The coronavirus pandemic and accompanying market downturn have left mergers and acquisitions in something of a quarantine themselves. Such activity has slowed to a crawl, and uncertainty reigns: What will the landscape look like when this crisis subsides? Where will opportunities arise? Is a recession likely—or has a depression already arrived?
Certainly there are those who have managed to make hay, despite the slump. Witness, for example, the $456 million deal between Johnson & Johnson and the U.S. government, and the accompanying hope that the pharmaceutical giant can fast-track a Covid-19 vaccine. But overall the picture is bleak. According to Forbes, worldwide M&A was down 35 percent from the last quarter of 2019 to the first quarter of 2020, and 39 percent in the U.S. The year-over-year decreases were 25 and 50 percent, respectively.
Particularly notable were Xerox backing out of a $35 billion deal to acquire HP, and Apollo Global Management withdrawing its $8.5 billion bid to acquire the broadcasting company Tegna Inc. and aerospace suppliers Woodward and Hexcel mutually agreeing to terminate their $6.4 billion merger. Indeed, a growing list of private equity firms have walked away from deals signed before the pandemic hit. In the PE space, we have seen financial sponsors dump at least a half-dozen deals so far in 2020 in the U.S. alone.
Nate Pund, a managing director for Houlihan Lokey’s consumer, food and retail group, told SGB Executive that M&A has, in effect, come to a halt while companies assess the damage the crisis has incurred, and what might lie ahead. The latter is obviously a very tough call. There are those who believe the world is already in a recession, and certainly there are many indications that that is the case: Company valuations have plummeted, unemployment has spiked and consumers are buying little more than bread, milk and eggs.
Will the virus fade with the warm weather, as some have predicted? Will the U.S. be able to restart its economy as a result? It’s all very unclear, as Pund said:
“Uncertainty is the killer of everything. When you don’t have any sense of the world, it is very difficult to make an informed decision. If you have bad news, you can deal with that. If you have good news, you can deal with that. But when you have uncertain news, you don’t know what to do.”
Some, like BNP Paribas M&A head Bruno Villard, believe the pandemic will have a lasting effect on the worldwide economic picture. As he told Bloomberg, “It will not be just a blip in deals flow.” But David Ludwig, Goldman Sachs’ head of Americas Equity Capital Markets, is more optimistic, telling that same outlet that once the threat diminishes, the rally will come “in a reasonable period of time.”
In the aftermath of past global crises—at least those that can be recalled in the memories of current business leaders—the deal economy was eaten by the bears only to run again with the bulls, such as was witnessed after the bursting of the Internet bubble in 2000 and the Great Recession of 2008-2009. As in past global crises, not knowing what is going to happen next in the markets has already contributed to buyers renegotiating, delaying, deferring or outright cancelling their M&A deals. What’s different this time around is that the impact of the global Covid-19 pandemic is primarily on the commercial economy rather than the financial system, leaving a big question mark as to the viability of target businesses (if not the potential buyers themselves).
The risk for buyers to proceed to do a deal in the short term is high, but there are many more factors one has to take into account to get a deal done. In addition to price and other economic terms, there are real new due diligence issues that have to be investigated, if you can even conduct a due diligence investigation in this environment, and one has to assess what debt financing will be available, and on what terms (if at all), and how much additional time to build in to any process for obtaining necessary regulatory and other third-party approvals for deals.
What Is Happening Now
Johnson & Johnson is on track to begin human testing on a coronavirus vaccine this fall, with the hope that it can release 600 million to 800 million doses in early 2021. In the meantime, the company readjusted its short-term financial goals, announcing on April 14 that its forecasted 2020 revenue is expected to be between $77.5 billion and $80.5 billion, down from its previous prediction of $85.4 billion to $86.2 billion. Stock dividends and investor confidence nonetheless remained high, and obviously the company believes better things are in store if it can meet demand for the vaccine.
There are other companies with vaccines in the pipeline, too. Chillingly, there were reports in mid-April that the virus is mutating, though researchers were still confident that those drugs currently in development would be effective.
Bloomberg noted that the crisis has resulted in other healthcare deals, like Thermo Fisher Scientific Inc.’s $11.5 billion acquisition of Qiagen NV, which makes testing kits. Bloomberg also pointed out that infrastructure deals remain very much on the table because cash flow is never an issue in that space and the contracts tend to be of the multiyear variety.
An interesting side note is that some deals, notably Morgan Stanley’s $13 billion acquisition of the discount brokerage E-Trade, included specific provisions preventing either party from invoking the coronavirus outbreak as a reason to renegotiate. Typically such agreements are subject to material adverse effect (MAE) qualifiers, under which either party might be freed from their obligations if an unforeseen event has a long-term impact on a company’s potential. But according to the terms of this deal, the pandemic could not be a reason to trigger an MAE.
Meanwhile, some sellers are pushing back—and hard. After The Carlyle Group and Singaporean sovereign wealth fund GIC abandoned an agreement signed in December 2019 to make a 20% stake in American Express Global Business Travel at a $5 billion enterprise value, Carlyle claimed that AMEX had breached the no “MAE” clause, which did not have a specific carveout in case of a global pandemic. AMEX’s well capitalized investors, including Certares Management and Qatar Investment Authority, did not take this lying down, firing back with a lawsuit in Delaware Chancery Court to force Carlyle to complete the deal and to expedite a trial to require the same.
What Might Happen Next
M&A opportunities tend to arise from financial crises, as companies’ fortunes wane and they begin looking to sell. And certainly there are always plenty of savvy buyers circling overhead, eager to take advantage of diminished valuations. Gap acquired Athleta in 2008 during the Great Recessio, and Phillips-Van Heusen acquired Tommy Hilfiger immediately after, in 2010.
The same thing can be expected to happen now. Private equity firms and hedge funds will likely lead the charge on such rescue deals, and certainly they have the resources; Bloomberg estimated that PE firms alone have some $2 trillion at their disposal. They might not swoop in immediately, as they have to tidy up their own portfolios, but they will surely be on the case.
Their targets will no doubt be in the travel, lodging and entertainment sectors, which have taken a major hit during the pandemic with shelter-in-place orders the norm. The World Travel and Tourism Council is predicting a loss of 75 million jobs and $2.1 trillion in revenue, and the U.S. Travel Association projects that 4.6 million people will lose their jobs through May alone. Marriott, meanwhile, serves as an example of how hard-hit the lodging industry has been; that chain had seen a 75 percent reduction in revenue as of early April, a shortfall that the U.S. government’s stimulus package can only begin to address.
Also ripe for M&A are industries looking to repair supply chains, once the pandemic is over. Bloomberg pointed to the automotive sector, for example, as one that might be looking to become less dependent on foreign sources for various components.
But again, there are caveats about such things as how a target company’s valuation might be impacted by the pandemic (especially given supply-chain disruption) and how decisions made between signing and closing might affect an agreement, given that they are made during such a tumultuous time.
The due diligence process has also been dramatically altered. On-site visits and in-person meetings have taken a backseat to video conference calls, not to mention the trickiness involved with obtaining original documentation in the current climate. Regulatory matters will also be elongated, which may require extending the “drop-dead” date featured in all agreements (i.e., the date after which either party may walk away from the deal as a result of unforeseen delays).
But there is great uncertainty about all this, as there is with the overall picture, and that uncertainty is as pervasive in the M&A space as any other. The best that can be said is that CEOs who are alert for opportunities, especially in the healthcare and travel sectors, stand to benefit the most.
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