As we look back on an eventful 2020, there are several key themes and trends that have reshaped the M&A market and how transactions will be conducted going forward. Although the recent surge in coronavirus cases, economic headwinds and divisive US political landscape still loom large, there is good reason to believe that North American transaction volumes will continue the upward trend we have seen during the second half of this year.
In the early days of the pandemic, the sudden and widespread effect of stay-at-home orders, business restrictions and disruption to our daily routines caused investors to hold their collective breath. Not surprisingly, M&A activity came to a screeching halt. Case in point, transaction activity in April was 80% lower than in December 2019.1 Private equity firms, which have been a major driver of M&A activity, postponed most new investments. Instead, they focused on shoring up the cash reserves of their portfolio companies and stemming losses caused by the pandemic.
But by the start of summer, the stock market, the debt financing market and M&A activity had already started to regain their footing. Of central importance to investors, it became apparent that many companies across industries were navigating the crisis and even thriving.
The investment community was quick to embrace new methods for getting deals done remotely. Video conferences and virtual site tours helped move transactions through to completion. As one example, Goldman Sachs has remarkably completed 95% of its deals this year without any face-to-face meetings, instead relying on commercial-grade drones to conduct site visits and flyovers for asset-based businesses.2
Just as disruption brought on by the pandemic led companies to re-evaluate their work from home policies and crisis protocols, it also forced them to focus on acquisitions as a means to supplant under-performing business lines and create stronger businesses, better-equipped to deal with how commerce has evolved in response to COVID and how it will be conducted going forward.
Several mega deals have led the M&A resurgence, a clear signal that corporate leaders remain confident in their businesses’ resilience and optimistic about long term economic growth. In response to booming demand for telemedicine and device-based remote health monitoring, Teladoc bought Livongo for $19 billion. The oil and gas industry, flailing from sharply lower demand for its products, has seen consolidation, albeit as a means of reducing costs. Chevron bought Noble Energy to become one of the country’s biggest shale drillers and build its footprint in the Permian Basin and the eastern Mediterranean Sea, an emerging energy hot spot, and in October, ConocoPhillips announced that it was acquiring Concho Resources. Among several transformative technology deals, AMD’s all-stock $35 billion purchase of Xilinx will now challenge Intel’s dominance in high performance computing and data center processors. And in the largest deal of 2020 to date, S&P Global recently announced its intention to acquire IHS Markit for $44 billion. If approved by regulators, this will create a data and technology powerhouse in the intensely competitive market for financial information services.
While large deals grab the headlines, deal-making in the second half of 2020 has been largely driven by smaller transactions. According to Bloomberg, although overall M&A volume is down 25% year-over-year through the first three quarters of 2020, middle market activity (deals less than $500 million) has been less impacted –down just 14%.
Our view is that part of the explanation is that smaller deals are less likely to be abandoned or significantly delayed amid economic uncertainty. Due diligence and regulatory hurdles also tend to be more manageable on a middle market deal, which lessens the likelihood that it gets scuttled at the eleventh hour.
Another interesting market observation is that add-on deals, which are often smaller and less risky than platform acquisitions, comprised 73% of private equity buyouts in Q3 2020, the highest number on record according to Pitchbook. The trend may suggest that private equity sponsors priced out of the larger deals, are seeking greater value among smaller businesses that may have been overlooked by other buyers.
M&A deal volume has not only returned to pre-COVID levels, but valuations also remain elevated.
How did the market recover so quickly despite lingering concerns about the virus and the underlying health of the economy? Well, after months of inactivity, there is pent up demand for quality investment opportunities. While physical distancing still poses a challenge across many sectors – airlines, restaurants, theaters, and live events, to name a few – there is no shortage of acquisition interest for businesses that are performing well amid the crisis. In fact, buyers are showing a willingness to pay a premium for companies that have proven “pandemic-proof”, a signal that their risk aversion outweighs the desire for higher returns. Sellers are further encouraged by the fact that large corporations and private equity funds still hold trillions in cash and can further stretch their wallets due to broad access to low cost debt. In addition, similar to investors in the equity market, buyers are looking past the financial results of 2020 and even 2021 in evaluating targets.
