Insights

Moving Forward in M&A After COVID-19
POSTED 6.9.20 M&A

Many people are concerned about the state of M&A when we get on the other side of the COVID-19 pandemic. Understandable. But as I pointed out in my previous article, “No Significant Drop in M&A Activity During This Recession,” I don’t believe M&A activity will be going south, post-crisis due to:

  • A shift to a Buyer-friendly market
  • Dropping prices of target companies due to declining valuations
  • The amount of dry powder for PE firms is still there, waiting to be deployed
  • Financing costs that continue to be low

Now, a new report from Deloitte has shed some new light on the situation and reconfirmed my insights.

In “Opportunities for Private Equity Post-COVID-19” they discuss how in these uncertain times and ongoing economic crisis, the organizations ideally positioned to help out the economy and business, and even countries get back on their feet, are PE firms.

Why?

They have plenty of cash, and they are willing to go the Island of Misfit Toys, so to speak, and find gems to invest in. They have the patience to get in at a low cost and turn a company around.

PE firms are unlike other investors in that right now, they have the capital, resources, and occupational experience to turn struggling companies into high flyers. That’s simply what PE firms do in good times… and have a unique advantage in these bad times to keep working their magic.

A lot has been said in the poplar press about how PE firms swoop in on broken down companies then turn around and sell them for 10 times more. The perception is that they pulled a fast one or took advantage.

I think this misconception goes back to the movie Pretty Woman and other depictions in pop culture. In that movie, Richard Gere plays an investment banker who buys companies and sells them off in parts after loading them with debt… in the process ruining peoples’ lives.

What PE Brings to the Table

Contrary to popular opinion, that’s NOT what PE’s do. They’re closer to house-flippers. They’re turnaround specialists. They do the good work of creating value where there was none before.

In this crisis, I believe PE firms will be the heroes and instrumental to a broader economic turnaround. They do good work, and it’s needed now more than ever. And nobody else is going to do it, with Strategic Buyers biding their time and holding on to their cash.

Companies struggling right now, and there are a lot of them, should not expect a government bailout. Most companies, even if they secure some of those funds, will not get what they need to move forward.

Another issue is that employees are getting laid off and collecting more in unemployment and other benefits… and that employers are concerned they won’t be able to get their experienced people back.

These are certainly uncertain times, and I think the attitude you should have moving forward is one espoused by Warren Buffett:

“Be fearful when others are greedy and greedy when others are fearful.”

We can also base this assumption of the rise in M&A activity tied to PE firms by looking to the past, specifically to the economic crisis of 2007 and 2008.

Back then, PE firms, along with other investors, sat on the sidelines. There were many opportunities that were not taken advantage of.

They’ve learned their lesson, and this time they will be aggressive in going after the low hanging fruit. PE firms are generally well ahead of public opinion on these sorts of things. The smart money gets in early, which, in this case, gives them a nice window in the next two years to get some great deals.
Lower middle market companies, those most at risk and vulnerable in this downturn, in particular will see lots of activity. These smaller businesses are easiest to make a quick investment in, without many other suitors.

The Role of M&A Insurance

For investors buying distressed assets, Representations and Warranty (R&W) insurance becomes more important than ever. This coverage makes deals clear, smoother, and more affordable.

For Sellers, not having the burden of a large escrow is a key benefit when they need cash to do other things.

For Buyers, R&W insurance is a “back stop” for risk. If they are buying assets, they won’t get a remedy otherwise if there is an issue post-closing and the escrow is not enough to cover the loss. With R&W coverage you get certainty of collection if there is a breach.

The great news is that R&W policies are now at the most favorable pricing they’ve ever been, and deal sizes as low as $15 million are eligible.

If you’d like to discuss coverage, pricing, or market conditions, please contact me, Patrick Stroth, at pstroth@rubiconins.com.