By the middle of March, concerns about the impact of the coronavirus on the global economy have plunged the Dow Jones Industrial Average 9,000 points from the previous month. U.S. cities are instructing citizens to shelter in place, and the White House is working with Congress to craft an emergency stimulus package, the likes of which have never been seen before. Against this backdrop, Mergers & Acquisitions asked six dealmakers to share their perspectives on how the coronavirus virus is affecting the middle market. Representing a range of viewpoints, including private equity, turnaround services and M&A law, they hail from Alvarez & Marsal, Merrill Corp., M33 Growth, M-III Partners, Paul Hastings, and the Riverside Co.
The coronavirus is a game changer, with significant ramifications for every aspect of the global economy. Our publication is committed to bringing you content that highlights key trends, issues and people in the industry, and we are publishing a wide range of content on the impact of the virus on M&A and private equity. We hope all our readers stay well in this challenging time, and we hope to hear from you with your experiences and insights. Here are the six interviews with middle-market dealmakers, arranged in alphabetical order by the source's last name.
Q&A WITH COLIN ADAMS
Managing Director, M-III Partners
How are deal terms being affected?
We’re deeply involved in middle market M&A, with sponsor, corporate and lender clients who are active in the space, so we come at this with a holistic view. We are seeing some deals fall apart, but not for the reasons you’d think. Sponsors are not experiencing negative financial issues. In fact, it’s the exact opposite -- they are already seeing so much opportunity in the market to come that they are rethinking existing terms and deals. Transactions underwritten at “solid” 15 percent return on invested capital several weeks ago now appear unattractive by comparison to the 25+ percent IRR’s that are likely available now and in the near future.
What are you seeing in the credit markets?
There’s no doubt there are seismic shifts taking place in the credit markets right now. Non-bank lenders, which stepped in to lend after the financial crisis of 2008, may be among the hardest hit by the current crisis, and after years of inexpensive money and loose terms, the private credit market may need to pause to work through existing portfolio and liquidity issues. This may be the opportunity for traditional commercial banks, which have healthy balance sheets and capital ratios, to step back into the middle market, but it will be different this time around: Traditional lenders insist on covenants that show credit maintenance and improvement. We are helping clients manage through this period of acute change, assisting with the strategy and tactics to best position portfolio companies to secure potentially lifeline financing.
What is your outlook?
Sponsors may need to get ready for a new normal. If a sponsor has a portfolio company that has a refinancing coming in the next six to 18 months, and that company has middling but not stellar performance, that refi has just become more difficult to get; and for the sponsor to reach its exit, they’re probably going to have to rethink their strategy. “Rinse and repeat” and do the next deal just got a lot more challenging. We’re going to spend a lot more time thinking through these issues with clients.
Q&A WITH PAUL AVERSANO
Managing Director, Global Practice Leader, Alvarez & Marsal Global Transaction Advisory Group
What are you seeing in U.S. M&A activity?
Currently, in the U.S. we are seeing a mixed level of activity, which appears to largely mirror the uncertainty in the public equity markets. Some new transactions, both buy-side and sell-side, are still coming in but at the same time certain existing transactions are being put on hold. The transactions currently at risk appear to be the larger transactions, while some transactions in the middle market are still moving forward, particularly those in the software and technology sector. Sell-side processes scheduled to launch are being put on hold, but we are still being asked to do work to get the businesses ready to go to market when things hopefully calm down. However this likely can, and will, change in the short term. Obviously certain industries, such as travel and leisure, transportation and energy/oil and gas have been significantly impacted.
What is your outlook for the U.S. M&A market?
