The widespread impact of the novel coronavirus also called SARS-CoV-2 and more commonly known as COVID-19, has slowed merger consultants’ business. The value of global mergers and acquisitions (M&A) fell in the first quarter by 28 percent to $698 billion, the lowest value since 2016. While the volume in the USA halved to $252 billion, it doubled in Europe to $232 billion, thanks to several mega-deals such as the takeover of the elevator business from Thyssen-Krupp.
In the last weeks of March 2021, the pandemic’s spread reduced M&A activity to a mere shadow of its former vigor. A year later, investment bankers and merger advisors are hoping for a recovery in the coming months. According to experts, emergency mergers, restructuring, and nationalization will dominate M&A activity.
The downward trend in the merger business will continue in the second quarter, expects Patrick Ramsey, who heads the global M&A business at Bank of America. As soon as the pandemic subsides, however, he predicts the company will pick up noticeably, stating, “The extent of the recovery will depend on the economic outlook and the recovery in stock markets.”
Merger advisors expect more government intervention to save strategically essential companies. “There will be bailouts. There will be many,” says Luigi de Vecchi of Citigroup. The state will play a vital role in this, not just for protectionist reasons, but because of the sheer need to save entire industries and revitalize strategic companies, and, where possible, to create national champions.
When and how the M&A business picks up again will depend on whether troubled companies also shake other industries and the financial sector, says Paulo Pereira of the US investment bank Perella Weinberg. Given the close links between the economy, he believes specific contagion effects are inevitable and adds, “But the financial system is now better capitalized than it was in 2008.” Much depends on the measures taken by governments and central banks. They need to enable the economy to recover.
M&A deals are threatening to collapse, and the sword of Damocles hangs over acquisition financing: the COVID-19 crisis is endangering the M&A market.
The soaring M&A market has ended: Due to the economic crisis triggered by a governmental and societal response to COVID-19, transactions have dwindled to a fraction of their former activity. As figures show, global mergers and acquisitions volume fell by 28 percent in the first quarter of 2020 and reached $698 billion (€643 billion), the lowest value since 2016.
Related: Why M&A Deals Fail.
Economic Impact & Consequences
How does the economic impact of the pandemic affect M&A transactions? Will the consequences extend over the long term?
We are faced with an exceptional situation that changes every day. We must, therefore, show rigor and caution. Companies’ priorities have changed first to protect the health and safety of their employees, then to organize the continuity of their activities and consolidate their cash flow. In this context, mergers and acquisitions take a back seat.
Also, the uncertainties linked to the uncertain duration of the crisis and its economic effects (which we already know will be very significant simply from the decline in activity at the end of March 2020) are leading companies to be very careful and suspend projects when they can. The few operations announced since early March 2020 correspond to projects already signed or being finalized, most often in sectors less impacted in the short term by the health crisis.
The medium-term and long-term development of the M&A market will depend on the duration of the health crisis. While the measures taken by governments and central banks appear appropriate, they do not appear to be sustainable in the medium term because of their cost.
Economic players have their eyes on China, which is gradually emerging from containment measures. Hopes of lockdowns and containment measures in European countries being lifted before the end of May 2020 were dashed, thus further depressing hope for a gradual resumption of operations later that year. How the parties take the crisis into account on the aggregates used to define the price (EBITDA, WCR, etc.) are decisive.
If the crisis continues into 2022, we can expect a significant number of business failures. Some will undoubtedly see opportunities there. Consolidations will also occur, given the weakening of specific players, if necessary, with state support.
Affect on the Due Diligence Process
COVID-19 impacts the audit phase of a merger or acquisition in two respects. First, the collection of information requested by the buyer is made more difficult for the seller for obvious, practical reasons. There is no longer any question of organizing site visits or in-person meetings with management, which traditionally form part of prior audits.
However, buyers are redoubling their vigilance during the audit due to the lack of personal contact and onsite observation. All the typical subjects of an audit must be approached from a perspective of obsessive scrutiny. This is the case with financial matters (what impacts cash flow, results, and access to financing), suppliers (what impacts in terms of supply), customers (payment terms), contracts, HR (possibility of teleworking or not), IT (is the network sufficiently robust), etc.
Information that Matters
In the context of the pandemic, what is the critical information necessary to carry out M&A transactions?
This essential point concerns timing: the parties must consider the delay caused by the crisis, which is a more extended period of exclusivity for the purchasing party. Regarding the assignment contract itself, at least five elements should receive special attention:
- The conditions preceding the completion of the transaction not only concern their time limit for satisfaction but also to cover the consequences of noncompletion (cost allocation)
- The clause relating to the interim period between signing and closing can no longer refer to a simple “management in the normal course of business.”
- Clauses accommodating particular events to cover COVID-19 specifically
- Price clauses, which should mainly provide for an estimation and adjustment mechanism to the detriment of “lockbox” clauses, to take into account fluctuations in terms of working capital and cash flow
- Declarations and guarantees will be impacted to give rise to exceptions (absence of significant change, customers and suppliers, human resources, etc.).
Three Big Dangers for the M&A Market
Danger #1: Renegotiation of Purchase Prices
The collapse in transaction volume is only the tip of the iceberg. It conceals numerous dangers for the M&A market triggered by the COVID-19 crisis. In the lingering crisis environment, buyers often try to renegotiate contract details.
Wanting to take advantage of a seller’s desperation, buyers ask themselves, for example, “How far down can I push the purchase price now?” This endangers the seller if they have already planned the entire purchase price in their budget.
Depending on how badly the pandemic has affected the target company’s business model, renegotiations on the purchase price are not only justified–but even necessary–from the buyer’s point of view. Delays in payment or even a reduction in the purchase price are therefore currently possible.
Buyers have more leverage in a crisis. The extended COVID-19 turmoil has made the issue even more explosive. For example, many suppliers are currently experiencing liquidity problems or have to use more defensive cash management. Especially companies that want or have to sell accept a discount on the transaction price to reap at least this reduced amount immediately.
Danger #2: Unstable Acquisition Financing
The second danger for the M&A market is even more severe: entire acquisition financings could fail due to COVID-19. A prominent example is the share price drop which threatened AMS’ capital increase. The Austrians were ultimately victorious, but other companies might be less fortunate.
Of course, there is collateral such as bank guarantees or insurance instruments, but they also have their price. If you question the buyer’s creditworthiness so much that you think about such expensive insurance, he may not be the right party for the deal.
Danger #3: A Contract Partner Withdraws
The volatility of the M&A market remains exceptionally high, which unsettles all market participants. Because many things have to be managed from the home office, deals take longer and consume more significant resources. The result: contracting parties could withdraw from ongoing M&A processes due to an unpredictable market.
While an exit is possible before the contract is signed, it becomes tough after the contract is signed. Only if the buyer can prove a breach of guarantee that justifies withdrawal or willful deception in the context of due diligence is it possible to withdraw after execution of the contract.
Most real withdrawals from an M&A process, according to observation, occur in the period between the signing of the contract and the actual completion of the transaction. As a rule, the parties agree on a so-called “long stop date,” i.e., a deadline by which all requirements for the deal must be met.
The Bottom Line
Despite the dangers, the M&A experts remain optimistic. The pandemic with its significant consequences will not be forgotten in a few weeks. However, the M&A market should recover quickly as the worst of the crisis passes. Companies will make up for missed and postponed deal opportunities as business and society emerge from the pandemic.