11 June 2020
Many of us are well used to the cycles of economic boom and recession. However, the coronavirus pandemic represents largely uncharted territory. Significant uncertainty in the context of M&A deal making, economic or otherwise, gives buyers the bargaining advantage over sellers and it will very likely be no different this time.
Of course, trade and private equity buyers have their own business and operational challenges. Some buyers will therefore determine that some or all of the cash that they would otherwise have used for M&A should be put to alternative uses, for example financing operating costs and replacing revenue lost as a result of the crisis.
However, many remain 'cash-rich' and cash will always be king in deal-making. These buyers can afford to bide their time to find the right deals.
Increased bargaining power for buyers generally does not mean that they will now be more likely to prevail in negotiating each individual deal term. Sellers will robustly pursue deal terms that protect them from closing uncertainty, on the basis that buyers enter deals with their 'eyes open' about the pandemic and its consequences.
Fundamentally, value is created through cash flow, growth and managing risk. No company or sector is fully insulated from the pandemic’s impact, but some sectors are clearly faring better than others. Industries that have been hit hard by the pandemic include retail, travel, leisure & hospitality, and transportation production. Industries that have been less adversely affected, or even thrived, include videoconferencing and other online technologies, biotech, food delivery, and online shopping. The impact on the valuations of companies in each group is not difficult to infer.
What will not change in M&A moving forward is a buyer’s focus on the quality of the target’s management team. The extent to which management has been able to manage risk, and to protect its business from the effects of the pandemic, through prompt mobilisation of its staff to home working or developing new products, will significantly inform a buyer’s view on management and in turn business value.
Private companies in most sectors are usually valued as a multiple of Earnings before Interest Tax Depreciation and Amortisation (EBITDA).
Where EBITDA has taken a hit as a direct result of coronavirus, sellers will be keen to present profitability to buyers before the coronavirus impact and so the ghastly acronym EBITDAC has crept into the M&A lexicon. The extent to which buyers will place reliance on EBITDAC, however robustly presented, remains to be seen. It may well be that forecast rather than historic earnings become the focus, with deal structures shifting accordingly to include a greater proportion of earn-out.
The outlook for many sellers may not currently appear rosy. However, just as in normal times, there is great merit in preparing properly for a sale process, in an orderly and timely manner. This will ultimately deliver the best result possible in the prevailing circumstances.
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