Insights

COVID-19 Is Not a Black Swan – and Here’s Why
POSTED 6.23.20 M&A

You’ve no doubt heard of the best-selling book from author Nassim Nicholas Taleb, The Black Swan: The Impact of the Highly Improbable.

In it, Taleb denotes “black swan” events as those that are unexpected or unpredictable. Examples include the 9/11 terrorist attacks, World War I, the rise of the internet, and the fall of the Soviet Union.

However, despite the worldwide, devastating impact on society, economies, entire industries, healthcare infrastructure, and more, the COVID-19 pandemic is not a black swan.

Taleb himself says so, noting that many experts, including Bill Gates, who has closely studied and funded epidemic research, have long said a global pandemic like this happening was a matter of when, not if. Taleb says this is actually a “white swan.”

This is not a black swan, despite the tumultuous times we’ve had in the face of this crisis, including economic downturns, widespread unemployment, travel bans, and more. We won’t go into the details here as to how this might have been prevented or who holds the blame, if anyone.

We’re concerned with the results and what happens moving forward.

As far as COVID-19, as countries see decreasing cases and are exiting government-mandated lockdowns, we can now see we are at the beginning of the end.

Economic activity is set to return, as people go back to work and those businesses that survived, large and small, start up again.

As I wrote previously, expect M&A activity to resume, but in a different form due to impacts of this crisis. We’ll see:

  • A shift to a Buyer-friendly market
  • Dropping prices of target companies due to declining valuations

This strong M&A market is also a result of previously existing conditions, such as:

  • The amount of dry powder to inspire continued deal-making
  • Financing costs that continue to be low

This is a recipe for PE firms to come in and find low-cost but high-quality gems to invest in and turn a profit, in many cases, faster than pre-COVID-19. Private Equity has the capital, resources, and expertise to take on the challenge of many struggling companies out there right now.

This is not to say that the economy will not experience a downturn due to the pandemic. Its impact will be felt in many sectors for a long time, including companies, investors, and consumers.

But there is opportunity. And this is very different than the 2008 Crash, at which time M&A activity slowed considerably for the most part.

As Sander Zagzebski, partner with Greenspoon Marder LLP, put it in a recent article for C-Suite Quarterly:

“Shrewd dealmakers will sense opportunities by purchasing discounted debt and providing debtor-in-possession financing packages. Smaller debtors may seek to take advantage of the new Subchapter V Small Business Debtor Reorganization provisions, which as drafted provide a more streamlined process for debtors with less than $2.725M in debt. As part of the recently passed CARES Act, that limit was increased to $7.5M for the next year.”

Sander likens this opportunity to that which a select few savvy investors took advantage of in the 2008 crisis.

“While capital market and traditional M&A transactions slowed significantly during the financial crisis, distressed investors became presented with numerous attractive options. Howard Marks and Bruce Karsh at Oaktree Capital were later lauded by The New York Times for their timely $6B bet on corporate debt during the height of the financial crisis, as was Leonard Green & Partners for its timely $425M minority investment in Whole Foods.”

“Overshadowed in the media by high-profile, pre-crisis bets on the overheated real estate market by the investors profiled in Michael Lewis’ 2010 book The Big Short and others, these blood-in-the-streets bets at the bottom of the market later proved to be enormously profitable.”

There are similar prospective valuable deals out there now… for those that can recognize them.

As Sander writes:

“Many investors are starting to view the world today as Karsh viewed it in 2008 and are seeking those unique buying opportunities.”

Still, there is plenty of uncertainty surrounding deal-making, as future impacts of the ongoing pandemic are unknown. Watch for Representations and Warranty (R&W) Insurance, which had already been enjoying a renaissance amongst lower middle market deals, to be a strong presence in deals going forward.

To discuss R&W coverage with a broker with hands-on experience with this product, I invite you to contact me, Patrick Stroth, at pstroth@rubiconins.com.