Record Point is an independent corporate advisory firm with operations in Sydney and San Francisco. We specialise in domestic and cross-border advisory services for public and private companies including mergers and acquisitions, capital raisings, corporate partnerships, debt advisory, restructuring, strategic reviews and valuations.
2019 was a strong year for M&A, and with supportive equity markets, low interest rates and significant amounts of investable capital, many expected that 2020 would be even better. However, the onset of the COVID-19 pandemic has changed the world dramatically and brought with it the end of the longest bull market run in history. An inability to predict the depth and length of the potential consequences from this crisis has profoundly impacted global business and investment confidence, and therefore the environment for otherwise logical and compelling M&A transactions.
Governments around the world face an unprecedented challenge of balancing the humanitarian and economic consequences of COVID-19 with only one certainty, that a preference towards one of these objectives will have severe consequences on the other. Although the current lockdowns and restricted social activity are essential from a humanitarian perspective, the result has been substantial disruption to supply chains, cashflows and the creation of funding gaps for thousands of businesses. Whilst prior to COVID-19, most businesses were focused on revenue and earnings growth, during this time and indeed post the acute phase of this pandemic, owners are more likely to focus on managing their core business and its recovery.
Consequently, M&A will become harder and it will be different. In this context, we ask the question, what should potential buyers and sellers expect when considering M&A?
Valuation
Uncertainty will be at the forefront of all valuation discussions in this environment. The inability to predict future maintainable earnings, the lack of visibility over the shape of the recovery, the contraction of trading multiples and the inevitable uptick in distressed M&A will negatively impact headline valuations. In the short-term and as was evidenced in the aftermath of the market correction during the Global Financial Crisis, this will likely widen the gap between buyer and seller price expectations, and so we should expect a rise in the use of value bridging mechanisms such as contingent pricing structures in transactions. For example, some buyers may mitigate their risk by utilising earn-outs to counter the uncertainty surrounding future maintainable earnings. How these earn-outs operate in the context of COVID-19 will become key negotiation points, particularly with reference to abnormal or one-off costs.
Due diligence
In Australia, due diligence procedures have predominantly been conducted online with virtual data rooms, however site visits and management meetings/presentations may face some challenges for the immediate future. Nevertheless, we believe that by utilising technologies (including ever-evolving video conferencing capabilities), this hurdle can be overcome. We also expect that buyers will spend an increasing amount of time on COVID-19 related due diligence, including aspects such as supply chain reliance, customer payment terms and outstanding debts, business continuity procedures, potential redundancies and employee claims.
Funding
Market volatility and the current focus by banks on existing clients and troubled situations may result in debt for new deals being far harder to come by. Whilst public companies might look to capital raisings to strengthen their balance sheets and build a war chest to fund M&A opportunities, it will be harder for private companies to access capital for M&A. That being said, financial sponsors have ample dry powder and are opportunistically and selectively looking for ways to deploy capital. Buyers may need to consider over-equitising with a view to refinancing once debt markets normalise. Furthermore, deferred pricing structures could also play a part in reducing the upfront funding requirements for acquisitions.
Documentation
We expect to see a divergence of buyer and seller positions with respect to allocation of deal risk in M&A documentation. Sellers are motivated to minimise the risk of completion not eventuating, whilst buyers want to retain flexibility to pull-out of transactions through broadly defined material adverse change clauses. Change of control consents or assignments may become more problematic if counterparties are seeking avenues to terminate or vary their agreements with the company. The negotiation of warranties and indemnities may become more prolonged, compounded by COVID-19 exclusions that warranty and indemnity insurance providers are seeking. Given the range of challenges and diverging positions that buyers and sellers will encounter whilst negotiating legal documentation, we recommend that all parties ensure that the key legal and commercial terms are well understood upfront to avoid the negotiation prolonging excessively or falling over at the end.
Regulation
The COVID-19 pandemic has had wide reaching impacts on all elements of government and business as a result of the inward focus required to deal with this crisis, and as such, we expect that the time required for regulatory approvals (e.g. competition approval from the ACCC and foreign investment approval from FIRB) will be materially elongated. That being said, there are currently no indications that the fundamental approach of these regulatory bodies with respect to approvals will change. In the case of FIRB, buyers and sellers alike should note that the threshold level for FIRB approval being required has reduced to zero, which means that substantially more mid-market transactions will require approval.
Opportunities
Whilst the current crisis has undoubtedly slowed down M&A, there has already been increased activity in certain areas such as capital raisings, as businesses seek funds to not only strengthen their balance sheets, but also to be prepared for acquisition opportunities as valuations fall and/or distressed opportunities arise. In the coming months, we expect that restructurings, be they distressed or strategic will drive a number of corporate carve-outs into play. Additionally, we may see an increase in cross-border activity particularly given the relative stability and resilience of the Australian market, coupled with a weak Australian dollar. Sellers with target businesses resilient in the current environment and opportunistic buyers, may find themselves with a diverse range of opportunities to pursue.
Record Point believes that now is the time for advance planning and preparation in relation to any M&A strategy. Engaging with advisors who understand the market and the changing dynamics that businesses are facing will be instrumental in facilitating transactions. Whilst the uncertainty of the current environment may cause buyers and sellers to reconsider opportunities, for others, these times present a rare opportunity to deploy capital at attractive valuations, and to execute on meaningful and potentially transformative M&A transactions. If you are currently considering your M&A options, please feel free to reach out to one of the Record Point team for a confidential discussion.
April 30th, 2020