In the day-to-day M&A business, we are currently experiencing a shift in the priorities of local corporates towards short-term crisis management and the withdrawal of international bidders. In the short term, there are massive restrictions on freedom of movement, we are experiencing a considerable slump in domestic consumption and exports, and the supply chains for imports are interrupted.
The consequences for the M&A processes are smaller bidder fields, a slowdown of ongoing processes and new processes are postponed until further notice. Current trading is being closely monitored, closing accounts (as opposed to locked box) are gaining the upper hand again in the purchase contracts, company values are being partially renegotiated or at least made more dynamic. The expectation of generally declining company values and of – not structurally induced – distressed sales give PE investors hope for a much more attractive investment climate.
If the situation does not settle quickly, we see rather long-term effects: Pre-strained companies quickly run into economic difficulties, which is associated with a rise in unemployment and rising social spending, especially increased spending on health care. In addition, there will be increased expenditure on short-term rescue measures for the economy and employees. This will lead to an unforeseeable increase in government spending, and thus a rise in government debt. The associated debt service ties up funds that are not available for education, infrastructure, innovation and other future-oriented investments. In the case of companies, there will be rising debt to bridge the loss of revenue, hence leading to a lack of future capital for investment in transformation and innovation, a decline in productivity, ultimately falling company values and rising interest spreads for refinancing.
All this might have severe implications for M&A in the long run: In the context of a sustained recession, equity-based financing will increasingly be needed. The high debt levels of governments and companies will lead to rising capital costs and falling company values, thus significantly reducing returns on the exits of PE investments in the boom years 2017-2019. PE fundraising will become more challenging due to over-allocation of LPs, secondary transactions will gain in importance, and new capital will be harder to raise. Turnaround deals and insolvencies will account for the majority of M&A transactions.
The hope remains that the spread of the corona virus to the particularly vulnerable part of the population (over 60 years of age and with a health history) will be rapidly reduced in a way other than by the current general restriction of freedom of movement and economic dynamism. And that the global race for an effective vaccine will quickly be successful, so that we will only have to prepare ourselves for the short-term M&A implications.