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The shifting M&A landscape amid Covid-19

A look at the trends that are becoming noticeable as business models are restructured, and the principles that could be relevant to decision-making.

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Having one or two banks as trusted financier(s) will enable an M&A financing package to be assembled swiftly and confidentially, so that restructurings can be negotiated and implemented rapidly.

THE Covid-19 pandemic has challenged businesses in every sector across the globe, forcing many companies to rethink their strategies to survive and/or to emerge stronger. The scale of the crisis has impacted the merger and acquisition (M&A) landscape. Certain categories of M&A transactions have become more relevant, while other categories of transactions no longer make much sense.

Mergermarket data indicates that Asia-Pacific M&A activity declined in the first half of 2020, with total deal value falling to its lowest level since 2013.

Deal volumes have been impacted by a pull-back in acquisition spending as buyers became rightfully cautious about the future earnings of prospective targets. Acquirers have erred on the side of caution by holding on to cash buffers, while waiting to tap attractive opportunities that emerge from the "viral storm".

Emerging trends

Several trends are becoming noticeable as business owners restructure and/or pivot business models to enable their companies to survive and emerge stronger.

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Consolidation in sectors impacted by prolonged travel restrictions or working from home

As travel restrictions and working from home are the norm for the foreseeable future until effective vaccines become globally available, sectors such as aviation, cruises, gaming, hospitality and crowd-dependent entertainment will face consolidation to cope with reduced demand.

Extended durations of working and studying from home will affect aggregate demand in industries such as automobile manufacturing and servicing, public transport, discretionary consumer goods, apparel (office wear versus home wear) and education services, as well as SMEs such as dry cleaners and bespoke tailors. Within each of these industries, companies will have to (i) reach consensus on the pace of recovery and the aggregate level of future demand; and (ii) undertake the requisite M&A to rationalise industry capacity. Failure to do so will leave a raft of "zombie companies" dependent on government aid for life support (such support is likely to be temporary), while competing for shrinking demand in a post-Covid world.

Privatisations of healthy companies will continue if market valuations remain low for extended durations

Privatisations will contribute to a proportion of the deal pipeline because founders and controlling shareholders have clarity on the intrinsic value of the companies they manage, and are therefore more likely to take decisive action to buy out their companies when market valuations fall below a certain threshold.

Financing will be an essential pre-condition of deals going forward

Securing financing is a pre-condition for those seeking to undertake M&A activities, in order to provide assurance that a deal can proceed amid these uncertain times. Having one or two banks as trusted financier(s) will enable an M&A financing package to be assembled swiftly and confidentially, so that restructurings can be negotiated and implemented rapidly. Some founders and controlling shareholders may choose to team up with private equity firms which can contribute financing and professional guidance on restructuring.

Governments will monitor and may intervene in M&A deals during Covid-19

Governments around the world will impose controls to guard against opportunistic bids. For instance, in Australia, the Australian Securities and Investments Commission (ASIC) reviews cross-border M&A deals to ensure that foreign buyers are not capitalising on the pandemic to purchase Australian companies in order to undertake mass retrenchments, or for intentions that run contrary to the national interest.

Guiding principles

Coming to terms with change and having the agility to pivot quickly will differentiate the victors and losers in this crisis. Those who successfully optimise their business structures early stand a better chance to survive and thrive. To get there, companies may need to undertake some form of M&A or restructuring. The following principles could be relevant to decision-making.

Act before circumstances force your hand

Companies in industries facing long-term decline in demand need to accept the grim reality and either engineer a consolidation with peers, or cut capacity to reduce fixed costs, release cash from idle assets and preserve operating margins.

Proactive steps enhance the likelihood of survival and give early movers a more extensive choice of partners to consolidate with. The aim is not to be the last company left without a partner or a solution.

Know when to be a buyer; know when to be a seller

When industry landscapes are littered with weakened companies, it may be tempting for stronger companies to seize the opportunity to acquire weaker peers.

Caution is necessary to avoid "catching a falling knife"; for example, a careful acquirer should (i) observe whether the target's business has further to fall, and (ii) commit to a purchase only when there is clarity on the target's value. To protect the acquirer from over-paying in a "falling knife" situation, the purchase consideration can be paid in instalments that are contingent on positive outcomes in the target.

Conversely, a business owner should welcome the opportunity to divest assets or businesses if a good offer is received. Have an honest appreciation of how the asset can perform under existing ownership, and compare this against the price that is being offered by a bidder.

Engage with your trusted financial adviser sooner rather than later

Financial advisers who possess the requisite industry knowledge and M&A skillsets can offer distinct advantages if you seek their advice early.

Competent financial advisers have oversight of multiple clients in the same industry and can offer valuable insights to help you evaluate choices and eliminate false starts. In addition, advisers can shortlist suitable merger partners and serve as discreet intermediaries when initiating talks with those partners.

Approach negotiations with a practical mindset

Business owners will naturally prefer to use pre-Covid metrics to value their businesses. That is fine if there is consensus that your industry will recover strongly in the near term. However, there are industries which are facing prolonged disruption and irrevocable shifts in demand patterns, in which case, past financial performance is no longer an accurate indicator of future cash flows.

Adopting a practical and realistic mindset when evaluating M&A valuations will contribute towards meaningful negotiations and sensible consolidations.

Survival trumps sentiment

Founders tend to have a deep connection with the companies they have built. But times have changed, and we now operate in a very different environment.

Even when a vaccine becomes globally available, consumption patterns and work practices would have permanently changed. Rather than cling to sentiment at the risk of business failure, founders will need to set aside their personal sentiments and evaluate what is best for the company, and be open to consolidation if it is in the best interest of the business, staff and customers.

  • The writer is head of Strategic Advisory, DBS Bank.

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