The Road Not Traveled

Well, here we are …

Over and over again, we kept being asked when the record shattering merger and acquisition (M&A) marketplace would take a turn. When would we reach the top of the peak of the market (mountain)? We kept waiting and watching for signs of a slowdown. What could possibly derail this runaway train?

And then BAM! Just like that, unparalleled disruption like nothing we have ever seen before. There was no canary in the coal mine on this one. No cautionary signs, just massive disruption that came on fast with little-to-no warning. And suddenly, after more than a decade of living in high cotton with a prolonged period of economic growth, low interest rates and seemingly unlimited access to capital, it all came to a screeching halt. At least for the moment.

Through April, the brokerage community has announced 163 domestic transactions. This is down 31% compared to 2019 but only 10% when compared to both 2018 and 2017. The activity in the industry during the first quarter was positioning the industry to eclipse 700 deals in 2020 and set another new record mark, far exceeding the record-breaking total of 651 announced transactions in 2019. However, a paltry 22 announced deals in April has slowed down the party.

The deal count only tells half of the story, however. Many transactions slated for April were delayed because buyers had their attention diverted while trying to figure out how to move 90% or more of their workforce to a completely remote environment. Additionally, it was not normal practice for a buyer to complete diligence on the remote capabilities of a seller. Many buyers were concerned about how to close a deal on 4/1, announce it remotely, not meet their new colleagues in person and figure out how to onboard and integrate them in a completely remote environment. Some buyers chose to push forward with their deals; others put their entire backlog of April transactions on hold.

As May has now arrived, we do expect several of the transactions originally earmarked for April to close this month. Buyers, for the most part, are honoring the terms of their term sheets or letters of intent for those who were already under these non-binding agreements. However, most buyers are performing additional financial diligence to determine the anticipated impact that COVID-19 will have on their future business. Deals are typically priced based on the trailing earnings for a seller – the profitability a firm produced over the last 12 months of operations. Buyers are now trying to ascertain what will happen in the next 12 months to be sure the assets they are buying aren’t poised to drop by 20%.

Murky Future

In situations where the future is still a little too murky, some buyers are implementing a structural change to their deals in which they are holding back a portion of the originally guaranteed purchase price. The buyers are asking the seller to share in the risk that their EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), at a minimum, stays flat. The buyers get some downside risk mitigation and, in most cases, the buyers are offering a seller a carrot so that if their business grows during the initial measurement period, they will be paid even more in purchase price.

Ultimately, the seller is being asked to share in the downside risk but has significant upside opportunity, a seemingly fair trade-off given the circumstances surrounding a global pandemic.

What Is Next?

Activity has picked up in May, and we expect the M&A market to continue, although perhaps at a slightly less breakneck pace. Buyers still have capital, and there has not been, to this point, any buyer who has taken themselves out of the market.

Consider that in 2009, the last time there was an economic downturn, there were two buyers who completed 10 or more transactions. And in 2019, there were 14 buyers who completed 10 or more deals. The demand is greater today than at any other point in our industry’s history. This is good news for those who are still considering selling.

The market is a little more complicated today than it was three months ago. There is less certainty in the future growth and profitability of potential sellers, and this will create an opportunity for creative deal structuring.

Additionally, with a looming Presidential election in November, whispers of concern that higher capital gains taxes could be around the corner are building.

Bottom Line

Some firms probably sat on the sidelines a bit too long, but valuations continue to be aggressive. Are they different than before? Possibly, but not definitely. The demand in today’s market should help stave off any major dip in valuations.

The great news is that there is still very strong interest in building relationships – even virtually. Our clients are having initial meetings with buyers remotely, and we are negotiating term sheets between parties who have only met via video conference.

Many sellers are pressing forward with their search for a new “partner” and recognize if they don’t find what they are looking for, they are not required to do a deal.

It is nearly impossible to time the market. Don’t allow your indecision to create more regret in the future.

Investment banking services offered through MarshBerry Capital, Inc., Member FINRA and SIPC, and an affiliate of Marsh, Berry & Co., Inc. 28601 Chagrin Blvd., Suite 400, Woodmere, Ohio 44122 (440.354.3230)

Disclosure: All deal count metrics are inclusive of completed deals with U.S. targets only. Scorecard year-to-date totals may change from month to month should an acquirer notify MarshBerry or the public of a prior acquisition. 2020 statistics are preliminary and may change in future publications. Please feel free to send any announcements to M&A@MarshBerry.com. Source: S&P Global Market Intelligence, Insurance Journal, and other publicly available sources.