Navigating merger & acquisition activity during Covid-19
At the start of the year, M&A experts predicted 2020 to surpass 2019 in terms of deal activity. However, since the outbreak of the coronavirus things have changed dramatically, with the unpredictability of the magnitude and uncertainty of its potential impact significantly impacting the deal environment. Experts at BDO outline how to navigate the change.
The global business environment is currently witnessing an unprecedented challenge. Although lockdowns and restricted social activity are essential to deal with the current pandemic, this will result in enormous disruption in supply chains, cash flow issues and funding gaps, dip in consumer spending and encounters in unchartered and unimaginable territories for most businesses and communities.
It is difficult to predict the consequences of a global pandemic and long-term lockdowns, that are impacting every aspect of daily life. With such uncertainty and unpredictability, post crisis the focus of business owners and managers is likely to be managing the core business and its recovery, as a result any inorganic M&A activity may take a backseat.
However, the Covid-19 shock may propel global M&A activity, as businesses will seek to raise more capital and find opportunities created by adversity to make acquisitions of assets or businesses at a more reasonable / distress valuation and also consolidate with players in the supply chain as well as erstwhile competitors, as a mutually beneficial strategy to survive, sustain and grow.
Opportunities may also arise in the stressed assets / insolvency domain, that banks and lending institutions will look for salvaging such assets post the crisis period. This might be an incredible period for corporates with strong balance sheets and cash reserves to get deals at reasonable or even bargain valuations.
Thus, this is the time for proactive planning, strengthening deal capabilities for special situations and engaging with advisors who facilitate closure of transactions. M&A deals would need to be approached with a different lens altogether since most conventional approaches may no longer be relevant.
Successful M&A will emerge as a critical tool for survival, growth and long-term shareholder value-creation in the post Covid-19 period. In such times, success in M&A will be measured with an ability to create opportunities, assess risks and factor these risks in the deals appropriately, without limiting the transaction approach merely by applying existing practices and yardsticks of doing deals.
Due diligence
Increased depth of exercise to assess risks and outcomes relating to Covid-19.
Challenges
- Lack of access
- Travel restrictions
- Remote working arrangements
- Sensitive data on employee health
Focus on
- Cash burn rates and business continuity assessment
- Impact on revenue
- Costs associated with supply chain alternatives
- Obligations under material contracts, including exercising force majeure
- Special adjustments to working capital due to slower pace of collections, etc.
- Counterparty risks
- Assessment of pre-Covid EBITDA vs Covid period EBITDA and expected time taken to go back to pre Covid EBITDA
- Insurance coverage
- Emergency preparedness and management succession plan
- Employee welfare liability
- Cyber safety assessment
Recommendations
- Adjust expectations related to access to information and timetables for diligence completion and revisit any past work based on new facts
- Extensive use of virtual data rooms and video conferencing
- Significant senior level time from diligence team
- Management interviews to assess business continuity robustness and challenges encountered and surmounted during the crisis period
Valuation
Sensitivities to business model assumptions to arrive at a viable price.
Challenges
- Uncertainty in forecasts
- Lack of benchmarks to support projections
- Market multiples severely distorted
Focus on
- Liquidity assessment of business
- Revenue impact during and post crisis period
- One-time/special costs/debt-like obligations to return to normalcy
- Factor deal structure aspects on the business
- Sensitivity analysis under different scenarios
- Choice of comparable companies and data
Recommendations
- Avoid locked-box and fixed pricing; offer deferred or staggered consideration
- Agree for post-closing purchase price adjustment mechanics to adjust consideration to reality
Structure
Flexibility to adjust consideration and simplicity in post deal integration.
Challenges
- Limited deal financing
- Unquantified risks and exposures due to Covid-19
Focus on
- Tax and regulatory considerations of transaction structure on all parties
- Legacy issues and potential penalties/claims related to Covid-19
Recommendations
- Consider cashless/share-swaps where feasible
- Build in escrow or holdback arrangements
- Factor tax waivers/benefits/concessions that may be available
Documentation
Contractual protections and risk mitigations needed to address Covid-19.
Challenges
- Material Adverse Change (MAC) clause
- Drop-dead dates
- Reps and warranties (R&W)
- Sellers authority between signing and closing
Focus on
- Consider full authority to get an ability to terminate upon MAC
- Factor realistic time to obtain governmental/regulatory approvals and other change of control approvals or third-party consents
- Interim operating agreements with powers balanced for action to be taken as a result or in anticipation of the consequences of Covid-19
Recommendations
- Careful wording of MAC clause
- Flexible extension in drop-dead dates to factor contingencies
- Greater emphasis on comprehensive interim operating agreements with specific information rights and reserved matters till closing
- Agree on situation specific R&W against general R&W and specific indemnities
- Accept only specific disclosures in disclosure letters, against generic ones
An article by BDO experts Samir Sheth (Partner & Head Deal Advisory Services), Rajesh Thakkar (Partner & Leader Transaction Tax), Lata More (Partner & Leader Valuations) and Suraj Malik (Partner Transaction Tax).
