Assessing the Role of Acquisitions in a Recession
U.S. economic activity declined sharply in March, and with new cases of COVID-19 still accelerating and the vast majority of the U.S. population under shelter-at-home directives, the true impact of the crisis will be felt in the second quarter, when U.S. GDP is projected to decline by more than 30%. More uncertain will be the timing and trajectory of a rebound, where forecast accuracy may prove to be as elusive as predicting the curve of the virus itself.
Business leaders have weathered downturns before, and are implementing traditional measures to conserve cash and, if needed, draw on revolvers. However, the impact from COVID-19 has occurred with a suddenness not previously witnessed, and with added concerns over the stability of supply chains and the well-being of employees.
And while producers in some sectors, such as disinfecting and hygiene products, have seen a surge in orders, far more businesses have seen demand collapse, or in the case of those in and around “non-essential” retail, hospitality and entertainment sectors, have been forced to suspend operations altogether.
Against such a backdrop, it’s not surprising that merger and acquisition activity has also largely ground to a halt. Announced deals declined 50% in the first quarter, with activity in the last week of March being the quietest week since April 2009. Moreover, early stage deals and those scheduled to launch in the near term have largely been paused, owing to challenges in projecting near-term business performance, an uncertain lending environment, as well as practical complications in conducting diligence, management presentations, and site visits while shelter-in-place directives are in place.
Nonetheless, acquisition opportunities will arise – initially in the form of distressed businesses as well as assets being sold to address liquidity concerns. Subsequently, we may also see an increase in the sale of non-strategic assets by public firms to simplify their operations. And eventually, with the recovery, may come a backlog of deal activity.
To many closely-held business owners, CEO’s and their boards, the thought of investing in the acquisition of another firm during a steep and sudden recession may feel fraught with risk. Other pressing actions, focused on riding out the storm, are understandably a more urgent priority. But there is good reason for those with a strong balance sheet to be open minded, if not proactive, towards acquisitions in a downturn.
Multiple studies, including those conducted by Bain, BCG and PWC, have concluded that firms who acquire during weaker economic periods generate superior returns. The reasons assuredly run deeper than simply a lower entry price. Industry consolidation, driven by liquidity needs, is likely to occur. Opportunistic discussions involving quality assets, not otherwise available in a more prosperous economy, will take place. Over the course of this crisis, business models will evolve (e.g. acceleration of e-commerce and store pick- up delivery systems) at an accelerated rate and to a potentially lasting effect. A well-prepared firm will be best positioned to emerge from the crisis in a competitively stronger position.
At this early stage of the cycle, it is most critical to have in place an updated strategy, with scenario planning, that considers the pandemic’s impact on the industry and the firm, together with a realistic assessment of how and where an acquisition could facilitate the ability to leverage an existing strength, build a needed capability, or expand into a desired channel or market sector. Such an exercise should ultimately result in a prioritized funnel of target prospects, with a strategic rationale as to potential benefits, that enables proactive outreach as well as a rapid response to inbound conversations. For those most deeply impacted by the crisis, the benefits are the same, though the range of outcomes will be unique – spanning from how to address excess capacity, solve liquidity needs, the potential for divestitures or even exit considerations.
In today’s environment, owners of the privately-held firms may also find a levelling of the playing field for assets of interest. A strong balance sheet can be a competitive advantage, and potential competitors may elect to deprioritize M&A while they address their own liquidity issues. Increased uncertainty in developing proforma business projections will advantage those with a deep knowledge of their target market, both in identifying potential synergies and in assessing risk during diligence. Private equity firms still have an enormous amount cash to invest, and (despite a near-term focus on the health of their existing portfolio companies) will certainly be bargain shopping in the months ahead. However, they will find that deals across the quality spectrum will require greater equity contributions (and likely higher-priced debt), which will further bring discipline to pricing. And for the family business desiring an exit, sale to a like-minded owner could be an important consideration for the continuity of his business and its’ employees.
Challenges will certainty persist for all firms in managing through the COVID-19-induced recession, though the effects of the pandemic will be uneven from company-to-company, even within sectors. At this point, the time is ripe to focus inward and ensure the firm has a vision for taking advantage of an eventual rebound. For the opportunistic owner willing to invest in acquisitions, thoughtful preparation now may be the first step in achieving that vision.