We’ve heard it time and time again over the last few months, the world is entering a “new normal”. But in the M&A game where deals are largely done based on anticipated future performance, understanding the “new normal” is not enough. Those looking to position themselves for M&A success are looking forward to the “next normal”.
M&A opportunities now and in the future
Despite headlines around recession and business failure, there are opportunities for both vendors and purchasers.
For strategic buyers, now might be the time to expand through acquisition, taking advantage of distressed businesses and depressed values. It is not, however, entirely a buyer’s market. Venture capital and private equity (PE) firms, present ample opportunity for sellers with strong balance sheets and a clear post-pandemic vision. In fact, PE funds are cashed up and ready to invest. During 2019, they raised a total of $632 million to invest in Australia. This represents the second highest annual total in the past decade. On a global stage, PE funds held approximately $188.7 billion in dry powder in mid-2019.
For others, the opportunity to combine forces with a competitor or a company operating in their industry vertical may provide the necessary strength to help them survive the crisis together.
While it may seem counter-intuitive to pursue acquisitions in an economic downturn, research shows that companies that do deals in recessions, ultimately see higher shareholder returns than their industry peers.
There are a number of trends driving M&A Activity. Talking to my colleague, Corporate Advisory Director Mark Calvetti, we know that during an economic downturn, most businesses will focus predominantly on sustaining cash-flow and remaining operational, potentially resulting in missed opportunities to position the business for future growth.
“Given that some businesses will not be able to achieve organic growth, especially during the COVID-19 period and beyond, business leaders should be considering different recovery models – one of which is M&A activity – to grow their business and take advantage of market opportunities particularly with competitors, suppliers, customers, and people. The right mergers and acquisitions can accelerate recovery and businesses should be proactively assessing their potential acquisition targets or investments. What we’ve learnt is that in a weak economy, like this and the past GFC, is that companies who made a significant merger or aggressively purse M&A deals have outperformed their competitors. It’s important not to get distracted by the short-term headwinds and lose focus on strategies that build long term value. Businesses need to take advantage because there’s only a short window of M&A opportunity once the economy begins to recover.”
Assessing value in the “next normal”
There’s little doubt that the current crisis has had an enormous impact on the perceived value of businesses both in Australia and overseas. The ASX200 is down 20% compared to pre-COVID-19 levels and many companies are downgrading profit forecasts or not providing any guidance at all as they struggle to find a clear line of sight for future performance and indeed viability. As a result, purchasers are demanding lower prices to account for the additional risks involved.
At times like this, assessing the true value of a business becomes a fine balancing act. It’s more important than ever to go back to valuation fundamentals. However, simply applying traditional valuation models will not be enough. The current situation requires valuers of businesses to think outside the box. What impact has the pandemic had on the underlying value drivers? And what does this mean for the business as it enters the “next normal”?
Some key considerations include:
- Cashflow forecasts and maintainable earnings estimates – What’s the expected duration and depth of the economic impact on the business? Will the business return to normal financial and operational performance post-pandemic? How much capital will be required to recover? How will new regulations, social behaviour, buying patterns etc. affect the business going forward?
- Discount rates – How should valuers deal with all-time low risk-free rates? How reliable is the underlying historical data that provides the basis for any discount rate used? Are there other factors that should be considered?
- Comparable transactions – Validating a valuation can be challenging when there are fewer comparable transactions and those transactions were based on pre-COVID-19 financial performance or forecasts. Could other sources of market information be used?
- Earnings multiples – Are the traditional earnings multiples used in your industry still valid? Are they based on forward looking estimates, and if so can the forecasts be substantiated?
The global deal environment has also fundamentally changed and there are a number factors you need to consider for your M&A strategy.
“Looking at the global stage, the disruption from COVID-19 and changes to Australia’s Foreign Investment Review Board (FIRB) processes, may slow down foreign investments. With the tightening of FIRB screening thresholds there are implications for any cross-boarder transactions. With the new $0 threshold, overseas investors & vendors need to be aware that acquisitions which previously didn’t require approval now need to be screened by FIRB. This means factoring in FIRB approval times of between 2 to 6 months, depending on the nature of the transaction, and possible delays to timelines along with associated application costs. As countries start to reopen, we expect to see additional challenges with the introduction of new measures and significant changes to deal making.” – Mark Calvetti