In our numerous discussions with business owners over last few months, the most common question we are hearing is: how has COVID changed BCMS’s business and what are the implications for our clients?
At BCMS, we are fortunate that not too much has changed.
We have plenty of experience working remotely and across time zones, leveraging distributed teams and utilizing collaboration tools.
While our bankers prefer face-to-face presentations with prospective buyers, these days the majority of first meetings are virtual. The upside is that arranging these meetings is faster and more efficient as there is greater flexibility in work hours and nobody needs to travel.
In person meetings do still occur, but they tend to be later in the transaction process, either prior to a more formal offer or in due diligence.
Our experience has been comparable to the broader market in that, other than a few very quiet months, deal activity has remained buoyant, with a range of strategic rationales motivating buyers.
In a few of our recent completions involving companies that were largely unaffected by COVID, revenue synergies and cultural fit played an important role in attracting the right buyer.
At the height of the pandemic, BCMS completed the sale of Boomerang Laboratories Inc., a contract manufacturer of liquid-fill personal care and light-duty household cleaning products, to Guy & O’Neill Inc., a portfolio company of Centre Partners Management LLC. This transaction highlighted the importance of cultural alignment between the buyer and seller, bringing together two companies with traditional Midwestern values and a shared vision to expand into new and complementary markets and product categories.
In another example, we sold a privately-held purveyor of fresh meats to a private equity-backed producer of prepared foods wherein the primary value drivers were our client’s original recipes, high quality products and longstanding customer relationships.
In August, we sold Kablooe Design Inc., an award-winning provider of medical device and consumer product design and engineering services, to Forward Industries Inc. (NASDAQ:FORD), which created strong cross- fertilization opportunities with their software, UX/UI and industrial design subsidiary. In another successful transaction, BCMS represented Optimed Infusion LLC, a medical infusion clinic providing intravenous and subcutaneous therapies for chronic conditions, in its sale to Horizon Infusions LLC, a portfolio company of BroadOak Capital Partners. The organizational fit with BroadOak/Horizon was an important consideration for the owners of Optimed which helped facilitate a timely and efficient completion of the transaction.
As we have seen in past recovery periods, middle market companies performing well will remain attractive to corporate buyers and private equity funds. In particular, we expect private equity to play a greater role post- COVID across the middle market as the supply and demand imbalance, sizeable pools of dry powder and increased debt availability create ideal conditions for deal-making.
If you are seeking an investment or to sell your business, we advise that you get your house in order today.
Talk to your investment banker about what work needs to be done in advance of formally marketing your company. These days it often includes determining historical and projected COVID-related explanations and quantitative adjustments and developing pro forma financial statements that include base-case and best- case scenarios which reflect the timing and magnitude of a sustained economic recovery.
Furthermore, given the logistical challenges of face-to-face meetings and impersonal nature of videoconferencing, there is greater importance in the quality of the offering documents that you share with prospective buyers and investors.
Your banker should be well-versed in crafting a thoughtful, comprehensive and factual story about your company – one that should answer questions about your business, not raise them.
What Lies Ahead
The rebound in M&A activity in the second half of the year is certainly a positive sign. In spite of a resurgent pandemic and potential gridlock in Congress, there is still good reason to have confidence in the economic outlook heading into 2021. Persistently low interest rates, ample market liquidity, renewed calls for federal stimulus and infrastructure spending, more certainty in economic regulations, and expectations that vaccines will soon be available to the public, provide an optimistic backdrop for continued private equity and corporate deal-making. As we observed when the economy started to reopen months ago, M&A as a component of companies’ growth and defensive strategies continues largely unabated. Investors and corporates with well- timed acquisition and divestiture strategies could secure growth for many years to come.
1 The 2020 M&A Report: Alternative Deals Gain Traction”. Boston Consulting Group. September 2020.
2 Goldman Sachs Bankers Are Using Flying Drones to Help Clinch Billion-Dollar M&A Deals”. CNBC. November 25, 2020.