The COVID Crisis and Sub-Scale M&A
Finding exits for sub-scale companies is more about finding visibility through the fog than envisioning opportunity across a big blue ocean. So when the fog set in a couple months ago across the broader economy, and we continued to market acquisition targets, it was second nature for us to start looking for clarity.
What we see is that acquisitions are still happening in specific sectors, though at a slower pace with lower valuations, with more focus on immediate returns.
When we market an asset, we usually do it across multiple acquirer segments, giving us a broad view of M&A interest. Obviously, today’s M&A appetite varies significantly by how COVID has affected the industry sector. Sectors like travel and physical retail are too busy with short-term survival to consider long-term strategic opportunities…at all.
M&A is not categorically dead
Consistent with previous macro crashes (i.e. ‘01, ’08 – see appended chart), we expect deal volume to go down 20-30%, but not to stop. We have found that acquirers in sectors that are only moderately affected by the crisis are eager to engage. Some of this likely has to do with the fact that we deal in sub-scale assets. Smaller assets are a way for acquirers to take advantage of their current leverage without taking on excessive risk.
The default is cautious diligence, but competition ultimately dictates urgency
We have had acquirers express their desire for a slow process given flux in the broader market. Of course, once other interested parties come to the table, any individual acquirer no longer dictates the timeline. When there is competition, an acquirer that wants to take things slowly can either accept the consensus pace or drop out. That is also to say, if you have a single interested party, prepare for a long slog. No one likes to take a leap during a crisis if they have the option to wait.
Acquirers expect bargains
As with timeline, no individual acquirer dictates the price if there is competition. However, if acquirers are universally expecting bargains given the current environment, then sellers should be prepared to sell at a discount. As shown by previous downturns, acquisition value decreases more than deal volume.
Revenue matters more
Companies are in the process of mitigating their risks. Acquisitions are inherently risky, however, acquisitions with a short path to a positive return on investment are less risky. An asset doesn’t necessarily need revenue to be an attractive target, but if it can paint a very clear picture of how it will boost its acquirer’s revenue, it stands a much better chance at a successful outcome in today’s environment.
In short, M&A is still happening, but there is wide variance in the probability of getting to a successful outcome. Where any given asset sits along the probability spectrum depends on damage to its acquirer sectors, and its ability to create near-term revenue. And valuations are down. The fog has arrived, but at least we’re catching some glimpses through it.