Ben Thompson
Distressed assets, private borrowing options and purchasing structures that require less borrowing will drive M&A activity this year.
Whether you think recession is around the corner, that we’re already there, that it’s media fearmongering, or you’re just waiting to see what happens, your acquisition strategy must be evaluated, and possibly modified, depending on the economy’s strength or weakness and your business’s insulation or vulnerability.
Where Do You Think We Are?
Clearly, one dominating factor is the strength or weakness of the economy, and that may depend on whom you believe and what definition of recession you prefer. In recessive economies where interest rates rise, borrowing typically slows and deal volume slows with it. But are we, in fact, already in or headed for a recession? Forbes wrote in November that if the definition of recession you accept is two consecutive quarters of negative GDP, then we have been in a recession since this past summer. According to a different definition, Forbes cites from the National Bureau of Economic Research, a recession is “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.” If you accept this definition, then we were not yet in a recession this past summer.
Many believe that the Federal Reserve’s efforts to curb rampant inflation with repetitive interest rate hikes may catalyze a recession. There’s no clear answer in the economic reporting: consumer confidence has been low, but jobs reports have been generally good (although this may be showing contrary signs). Industrial production has been in decline, but retail sales have been improving. It’s possible that if enough pundits declare the worst is upon us or that the light at the end of the tunnel is rather the proverbial freight train headed right for us, we could drive ourselves into a self-fulfilling prophecy.
Living with Uncertainty
If the market indicators don’t give you comfortable answers one way or another, there are of course other considerations that should be given attention. You still have decisions to make regarding the growth of your own business. Since the nuances of market turbulence and economic tension carry many exceptions, your acquisition strategy – if you still hope to pursue one – must include a 360-degree analysis of where the company stands.
What are Your Economic Particulars?
Every industry has its own peculiarities. Do you or an acquisition target fall within or outside of a general trend? Healthcare, information technology and consumer staples often have greater immunity to recession effects. However, many of the most stable industries have been profoundly affected by supply chain challenges in recent years.
Tourism, hospitality and real estate tend to be another story. There are plenty of confusing market indicators. And if we are in a recession or headed for one, it will have its peculiarities. The current strength of the labor market – unusual in recessionary times – may be the result of corporate financial strength, and if you are one of the cash-rich companies out there, and taking an optimistic, long-term view of things, you may well see opportunities that fit your overall growth strategy. Here are four things to consider:
- Be willing to think outside of your typical or preferred deal size. It is likely that near-term deals will trend smaller, and some fitting assets will lie in companies that may ordinarily be out of your zone of review.
- Don’t shy away from bankruptcy proceedings (which is good practice in any market). We will see more petitions this year and next, potentially ripe grounds for undervalued assets.
- Transaction costs should also be more competitive. Many deals will be able to absorb liability exposure, and professional services providers will be responsive to the market.
- Be patient. Absent a no-brainer target, purchase capital may be best retained for later in the year or early next year when the strains of market retraction have fully set in.
Approaching Distressed Companies
Is there a difference in how to approach a potential target in recessionary versus normal times? Some may argue so, but it depends on your standard approach protocol. It is incorrect to think that there aren’t any competitors circling distressed but attractive targets. Some of those may present deal structures that leave stakeholders in an equity position, which may be more enticing to founders and investors wary of taking what they know are low-market offers. But there is a rather obvious inclination to be more aggressive and swifter, both in reviewing candidates and negotiating with them. Distressed assets, private borrowing options, and purchasing structures that require less borrowing may also drive M&A activity this year.
A Historical Perspective
Although not always instructive, history is always informative. Have there been economic downturns similar to what we’re experiencing now, and if so, what can we learn?
Following the recession of 2001, M&A activity in certain sectors took off. Financial services and entertainment, among others, led the way, and while deal volume was moderate, an infusion of private equity into the market helped raise the deal value to an all-time high. Most of us recall where we were in 2008-09: the worst recession since the Great Depression. The M&A picture that followed continued to see more PE capital, as well as more cash deals in tech, online services, and some retail. As before, the deal volume was not impressive, but deal values reached another all-time high as corporate cash, PE investments, and competition grew the size of deals. The message is that rather than sinking, the ship finds a way of righting itself – although it may have a very different appearance. If your analysis of your own market position and growth strategy are truly objective, you have a greater chance of seeing clearly past current turbulence.
The Opportunities Ahead
Things may slow down, but certain opportunities, if played well, afford tremendous benefits down the road. Some smaller cap deals can often be quicker, with considerably less transaction costs. Dealmakers should spend time calculating their plan for and approach to the coming quarters. There will most certainly be less activity, but what activity there is can be especially affordable and particularly valuable.
