburden themselves from the more costly requirements of public markets. Similarly, expanding the scope of the search parameters will mean that financial buyers will continue to look outside of their earnings before interest, taxes, depreciation and amortisation (EBITDA) sweet spot, which, in our experience, has caused financial buyers to broaden the potential acquisition target base.”
Apart from COVID-19, several other factors will affect deal activity in 2020. According to Deloitte, divestitures are expected to be a key feature of M&A activity as companies hope to make the most of high valuations and to reposition assets ahead of any potential downturn. Deloitte’s ‘State of the Deal – M&A Trends 2020’ report notes that 75 percent of corporate respondents expect to pursue divestitures in 2020, the second highest level in the past four years. Primary reasons included changes in strategy, financing needs, and divesting technology that no longer fits with a company’s business model.
“General macroeconomic factors, such as concerns about the current impending economic downturn, interest rate fluctuations, international trade agreements and tariff levels, geopolitical circumstances and specific situations, such as repatriation of certain businesses to their ‘home’ jurisdictions, can also have an impact on activity levels,” says Mr Arnone.
Prior to the outbreak of COVID-19, deal activity was expected to be spread across several target sectors in 2020. According to Deloitte, among firms which were asked where they were interested in pursuing acquisitions outside of their own industry or sector, technology was the most common choice, with 16 percent. Other attractive sectors include life sciences, healthcare technology, financial and business services and FinTech. “We further expect there to be activity in industries that are experiencing industry-specific adjustments with buyers on the hunt for particularly good deals,” says Mr Arnone. “In Canada, these sectors would include traditional retail, cannabis, automotive, manufacturing and mining. Similarly, and as the market correction looms large, we anticipate buyers will look to acquire businesses that are naturally more likely to survive, and thrive, in an era of economic uncertainty.”
The COVID-19 outbreak will impact certain companies and industries more than others, however. “The retail and consumer products industry will be hit particularly hard,” notes Mr Schwarzer. “In addition, we will see many distressed cases in automotive and industrial products. Travel and tourism may find opportunistic investors. On the other side, sectors like healthcare, medical technology and food should not be impacted by the crisis and may in fact look even more attractive to investors after it is over. Other sectors which very likely will even benefit are technology, including telecommunication, energy and education – especially institutions involved in distance learning.”
Other potential headwinds
Coronavirus aside, the number of cross-border deals has recently decreased amid geopolitical tensions and rising protectionism in the US and elsewhere. This could see non-US buyers instead target regional opportunities closer to home.
“Depending on the severity and duration of the current market correction, this could result in a short or medium-term decrease in activity followed by an upswing if there are ‘deals to be had’,” says Mr Arnone. “Alternatively, any correction could be longer term, resulting in opportunities for distressed, turnaround or work-out types of acquisitions. In either event, we believe that there will ultimately be some impact on activity levels. Trade wars, currency fluctuations, geopolitical events and a variety of other factors can all be seen as creating the potential for a negative impact on M&A activity. However, when it comes to dealmaking levels, the only thing we can say at this point is that the only certainty is that there is no certainty.”
The US presidential election is also on the horizon. This year’s cycle could be particularly bruising given the polarised nature of political discourse in the US. During the last presidential election year in 2016, both the volume and value of M&A transactions declined from 2015. In fact, the last two election cycles saw a marked drop in M&A activity versus the year prior, with a notable decrease in the months leading up to election day.
Acquirers tend to wait for calmer waters after the election. It would not be surprising to see some deals pushed back to 2021, when the political situation may be less complex and the global economy on the road to recovery.
For those firms willing to engage in dealmaking, the competition for assets may be strong between traditional market participants with capital to deploy, which include hybrid hedge funds, pension funds, select mutual funds, family offices, sovereign wealth funds, strategic buyers, independent sponsors and traditional PE. “We anticipate that successful firms will be prepared to transact at the outset of the deal process having given thought to everything from the value proposition, strategic analysis, timing and execution through to integration, which in the current environment should include a consideration of the financial or operational impact of COVID-19 to the target company,” says Mickey Lungu a partner at Cassel. “They will be flexible enough at the negotiating table to address, among other things, potential valuation gaps, whether through traditional purchase price bridges such as earn out mechanisms and rollover equity, or structural changes such as employing longer hold periods. They will take active steps to mitigate completion risk, including implementing a buyer funded representation and warranty insurance policy to propel deal momentum, or improving the due diligence review processes that too often bog down transactions and related negotiations.”
The US presidential election, ongoing geopolitical challenges, recession, the continued growth of shareholder activism and the coronavirus outbreak all threaten to derail or delay M&A activity in the short to medium term. While there will be opportunities for growth and deals to be made, it is likely that many would-be acquirers will adopt a cautious approach. The outlook for global M&A appears bleak for the foreseeable future. How the market rebounds from COVID-19 will be a deciding factor.