COVID-19 leaves M&A activity exposed to the elements

The coronavirus crisis was a storm front that grew quickly and struck fiercely, leaving global M&A activity exposed to the elements in ways that were almost impossible to prepare for

Globally, deal making fell to its lowest levels in more than a decade in the second quarter of 2020, with just US$485bn worth of deals – down from US$1tr a year earlier. The stark difference between business before and after COVID-19 is laid bare in the most recent Baker Tilly International/Mergermarket reports on M&A opportunities in both Europe and North America. 

Investor confidence across both regions has been left shaken after a turbulent period like no other.

Across North America, 87% of dealmakers reported COVID-19 is having a negative impact on their investment decisions. Half are shelving plans for any cross-border M&A until the pandemic abates, and deal totals in the first half of 2020 sank to some of the lowest in recent memory. Additionally, social protests and upheaval, lockdowns, trade wars and a looming presidential election have all contributed towards the decline in M&A deals. 

Elsewhere in Europe, confidence had already been dampened at the start of the year by generally poor economic growth and ongoing political and economic uncertainly around Brexit. COVID-19 all but crushed any remaining confidence. Mirroring sentiments in North America, some 83% of respondents in Europe believe Covid-19 will have a negative impact on cross-border M&A through 2020, and possibly beyond.

But while the trend across both regions shows that megadeals were shelved or abandoned, the mid-market is seen as a source for potential recovery across both regions.  

While only 7% of respondents were bullish about the North American market overall for M&A compared to other markets, 18% believed mid-cap deals in the region offered better opportunity than in other zones – a number matched by European dealmakers, where 18% say there are better mid-market opportunities in Europe compared to other regions globally. While still relatively small, these sentiments are significantly larger than the 2% who say the same for the overall M&A opportunities in Europe.

As with past recoveries, mid-market deals will be the first to emerge from the downturn, and PE investors are positioned to take advantage of today’s favourable valuations.

Mid-market companies offer several advantages. Acquiring these firms can create easier entry points to markets as there are fewer regulatory hurdles compared to mega deals. They also offer more reliability than small cap firms with untested business processes and uncertain financial stability. In recent years, the European mid-market has accounted for more than 70% of deals, reaching as high as 75% in 2019. Deal making in this segment could pick up in the year ahead as mid-market companies undergo financing and revenue strains as consumer demand dries up amid the pandemic. The result could see distressed M&A at depressed valuations or consolidations within industries.

In the US, 48% say the level of private equity activity will increase over the next 12 months. 78% say finding a buyer willing to pay the desired valuations will be the top exit challenge for private equity firms.

Across both continents, eyes are firmly fixed on the private equity space. Poor results in recent months have left private capital exposed to downturns, particularly those invested in sectors worst hit by the global lockdown, such as hospitality, travel and retail. Private equity funds have huge amounts of cash that they have to deploy. During the first weeks of COVID-19, private equities were focusing on operations and estimating the cash impact of the crisis, but they will now be looking at the impact over their investment horizon. They will have to look for ways to make up for the losses they are suffering this year. So, they have to be looking to bolder acquisitions to get their returns on the capital investments.

In contrast, across Asia, the original epicentre of the COVID-19 pandemic, Baker Tilly experts are seeing increased movement in some sectors and activity commencing earlier than expected as countries exit lockdowns.

One sector emerging strongly in the region is technology, backed, in part, by the immediate investment needed in digital infrastructure for companies across industries, as well as the ongoing demand likely to be generated due to changes in the way people live, work and shop. In-demand sectors look to include 5G technology, innovation and the implementation of AI as businesses reposition and digital companies grow their market share.

And technology sits comfortably as one of the most attractive sectors for M&A globally in the months ahead.

In Europe, procuring new technology is tipped to be the strongest motivator for investment, with 88% putting tech and IP as the top deal driver this year. The forced digital transformation of businesses has highlighted the need for better tech investment, and European tech firms are well placed to benefit. Likewise, the digital sector came into its own as the COVID-19 pandemic spread through North America, helping companies not only continue trading but keeping people connected during the crisis. 

But amid any optimism is the threat of future slowdowns if the virus cannot be brought to heel, a threat that is very real in many countries as they are hit by a second wave of the virus, and face reinforced lockdown restrictions. The situation is precarious and leaves many questions unanswered from clients around M&A opportunities as well as those seeking advice on how to accurately value a company and navigating the challenges of completing cross-border deals. 

Read the full Baker Tilly International/Mergermarket reports on M&A opportunities in both Europe and North America.