14 Apr M&A: A Market in Limbo
Don Bravaldo shares an update on the Mergers and Acquisition Market during the COVID-19 crisis in an article entitled “M&A: A Market in Limbo” which was published in the quarterly Andersen Alumni Newsletter.
M&A: A Market in Limbo
~ Don Bravaldo, Alumnus, Arthur Andersen & Co. (1993-1996) and
President, Bravaldo Capital Advisors, Inc.
The social and financial toll of the coronavirus pandemic reveals itself hour by hour, day by day. Although a precise determination of the impact is still some time off, I feel confident concluding that the lower middle merger and acquisition market is in limbo, defined formally as “an intermediate state or condition.”
As expected, we have started to receive calls from value-oriented equity (PE) and hedge funds trolling for distressed assets in hopes of acquiring damaged companies on the cheap. It never takes long for the sharks to emerge during a crisis. Though tough to watch, it’s really just a natural expression of what capitalism is all about. Sharks play a necessary function in private capital markets, as they do in the natural food chain.
Ear to the Ground
Below is a summary of recent inquiries and market participant conversations reported by Bravaldo Capital Advisors team members.
Business owners. Calls from concerned business owners have ranged from “We just laid off 200 employees, can you help us locate a financing and restructuring attorney?” to, “Sales are up 30% over prior year and continue to climb; what should our strategy look like from here?” There’s no guesswork involved in figuring out which call was from someone in the restaurant industry, and which is from the owner of niche ecommerce business.
Deal attorneys. We’ve heard from several deal attorneys, including one who reported heading into the weekend on Friday, March 13 with an executed deal in hand and final funding scheduled for that Monday, the 16th. Over the weekend, unscheduled crisis calls and emails indicated that the buyers were pulling out of this and other deals. They cited material adverse changes and force majeure provisions in contracts to kill deals. Similar scenarios have played out for many large, lower middle market transactions.
Bankers. Our banking contacts tell us they need to pause on any new debt financing opportunities, as traditional banks are all but sidelined right now. Understandably, they are busy supporting hard-hit borrowers seeking relief. As well they are devoting resources and energy to administering portions of the largest stimulus measure in modern American history, the CARES Act and its Paycheck Protection Program for small business.
PE fund managers. Growth-oriented private equity funds in our circle are in a temporary holding pattern as well. Most are busy completing portfolio risk assessments and attempting to triage badly damaged portfolio investments in hard-hit sectors.
A lucky few deals, mostly in the strategic add-on category, or deals that have been over equitized (low-debt leverage deals) have been able to fund and close amid the crisis.
The Sell Side
As for sell-side processes, many yet-to-start mandates are back on the shelf. Our firm is fortunate to have current seller clients whose businesses have experienced modest positive impact on performance during the pandemic.
We are cautiously pressing ahead with sales processes. We are making plans to perform more deal work remotely, conduct video meetings with buyers, and provide additional company information through virtual data rooms for remote due diligence. Optimistically, we are targeting transaction closing efforts for June 30 and beyond.
The big question in all this regards the status of private company valuations. Have we suddenly sunk from a high-gear sellers’ market with record valuations, to a low-gear buyers’ market with longer-term, depressed private company valuations? The answer is unclear.
Valuation is a function of two components: (1) a calculation of the present value of current and future business cash flows, and (2) an adjustment for the risk of sustaining those future cash flows. Setting aside badly damaged industries like travel, hospitality, entertainment and traditional brick-and-mortar retail, and assuming a return to work in the coming weeks or months, how does one assess risk appropriately in the current environment? Time and experience are essential tools. Public markets typically signal the way forward, but because private capital markets tend to be less liquid, it can take more time to settle out. Patience will be key.
New Kind of Crisis
This crisis is markedly different from the 2008 recession. A key difference is that private equity is awash with capital, with $1.4 trillion in dry powder waiting to invest as of December 2019. As well, banks are better capitalized due to requirements that resulted from the 2010 Dodd-Frank Act. The Federal Reserve seems to be ahead of the curve and is pulling out all the stops to keep debt capital markets liquid. Risk assessments and workouts will not take long, and will not be all-consuming for PE.
Assuming the COVID-19 curve flattens and financial markets stabilize in coming weeks, there will likely be an expected wave of distressed investors in the market, joined by a flood of high-quality PE investment funds. Among industries that may command a premium are those likely to thrive in the post-coronavirus period. Examples include:
- E-commerce retailers.
- Consumer logistics /delivery services.
- Food delivery services.
- IT outsourcing.
- New consumer products.
An excess of demand over supply has been a driver in lower middle market valuation for quite some time. Though a rapid and broad economic turnaround may be unlikely, we anticipate strong demand for acquisitions later this year.
Bravaldo Capital Advisors will always pull for the underdogs and the heroes of capitalism—the owner/founders, family-run and closely held business owners that make up our client base. With luck and a realistic acknowledgment of damage to valuation in certain sectors, we remain confident that the broader U.S. economy can return to strength more quickly than many pundits predict. If so, we have an excellent chance to liberate ourselves from limbo on the way to a renewed seller’s market.
As we do, we will be faced with a number of questions. Who will emerge as the new winners? How long will it take consumers to return to travel and tourism? How might consumer behavior and purchasing decisions be permanently changed going forward? These are just a few of the unknowns for strategic acquirers, PE investors and capital providers.
If I know Andersen alumni, you are reaching out to clients, partners, friends and area business leaders to find out how you can assist in these unprecedented times. Let’s continue to do all we can to help small and midsized private businesses successfully regain their footing as we emerge, together, from this crisis.