During economic downturns valuations drop and dealmakers rightly expect a shift from a sellers' to a buyers' market. It is uncertain whether this will prove to be true for the COVID-19 recession. Among other factors, it will depend on the extent of promising acquisition opportunities as well as on the availability of stimulus money (both from government and other financing resources).
While PE funds show a great appetite for investment opportunities and are likely to spend vast amounts of money (see interview), strategic buyers have other objectives and must act more diligently in preparing their shopping tours. While authoring roadmap21, we queried in-house M&A strategists on how they will navigate present acquisition challenges and how they perceive the European M&A market for the years to come. Here are our key takeaways:
Strategic buyers will revaluate their acquisition roadmaps underlying their overarching growth strategy and update their target lists essentially around the question of whether to invest in organic growth (i.e. new business models, technology and products) or whether the same could be achieved through expansion deals (but only if those transactions effectively expand their business scope and get them to the goal faster). Corporates that follow a systematic and deliberate corporate strategy clearly know how M&A could enhance their core business and thus have an advantage over their peers.
Corporates are expected to pursue markets that proved resilient during the pandemic rather than explore opportunities that are cheap for a reason. This is also why M&A strategists forecast less market consolidation given that transactions that add similar products or customers or other "more of the same" deals will most likely not fit their post-pandemic roadmap. Two weak companies combined do not create a great company. Purchasers of weak or distressed assets will therefore have less competition from corporates.
As promising opportunities will increasingly be available at short notice or will be offered in a competitive bidding process, corporates will be required to act faster than they are used to. Therefore, it is all the more important to have the full landscape of potential targets at hand prior to assessing companies that might not be suitable for the company's strategy. Corporates should thus be willing to accelerate internal processes and provide more resources for both deal preparation and its execution.
Corporates will preferably go after deals requiring selective integration only. This approach has been frequently followed by US purchasers who — accepting incompatibilities from the outset — have not always been eager to integrate the businesses they have bought. Instead they chose to partner up with their acquisitions (e.g. Microsoft's acquisition of LinkedIn in 2016). This permits each organisation to focus on what it does best and yet enables buyers to realise value enhancements at the target. It remains to be seen if purchasers will really recognise the autonomous status of the target and are willing to let it operate independently with existing management being kept in the driver's seat. If this approach prevails, corporates will expend less effort on developing complex integration plans, provided they are clear on how to create value from the acquired targets without fully integrating new assets.
Starting from low 2020 deal volumes (decline by 26.7 % compared to 2019 as per 3Q20 Global M&A Mergermarket Report), executives anticipate a boost in the number of transactions. Likewise, the variety of deals is expected to increase. Instead of pursuing controlling interest deals only, strategic buyers will be more inclined to acquire minority stakes, enter into partnerships or set up joint venture structures (with contractual rights to increase the shareholdings in the future). Earn-outs or deferred payment mechanisms will help to overlook potential weaknesses when acquiring expensive assets such as digital assets, AI or similar growth technologies.
As strategic buyers recognise things in assets that the sellers cannot see for themselves, the increased deal variety could also lead to a higher number of asset deals instead of share deals. This forces sellers to undergo a cleansing process and carve out single assets or business units for divestment purposes. Acquiring warehouses, factories or other assets is incidentally also what political leaders are longing for, namely to bring back production sites closer to their key markets and reduce supply chains. Most notably, digital assets will likely be of value in light of higher cybersecurity needs and machine learning technologies (raising legal questions of how to properly transfer algorithms).
Deal making will require more creative elements such as defining formulas that disregard short-term revenue downfalls and make decision-makers comfortable with the target company's economic state based on its cash streams in a normal environment. In the short to medium term intangibles such as digital assets might drive valuation more than financials.
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