I am bearish on the U.S. M&A market in the short term. I would expect significant disruption given market events until we have seen the number of coronavirus cases peak and we get on the backside of the pandemic, meaning the number of new cases announced each day decreases. Once that happens, I am bullish on M&A activity in both the medium and long term once the market adjusts to the “new normal." There is a tremendous amount of dry powder that needs to be deployed, record high valuations will likely decrease, we will continue to have a very favorable low interest rate environment and access to financing (both from commercial lenders and alternative financing sources (i.e. – private credit/debt funds) and certain underlying dynamics which have been driving M&A to this point (i.e. – digital transformation and technological disruption) will continue. Over the last few years there has also been a significant increase in the amount of capital raised for both distressed and special situation funds, and we have seen proactive outreach from these investors at Alvarez & Marsal. Market chaos breeds opportunity. The recent reduction of interest rates to near zero will help fuel deal activity, especially on larger, highly-leveraged transactions, once the impact from the coronavirus begins to wane.
How has the environment affected private equity portfolio companies?
Those businesses with Asian supply chains have been materially disrupted. While we haven’t seen a significant impact yet on the demand side, private equity firms are telling their portfolio companies to brace for impact. Most companies are proactively drawing down on revolving lines of credit and other sources of financing to put as much cash on the balance sheet to weather the storm. At this point nobody knows what the full impact will be of the coronavirus, nor how long it will last, so we see our clients at Alvarez & Marsal taking all necessary defensive measures. We have also recently had several private equity firms call us on a proactive basis to work with them across their entire portfolio in order to get ahead of any potential issues. At A&M we are advising our clients to focus on gaining visibility into short-term cash management and liquidity, in addition to proactively manage net working capital, discretionary spending and short term profitability improvement.
How is “distance dealmaking” being affected?
To date I think it’s a bit too early to tell. From a due diligence perspective, many processes have already been streamlined and are being done electronically – such as virtual data rooms – but now all of that technology is going to be put to the test like never before. I think many PE firms were already using technology to help identify deals, with techniques such as “web scraping” of online data becoming more prevalent. However, as far as closing deals remotely, that is another story. There has been, and likely always will be, an element of dealmaking that requires face-to-face contact – there is no substitute for spending time with people. Additionally, in order to conduct due diligence, one must be able to go on site and visit manufacturing facilities, distribution centers, etc. – it simply must happen. So in my opinion technology will only take you so far – but in the current environment we’re going to now see how far that is.
Q&A WITH BRIAN BUNKER
Managing Director, Commercial Growth, The Riverside Co.
What are the implications of the coronavirus, from an operations perspective?
The virus hit over Chinese New Year, when factories are closed and the high number of migrant workers have returned to their home town/village. The holiday was extended, so factories were closed longer. In addition, were closed, so, even if factories had safety stocks that could be shipped, goods were not be able to be moved to ports. Fortunately, large orders are shipped prior to the holiday to cover 2-3 weeks of factory closure. However, eventually, there will be inventory shortages at overseas and domestic customers, stock-outs will, inevitably, impact 1H revenue at portfolio companies. It is still too early to scope the full impact; however, portfolio companies are implementing action plans, assessing stock levels, communicating with customers and trying to shift sourcing to other countries. Fortunately, due to the tariff dispute, this process began 18 months ago, so, in general, dependence on China has been somewhat reduced during that time. In general, extended closure of factories impacts sales as well as Ebitda; staff still have to be paid and the facility/equipment maintained.
As of mid-March, according to a China General Chamber of Commerce survey of China’s top 500 manufacturing companies, 97.08 percent of factories have re-opened, and 66.17 percent of employees have returned to work. All of Riverside’s operating company suppliers and manufacturing sites in China have resumed operations and are working through order backlogs. Most malls and department stores have re-opened, and customer traffic is slowly returning. The spread of the virus to Europe and North America is now impacting supply chain and consumer demand in those areas. Travel restrictions are severely limiting the ability to conduct due diligence visits and negotiations.
Q&A WITH BRIAN SHORTSLEEVE
Co-Founder and Managing Director, M33 Growth
What impact have you seen the coronavirus have on growth capital?
