Deal or No Deal: What factors are driving a fractured return for M&A?
New Cavendish Corporate Finance Partner Karri Vuori talked to CNBC’s Squawk Box Europe about the turbulence in the deal-making market and the shifting trends that have occurred during the first three quarters of a pandemic ravaged year.
An ‘epic disaster for M&A’ was how CNBC headlined the interview, and that it was: Q2 was awful…. but only Q2. With a solid Q1 reflecting deals already started in 2019 it was no surprise that this was a strong period and nor was the steep drop off in deals in Q2 as much of the world went into varying degrees of lockdown and uncertainty. However, what caught everyone by surprise was the huge rebound in Q3 as the market learnt that deals could still be done.
So, if on the face of it Q2 was all about repairing balance sheets internally, the groundwork for a massive revival in deal-making in Q3 was already in the making in dealmakers’ spare rooms, bedrooms and over various video conferencing platforms. But, like the wider economy, the nature of the M&A recovery has been varied depending on region, industry and the nature of the business.
Some key points:
Megadeals are to thank for Q3’s emboldened outlook for M&A as mid cap deals struggle
Given it was coming off one of the most inactive quarters in recent history, it is surprising that based on deal value, Q3 was actually busier than the much more stable Q3 of 2019.
To emphasise just how quiet Q2 was, and just how quickly a bounce back occurred, deal value in the US was up 425% from one quarter to the next, and up 55% in the more subdued EMEA regions.
An explainer for those impressive stats comes in the form of the rise of the megadeal, which disguises the fact that mid-cap deals remain weak and are actually having their worst year, in terms of deal volume, since 2009.
The uneven return of M&A deal flow is also characterised by region and industry
It’s important also to note that not all regions are enjoying such an elastic bounce back in deal-flow. Europe continues to struggle and had its worst year, in terms of deal volume, since 2010. Delving deeper into regional separation, we see, surprisingly, that buyers seem to have collectively said ‘what Brexit?’ as a staggering 60% of European deal value took place in the UK. This of course hints at an extremely quiet time for M&A elsewhere in Europe.
The disproportionately strong UK showing is partially driven by a concentration of megadeals such as ARM/Nvidia and Willis Towers Watson/Aon in the UK but also the prevalence of a large private equity industry where many firms had raised new and bigger funds prior to the pandemic that needed to be put to work. Across the mid-market we also see hints of a mini-renaissance of founder-owned business sales ahead of the UK capital gains tax review.
From an industry point of view, the megadeals are mostly being led by the tech industry, which, contrary to many others, is recording record profits and has been the key driver of the recent stock market rally.
It’s here, again, that we need to look behind the headline figures to show how and why deals are occurring;
- In a show of just how big tech has become over the course of the pandemic – the industry represented almost a quarter of total deal volume in the US
- And whilst tech companies can be making deals flush with cash and record high stock valuations; M&A in other industries is being motivated by different reasons. In some cases, forced consolidation as companies seek to reduce costs, and in others – especially in the consumer industry – distressed M&A
Valuations are changing with the situation
There is a silver lining for sellers with robust business models though; the drop in deal volume has given rise to greater demand for high quality deals, as they are now scarcer. This means that in such cases, deal values are rising.
Yes, we’ve seen the tech industry lead some extremely high valuations, but interestingly some of the better placed consumer M&A’s are attracting values with average multiples across the sector rising from c.9.5x EBITDA pre-pandemic to c.15x. Granted, this is also partly driven by decreasing earnings across the sector thus lowering the denominator in the equation.
That said, where the two industries differ is in the current situations they occupy. Tech is showing record profits, meanwhile bricks and mortar retail and leisure propositions are still suffering with weak demand as a result of lockdown.
In more modestly affected sectors, investors appear increasingly willing to look past 2020 toward a ‘Covid-adjusted’ EBITDA metric or straight through to 2021 earnings in more predictable sectors, compensating for the fact that poor lockdown performance is not indicative of a company’s overall performance and potential going forward.
Whilst we remain in a buyer’s market, sellers of high quality businesses have seldom had it so good
We’ve been encouraged by the fact that the market very quickly learnt that deals can still happen, even during lockdown. So have the buyers:
- Private Equity is in a markedly different position now than it was in Q2 where PE firms were focused on balancing, refinancing and helping existing portfolio companies. What was remarkable was how quickly they returned, armed with $1.5 trillion in dry powder and cheap loan facilities from the banks who are still lending and who were exceptionally flexible compared to the last recession in relaxing covenants and supporting companies
- The unprecedented Q3 saw private equity’s contribution to buyouts and exits as one of the biggest on record; in the US it has made up around 20% of the total deal making market, that figure rising to 28% in Europe. What we see as particularly encouraging is that private equity firms weren’t just buying in Q3, they also exited over $230bn of assets (second only to Q3 2017 in the last five years), as they only tend to sell into healthy markets
- Given the sheer size of PE dry powder, ongoing generously flexible bank covenants and ample opportunity created by COVID disruption, we don’t see this trend abating anytime soon
- Corporate buyers have also shored up balance sheets through a period of record equity raising in Q2 and access to state stimulus aid, so despite record corporate debt levels, corporate acquirers are considerably better placed now than earlier in the year
It’s not just about those with capital to spend though. For sellers of businesses that are in rude health and with robust business models, there has seldom been a better time to sell given the amount of capital competing for the best deals.