Times of uncertainty in the economic environment and the capital markets demonstrate how critical it is for growth-stage businesses to focus on driving towards unit economics that work. This means operating profitably—or at least at break-even—rather than being dependent on the whims of the capital markets to fund operations. Profitability gives founders the flexibility to navigate uncertain times, double-down on key customers and focus on investing in the future.
Additionally, in times of economic uncertainty, businesses look to move faster, speed decision-making, focus on the most important work and reduce operating expenses. Because of this, there is increasing interest in the solutions that allow businesses to achieve those goals. At M33 Growth we invest in B2B software platforms—like Titan Cloud Software, W Energy, Assuricare, Reebee and Mize—that allow businesses to do just that, driving productivity in the enterprise by using cloud software to automate complex vertical-specific business processes.
Why are smaller, already distributed companies seeing less disruption in the current climate?
By definition, cloud-based ERP software platforms enable employees to remotely access critical financial and operating data, and to continue to drive forward key workflows (examples: timely closing monthly financials, continuously monitoring underground storage tanks to remain environmentally compliant, facilitating the timely payment of homecare workers). The customers who use this type of software are often working remotely, and the teams who develop and maintain this software can work remotely, so there is minimal disruption.
What role can vertical-specific B2B technology play in ensuring minimal business disruption during the COVID-19 outbreak and beyond?
Vertical-specific software platforms are on the cutting-edge of a megatrend driving productivity and automation in enterprise and will continue to grow rapidly as software solutions continue to penetrate business processes in both large and small companies, regardless of uncertainty in the markets. These platforms enable internal business processes to be run remotely in the cloud and the more key applications and workflows businesses put into the cloud, the more able these businesses will be to minimize business disruption at times like this.
Q&A WITH NEIL TORPEY
Partner, Corporate Department, Paul Hastings
What is the impact of the coronavirus on middle-market deals and private equity-backed portfolio companies?
There was a pause in activity when travel restrictions and social distancing regulations were announced and certain transportation industry players curtailed their China-related activities, but in the past weeks, the markets in Hong Kong and China have slowly begun to get back into shape as it has started to appear more likely that the issues relating to the coronavirus outbreak, while very serious, will be manageable and there is optimism that (as with SARS) the situation will stabilize over the coming weeks as Spring and warmer weather approaches. Assuming that the situation continues to stabilize in Asia, and that the spread of the virus in North America and Europe is contained and the situation in those countries can be normalized over the next several months, I think it’s reasonable to predict that the long-term negative impact on the markets and deal activity as a result of this outbreak are not likely to be material.
Does the inability to travel to and from China make it difficult to close deals already underway?
It definitely can, particularly if the investor is doing due diligence involving travel to China (e.g., to visit physical facilities or meet with management teams) or needs to conduct face-to-face discussions with a portfolio company or its customers or suppliers in China—even taking into account that, in those cases, lots can be done by phone or video conferencing. Once a deal is really ready to be closed, most of the execution can be done by phone, email and wire, so in those cases travel restrictions may tend not to cause problems in doing a closing that cannot be worked around.
Does the possibility of China being cut off for a long period affect dealmakers’ confidence in investing in companies there?
So far, such a cut-off seems to be a low-probability issue. It is in everyone’s interest to have China back to ordinary course operations, and we would expect enormous efforts and resources to be applied to achieving this result.
What about other risks?
There are more risks and problems associated with the spread of COVID-19 than can be counted. Governments and enterprises are responding to the economic, financial, political, public health and other dimensions of the situation as best they can using a wide variety of the tools at their disposal—with varying degrees of success, but in ways that make one hopeful that a good outcome can be achieved. Different countries and companies will continue to prioritize the issues presented by the crisis in different ways and allocate resources to detection and prevention and amelioration in accordance with their respective individual circumstances.
How are issues related to the virus affecting potential investments?
As far as I can ascertain so far, the situation is not leading investors to make material changes in their medium- or long-term investment programs or strategies—but it may be too soon to come to meaningful conclusions about the lasting impacts of this crisis.
Q&A WITH RUSTY WILEY
CEO, Merrill Corp.
How will the continued manufacturing slowdowns and stock market volatility affect long-term M&A activity?
In the wake of turmoil in the global financial system, the outlook for M&A is far from clear. The outbreak is affecting all facets of life – from travel to events to government mandated lock downs. All of this may cause delays in closings deals or completing the due diligence process, which typically takes between three to six months to complete.
How is the virus affecting M&A in China and other countries?
We are seeing a steady number of new projects being created on our platform. In fact, our numbers across all regions are up over last year for both January + 8 percent, and February + 4 percent. So far, in March, they are up 20 percent compared with the same period a year ago.
This may be happening for a variety of reasons, including the result of demand being driven forward. Companies could be trying to get a deal done sooner, or at least started, before the full impact of coronavirus is felt. Additionally, as more companies face economic disruption, we may, unfortunately, see more distressed companies needing help.
What are the potential roadblocks the M&A industry may face, following containment of the virus?
As a software as a service application, virtual data rooms provide secure digital transfer of information to conduct due diligence at anytime from anywhere. This becomes all the more crucial in reducing delays in due diligence activities and communications so transactions can continue to take place despite disruptions.
How is “distance dealmaking” being affected?
In dealmaking, speed is key. The longer the process runs, the higher the risk that the deal goes cold and potentially unravels. So, dealmakers want tools that help them manage the M&A process effectively and efficiently. At times like these, the ability to do that regardless of your location, including working from home, for example, is crucial. Our Datasite platform allows customers to do just that.
Virtual data rooms may contain many thousands of documents that need to be evaluated by interested parties on the buy side. We’re taking advantage of machine learning and natural language processing to cut out the time consuming and low value tasks that are associated with managing the due diligence process, often saving weeks. We’re using AI to help deal makers rapidly redact a document or an entire dataroom, easily filtering access to highly confidential content. This is critical, as redaction is used in at least 75 percent of deals.
Another feature of our application, Q&A, allows dealmakers to effectively and easily collaborate to avoid lost questions and forgotten answers to ensure they are targeting the right buyer, thereby ensuring they secure the best deal efficiently.
Additionally, we recently introduced a new application to optimize the early stage asset marketing processes for dealmakers, including buyer outreach, workflow tracking and eporting, document management and customizing email content. The application offers real-time information on a project anytime, anywhere, serving as a single source of truth for an organization’s asset marketing projects, which greatly enhances management activities.
Genuine economic deterioration is a primary risk to private capital markets, according to PitchBook. – PE tends to behave as a GDP-linked business. As consumer spending and business investment is set to decline, we expect to see a slowdown in PE transaction volume that follows the expected economic contraction. Tighter credit markets will force adjusted transaction capital structures; create private debt and special situations opportunities – With tighter lending, PE firms will be forced to enter transactions with more conservative capital structures that include a larger equity proportion. But, PE is well positioned to adapt with over $2.4 trillion in dry powder. Read the full story: Private equity deals will slow down, as global economy stalls amid coronavirus pandemic.
For the past two months, the coronavirus, also known as Covid-19, has been front page news across the world, as the situation escalates with new cases and an increased number of fatalities. While the long-term economic impact on American companies remains uncertain, there are important lessons to learn on how to manage future pandemic risks. Read the full story: Coronavirus contingency planning checklist for the middle market.
The coronavirus threat is the type of risk that material adverse change, or MAC, clauses are designed to address in M&A. The MAC clauses are used to qualify representations, warranties and covenants in an acquisition agreement, establish a threshold for determining the scope of disclosure or compliance relating to risks associated with the target’s business, and to delineate the circumstances in which a bidder is permitted to a transaction without liability. Read our full Q&A with Nixon Peabody's Dick Langan: Why the coronavirus makes material adverse change (MAC) clauses more important than ever.